Private equity investment in healthcare and the 4 questions executives should ask before the sale

A sale and resulting transition should be carefully examined in several domains, including the emotional experience of "selling your baby."

Private equity firms haven't always been interested in investments in healthcare services. In the late 1980s and 1990s, private equity firms avoided investments in healthcare due to the operating environment and because the related business models appeared more complex than in other industries.

Today, however, private equity groups play an increasingly important role in the healthcare services sector, with these firms investing sizable amounts in healthcare companies.

Private equity investment in healthcare has grown considerably in recent years, with global healthcare private equity deals doubling from 2010 to 2011, according to KPMG. In 2014, strategic merger and acquisition deal value in the healthcare industry nearly doubled from 2013, according to Bain & Co.'s 2015 Global Healthcare Private Equity Report.

Tom Schramski, PhD, is a certified M&A advisor who serves as president and managing partner of Vertess Advisors. Vertess is an international M&A firm that exclusively provides advisory and consultation services to healthcare and human service organizations.

Dr. Schramski took the time to discuss some of the issues surrounding private equity investment in healthcare as well as some of the major trends he's seeing in healthcare M&A.

Question: What are the biggest trends you're seeing in healthcare M&A today? What are the drivers behind those trends? tomschramski

Tom Schramski: We see a number of interrelated trends with four that stand out today.

First, acquirers are continuing to focus on consolidation and affiliations that achieve many of the goals of consolidation but don't have the same associated expense and risk. This is particularly true in markets like durable medical equipment where Medicare competitive bidding and other factors are having a profound impact on reimbursement.

Second, healthcare services that are very technology-enabled are favored because they can accelerate everything from reimbursement (improved cash flow) to performance data analysis (basis for contract award).

Third, buyers appreciate opportunities with potential for further diversification, and even retailing, to mitigate risk in a dynamic marketplace. In the example of urgent care centers, some buyers are not only seeking revenue diversity (e.g. occupational medicine) but also new ways to generate cash revenue from retail offerings (e.g. treatments like eyelash lengthening).

Fourth, private equity groups and others are becoming more attentive to the de novo potential — how quickly the service model can be replicated as part of a growth strategy that is not entirely dependent on the potential risk and expense of acquisition.

Overall, buyers, especially private equity groups, are becoming increasingly sophisticated in their acquisition habits.

Q: In what situations should a healthcare company consider a private equity group as a buyer? Are there any situations where they shouldn't?

TS: There are a number of situations in which it can make sense to consider a private equity group buyer. These include when the seller wants to de-leverage some risk through a partial cash-out, when the owner wants to remain active operationally and increase the value of the remaining equity, and when the seller is attracted to the "second bite of the apple" opportunity offered by the private equity group. Also, a private equity group can be an excellent option for capturing more of the value of a fast growing healthcare company, as compared to the trailing 12 months of adjusted EBITDA approach used by many strategic buyers.

When the situation is the converse for the company (the seller wants to cash out entirely, leave immediately after closing and/or is generally risk intolerant) then a private equity group is typically not the best option. In these cases it is often an early mutual decision because of the unique requirements that private equity groups often bring to the table.

Q: What are some of the key considerations for healthcare companies looking to sell to a private equity group or any other buyer?

TS: When we meet with healthcare executives considering a sale we always ask several questions that we believe are critical for a successful transaction.

What are your personal goals and objectives for a potential transaction? A sale and resulting transition should be carefully examined in several domains, including the emotional experience of "selling your baby." What most sellers don't realize is that there are often multiple ways to accomplish their goals, including financial targets, beyond the cash offer.

How well do you understand the internal dynamics of your business? It's important to know not only the effective bottom line but also all of the major factors, financial and otherwise, which impact the company's success. Buyers will always probe in these areas and the ability to respond with data, including a business plan or projections, is a value enhancement.

How well do you understand your marketplace and future opportunities? Sellers often know their risks and challenges well but don't want to talk about them with a potential buyer, and sell themselves short on future opportunities because they may not want to borrow or spend the cash necessary to fund a new venture. Even in this latter situation it is important to know where an investment could be deployed for the greatest future benefit if the funds are available. Being able to speak thoughtfully about the challenges a business faces increases the likelihood of a successful deal.

Are you willing to use professional resources to facilitate your transaction? Even when sellers choose not to use an advisor or intermediary they need to have some assistance in the legal and tax areas to accomplish their goals.

As M&A intermediaries and investment bankers know well, the deal process can be very demanding and time consuming. We walk prospective sellers through a typical transaction so they can see what is involved and when they will be called on to be most active and make important decisions.

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