Why consider a merger or acquisition?
As a practicing chiropractor or health care practitioner, administrator, or owner of a business or professional practice, you are facing ever-changing challenges in today’s industry environment. One of the changes is the trend toward consolidation through acquisitions and mergers. This trend started about ten years ago and gained momentum in the late 80’s and early 90’s. The following is a discussion of the industry today regarding mergers and acquisitions, and presents some of the pros and cons from the perspective of an owner/manager of a business considering such a move.
During the past several years, the rehabilitation industry has witnessed a dramatic increase in the formation of large health care corporations. There is controversy regarding the benefits and drawbacks of these corporations versus being in an independent private practice. The advent of managed care and payor’s increasing control over health care dollars is setting new trends that affect the decision to remain in private practice or merge with another entity or public corporation. I believe the move toward greater consolidation is inevitable. It is becoming more difficult to succeed in private practice unless you have a lock on your market share that includes the payors and deals with the overall impact of managed care in your service area. Today, it is not “business as usual.” Sometimes it can even be a question of surviving, or preserving what one already has rather than expanding.
If you decide to follow the acquisition or merger road to achieve your business goals and dreams, be aware the road can be long and bumpy. The process of buying or selling any business can be costly, not just in terms of money, but also in time, effort, perseverance, and knowledge of finance. It is important for the practice owner to make sure the future partner or owner is right for them. On the part of the buyer, “due diligence” is required, which includes audits, appraisals and legal work. The process of getting to closing can be overwhelming, especially if you are already busy running a successful practice. The series of evaluations, validations, and negotiations can be complicated, time consuming, and expensive, but is necessary considering that people’s lives and livelihood’s, as well as large sums of money, are at stake. Furthermore, evaluation techniques, financing methods, tax laws, and funding sources such as investment banking, limited partnerships, and equity issues, have changed and emerged over the years, encouraging creative variations in the structuring of a deal.
Pros and cons of a merger
Now let’s look at the advantages and disadvantages of a merger with a corporation (Please refer to Item One). In the area of control, the corporation does take a central role, as opposed to direct control.
There are standardized business procedures, including budgeting, management meetings, and various kinds of reporting that will be required. The corporation maintains control over expenses and revenues. Regarding the quality of care, some believe this can decrease after a corporate buyout. For the most part, I don’t believe that this is the case because the merger does not usually greatly affect the front line clinician, the laws and ethical standards regarding the practice of chiropractic are usually strictly followed, and no matter where or for whom a chiropractor practices, he or she should uphold high standards in all settings (although, in a corporate environment. the ability to enforce quality standards may be greater than in private practices, where individual practitioners meet their own quality and ethical standards).
What I have sometimes seen is a temporary shift in morale, sometimes up and sometimes down, depending on the situation. Because changes have occurred in management, people are sometimes fearful of the change, or fearful for their positions, until they see that everything is all right. Things usually settle down within 60 to 90 days. Also, if postmerger integration is done properly, there should be no major problems.
In the area of contracts, corporations, or large institutions have the edge. Because of the regional or national density of their clinics, they are able to attract payors as customers and usually have more contracting experience. Most corporations offer a single point of contact for the payors. They can also help with the negotiation of contracts. In the private practice sector, networks have been developing to help better compete with the larger market share of the corporations. Marketing strength and marketing ability are two other areas in which corporations usually have the edge.
The strong infrastructure provided by many corporations offers experienced staff and support that assists in such areas as recruiting, so critical in our profession today. Corporations can also provide assistance in developing effective marketing plans, doing market research, and providing full-time marketing personnel if you don’t already have such a staff. Management usually conducts training programs to understand managed care and provides assistance with quality and expense control. The corporate infrastructure can be very helpful, making available the services of accountants, lawyers, management experts, or other services if they are needed.
The corporation may have greater resources in the outcome systems utilization. Many times, the business operation is enhanced by various management reporting systems. Members of the private sector must pool resources or be members of various networks to have access to the same information, unless they use one of the new companies that provides such service.
In the area of financial growth, the private practitioner can be dependent on his/ her individual ability to grow the business. It can become essential to open new locations in one’s community to retain or gain market density to be able to provide services to payors or various managed care entities in the community. With a corporate owner or partner, the corporation, rather than the individual person or practice, provides the capital and becomes the risk taker.
Other considerations regarding a corporation are the new career paths that may develop or become available. Also, even though you are on salary, there are probably perks (possibly stock options and incentive bonuses) available, as well as security from the challenging external forces at work in the industry today. Hopefully, the company will have a decentralized management philosophy and allow you to make most of the decisions while using them for support and growth opportunities, although this is not always the case.
What is your business worth?
How do you determine what your practice is worth? Let’s look at valuations. You have invested time, money, effort, and education, into your business. You wouldn’t hesitate to have your home appraised or look up the blue-book price of your automobile, so why not take a wealth check on your practice? The most obvious reason for having a valuation performed is if you are planning on selling, but there are also other benefits to consider. For instance, the valuation helps you gain access to the value of your invested time. It lets you know if your investment is earning a satisfactory return, as well as allowing you to spot potential problems. It may even help you obtain needed financing for growth, if that’s your goal. It is typically harder to nail down an exact valuation on service companies than other business entitles.
In short, the worth of a business is determined by adding up three kinds of assets; then subtracting what you owe. First is current cash and inventory; second is usually furniture and buildings; vehicles and equipment; and third is intangibles, like your reputation, good will, trade name, customer lists and so on. In valuing a professional practice the most difficult part is intangibles, namely, the quality of referral sources and the quality of the payor sources.
Unfortunately, arriving at an exact figure for intangible assets, which are the backbone of service companies, can be very tricky. This is in contrast to a manufacturer, who can easily calculate what he/she owns by totaling inventory and assets and subtracting the liabilities.
Understanding and determining value has changed as the realities of competition, profitability, and reform have influenced the business of health care. Remember, a valuation is only an educated determination and may not be what an interested buyer is willing to pay for your business.
Selling price can be determined by other factors, such as the strength of your practice, the strategic fit with the buyer’s business, the current state of the economy, desirability, and market density needs of the buyer.
Many appraisers will use the income approach when valuing a professional practice. This approach is based on the premise that the maximum amount that an informed buyer will pay for an asset is no more than the amount of the net present value of that asset’s projected future income. The objective of ownership is to obtain a return on investment, and to keep the capital invested intact. Because a dollar today is worth more than a dollar years from now, future income is discounted to present worth at a rate of return that reflects the degree of risk and the time horizon involved.
What kind of information will be needed?
Whenever I am asked to perform a valuation on a client’s practice, there are certain data that I require (Items Two and Three). After reviewing this information, I usually take the last financial year or annualize a current period if it is more than three months. I always check to be sure that certain trends haven’t occurred in recent months or years to cause me to question the validity of revenues. Then I recast the expense side of the business for that same period.
This involves normalizing certain line item expenses. Usually there are a few unusual and non-recurring items that will be removed. Owner’s compensation is expenses as salary. Sometimes, such things as continuing education, travel and entertainment, and fringe benefits (e.g., profit sharing and pension plans and depreciation handling that has been on an accelerated basis for tax purposes) will be adjusted. Once the expenses are recast, there are usually more dollars that drop to the bottom line. Prior to provision for income taxes (or “EBIT”- earnings before income taxes) the recasted income is multiplied by a multiple that reflects an acceptable industry number. This will usual range somewhere between 2 and 5. This will result in a valuation. There are, of course, other factors that could come into play, but this will give you some idea as to how value is estimated.
I believe there has been some decline in recent years on valuations as a result of industry changes. Some of the larger corporations that were in somewhat of a buying frenzy over a number of years have curtailed much of their acquisition activity. Of course, others have not, and new companies with acquisition capital have emerged. Does this mean your “window of opportunity” to sell your practice for a good multiple is closing? I don’t believe so. There are still plenty of buyers out there who approach me every week to bring them potential acquisition deals. I can assure you that there is plenty of opportunity to find the right corporate partner or buyer if that is your goal.
Let’s now discuss what you can anticipate if someone looks at your practice and what might be involved in their due diligence process (Item Four).
Every company I have worked for or consulted with that has purchased a practice has a different format. Some companies will request a variety of information that might include three to five years of financials, as well as income tax statements. I would like to comment briefly on types of deal structures. Most transactions involve payment in either cash, notes or stock; or various combinations of these. It might be an asset purchase or a stock purchase. Of course the tax treatment is considerably different in the two. The seller’s corporate status, being either a C corp or an S corp, also leads us to recommend certain deal structures. Needless to say, this is one of the more complex issues in buying or selling a business, so it’s wise to seek and follow the advise of your consultants.
What should you look for in a corporate partner?
- What type of corporation, or health care company would you like to have as a partner? Let’s look at some questions to ask.
- Are past acquisition owners still part of company? Many times, you’ll have the opportunity to query previous acquisitions and those managers/owners who sold to this particular corporation.
- Is it a quality buyer? Is it a public company or financially solid with appropriate accountability? What type of commitment can you get to fulfill your business plan?
- Does it have a strong infrastructure with business systems, marketing savvy, and progressive goals?
- Is it “payor smart?” Can it deal with managed care and other payor sources?
- How is the chemistry? Do you feel that the company intends to acquire only balance sheets and earnings?
- Does it have appropriate clinic and operational density so as to deal with managed care in your area?
- Does it have dedicated resources?
- Does it understand the trends of your industry?
- What will the compensation package look like? Incentives? Earn-outs? Stock? Will you be paid for unrealized growth potential if the practice grows? Are there any opportunities for earn-outs or stock options after the sale?
- How will you be integrated into their corporate culture and operations?
Teeing up the practice
Now, let’s look at what you might do early in this process to make the practice look as good as possible to a potential buyer. There are legitimate ways to boost the value of your business, or as we say in the industry, “tee it up”. Here are six areas to consider:
- Break dependence.
Even if the idea of cashing out isn’t foremost on your mind, now may be the time to study your role in the practice. If the practice is completely reliant on you, perhaps training new staff members would make your role less critical. Additionally, analyze your dependence on certain referrals. Attempt to diversify your referral base or maybe add a new service or launch a new marketing campaign.
- Take a lifestyle reality check.
To win over a buyer, it’s vital that you show increased profits; hopefully, the are above industry averages. So, if your practice has afforded you an upscale lifestyle, now may be the time to give up that luxury car, reduce your salary or avoid paying yourself some or those extra incentives, so that you might add more to the bottom line.
- Overhaul your overhead.
After assessing your expenses, you may discover that it’s time to negotiate a better lease, shop for lower advertising and long distance phone rates, or reduce your insurance costs. Take a look at the fees you’ve been paying your advisors, such as lawyers and accountants.
- Tighten up management.
Put your business in order by taking a hard look at all the systems-management reporting systems; collection efforts; accounts receivable control; staff productivity; and expenses on continuing education, travel, and entertainment. In many areas, if you take a hard look, you’ll find that you can institute some savings policies.
- Evaluate staffing.
Check your current employees or independent contractors who may not be pulling their weight. You can be sure that a potential buyer will certainly be put off or discount the buying price, if the first task he has is in taking over your practice, is to dismiss, recruit and train new staff.
- Get expert advice about a merger or acquisition.
Mergers and acquisitions are complicated and time consuming, but are well worth it if done correctly. Often, the services can be performed at no up front cost to you; the payment generally comes on closing as a small percentage out of the price of the deal. The consultant can, in effect, become a “seller’s agent,” who has your best interest as his/her primary goal and responsibility. I recommend using an expert in your field, whatever that field, and that person should have had experience with mergers and acquisitions and be able to provide names of satisfied clients for references. A good consultant should be able to locate a partner or buyer, do valuations, negotiate on your behalf, close the deal and help you with post merger integration.
There are various agencies and individuals who do appraisals or sell businesses, such as The Institute of Business Appraisers, the American Society of Appraisers, and the International Business Brokers Association, but they are also not health care experts.
Regardless of who you choose, be careful to check references and be sure the appraiser you choose understands the health care industry and, in particular, the chiropractic industry. After spending many years assisting clients in buying and selling practices, I’ve developed what I call the “Rules of the Road” to make for a successful transaction. These certainly won’t guarantee success, but are good starting points. A summary of the acquisition process is found in Item Six.
Peter Lord, PhD, PT of Jacksonville, Florida, received his PhD in Business Administration and his B.S. in physical therapy. Dr. Lord currently serves as President of HealthQuest, Inc, which provides consulting services to the medical and rehabiliation industry and health care professionals. He has also been in private practice for many years and served as Vice President of the Private Practice section of the American Physical Therapy Association. Please contact Dr. Lord by calling 904-778-2090 or fax 904-777-5200.