By Ken Krivacic, OD
June 19, 2019
Almost a year ago I wrote a piece in this publication on my feelings about selling a practice to a private-equity-backed buyer. I was against it at the time for me. My feelings have not changed much since then, but I have taken my exploration further by listening to several private equity firms give their pitch for selling a practice to them.
My partners and I have even hired an outside consultant to evaluate our practice and “shop” it to several private equity firms.
I would like to share with you what I have learned in the process, and offer guidelines for determining the best PE-backed companies to sell to. We have not received our finished evaluation yet so I cannot comment on what a firm would pay us, but there are guidelines that most use.
No Two PE-Backed Buyers Are the Same
The biggest takeaway has been that none of these private equity buyers are the same. Yes, they all want to buy your practice, and they all have large firms backing them, so money does not seem to be a big issue. However, all these companies pay differently for your practice.
Some may make you a great offer on the sale of your practice, but then pay you a pedestrian rate to stay on and work. Others may pay less upfront, but then pay better for your service after the sale.
The Selling Doctor is Perceived as Valuable to Acquisition
A trait common to most private-equity-backed buyers is that they want the practice owners, who are seeing patients on a regular basis, to remain in the practice for at least two years or longer after the sale. Why wouldn’t they just buy your practice, let you go and replace you with a lesser-paid optometrist?
Sure, they could use this tactic, but the practices they are interested in are usually successful – generating at least $1 million a year per doctor, and the reason they are successful is usually the doctor. It would not make sense to buy a practice and then get rid of one of the biggest revenue generators of the practice. So, if you do decide to have a private equity firm buy your practice, be prepared to stay and continue to see patients for at least two years.
How Do PE-Backed Buyers Decide How Much to Offer You?
Almost all private-equity-backed companies use EBITA to gauge what your practice is worth. EBITDA, or earnings before interest, taxes, depreciation and amortization, is a measure of a company’s overall financial performance and is used as an alternative to simple earnings or net income in some circumstances.
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The earnings, tax and interest figures are found on the income statement, while the depreciation and amortization figures are normally found in the notes to operating profit or on the cash flow statement.(1)
So why EBITA? Why not just use the net profit of your practice? Dave Roos, a financial journalist, says: “According to generally accepted accounting principles (GAAP), the standard way of calculating net income (revenue minus expenses) is the only way. But in the 1980s, a new breed of companies specializing in leveraged buyouts (an especially risky type of hostile takeover) began popularizing the use of EBITDA as a more accurate measure of long-term profitability. The argument is that EBITDA — by ignoring expenses like interest, taxes, depreciation and amortization — strips away all of the costs that aren’t directly related to the core operations of a company. What is left, say the supporters of EBITDA, is a purer measure of a company’s ability to make money.
“The truth is that EBITDA, if used to make “apple-to-apple” comparisons of two traditional businesses (like manufacturing or retail), can be very helpful. EBITDA reduces the financial noise down to a single number that represents ongoing income from a company’s core business operations.”(2)
I know, it makes my head spin, too, but that is the method they are using to value your practice. Once your EBITA is established, a multiplier is applied to give you a purchase value.
For example, let’s assume you have a $1 million dollar practice and your EBITA is 20 percent of income and private equity is paying six times EBITA – what is the value of your practice is those terms?
EBITA: $200,000 ($1,000,000 x .20)
Buy Out Price: $1,200,000
These numbers can vary depending on how attractive your office is to a potential buyer. EBITA percentages can range from 16-24 percent, and multiples can range from 5 to 10x, and in rare cases, even higher.
What Happens After the Sale?
After the purchase price, the next thing you need to weigh is what happens after the sale. Like I mentioned earlier, most buyers want you to stay on as an employed doctor from anywhere from two to five years. Salaries can be a flat rate, for example $125,000 per year, or they can be a percentage of the revenue you generate. Those percentages can range from 12-17 percent. Keep in mind that you are now an employee, so how you pay yourself is no longer up to you.
Which PE-Backed Buyer Will Run Your Practice the Way You Like?
Beyond the buyout and your payment structure, you also need to decide which PE company will run your practice like you would want it to be run. Some companies are more retail-oriented and will run your practice as such. Others are medically oriented and will slant in that direction in the running of the practice. More than likely you will be with the PE company as an employee for a few years, and should lean toward one that has a similar philosophy in how it runs the practice.
PE-Backed Sales Are Not for Everyone
For all the talk we hear about it, private equity is still a small portion of optometric offices in the U.S. Will it take over optometry? We can look toward dentistry for that answer. Private equity has been a player in dentistry since the mid-90’s and still has fewer than 20 percent of all practices.
So, who is the best candidate for a private equity buy-out? The list would include:
- Doctors looking to retire within the next five years
- Doctors who don’t enjoy the management side of running an optometric practice
- Doctors who only want to practice clinical optometry and leave the business to a management group
Finally, do your homework. Selling to private equity is a big decision and would lead to a radically different way of practicing optometry. Make sure it’s a decision you make for both financial, and philosophical, reasons.
Are you considering selling to a private-equity-backed buyer? What will be the key factors of your decision?
(1) Investopedia.com – Adam Hayes 5/18/19
(2) How Stuff Works.com – What is EBITA? – Dave Roos 4/4/11