Updated! Healthcare M&A: 10 Questions for Physicians Negotiating the Sale of their Practice to Private Equity

Private equity (PE) may have dipped at the end of 2021, but early indications are that may be short-lived. In fact, 70% of healthcare execs predict more M&A activity in 2022.

Whether it’s a primary care office, oncology practice, anesthesiology group, or another healthcare provider, PE buyers love the consistent cash flows and growth potential these businesses provide. Despite the COVID-19 pandemic and a 14% decline in global PE volume, healthcare PE deals in 2021 actually jumped higher than they were in 2018 and 2019.

Selling to PE firms comes with unique benefits to the healthcare provider. It often removes administrative burden from physicians and allows them to focus on what they do best – practicing medicine. PE investment also gives practices the capital to modernize or upgrade, which benefits patients and can create economies of scale.

Here are 10 questions every practice owner must ask when negotiating a transaction:

What is the value of the business and how does it relate to purchase price?

PE firms tend to base their purchase price on a multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). Depending on the practice’s specialty, there are typical industry standards when it comes to the multiples paid by buyers. However, PE firms are buying more than just the physical assets or a brand name – they’re purchasing future revenue prospects, contracts, and potential intellectual property or proprietary processes. The value of the business is far greater than its physical assets or current annual income.

What is included in the sale?

Even a relatively simple office-based practice may be comprised of several business units or asset classes. These can range from patient accounts receivable, medical office buildings, intangible assets and new business opportunities. Physicians must clearly outline what to include in the sale and what to retain.

Will the buyer acquire a controlling interest?

Normally, PE firms want a majority interest in the business to have the power to act decisively when managing their portfolio of companies. But not always. Some PE firms are satisfied with having a substantial, yet minority, stake in a business if that helps maintain original owners’ entrepreneurial spirit.

Will a representative from the PE firm serve on the board of directors?

A PE firm’s representation among the directors and officers depends on whether the investment is in the medical practice or a derivative thereof, such as a joint venture. If a new entity is formed to consolidate multiple practices or to form a new business, it is more likely the PE firm will require significant representation on the board and key officer positions.

Will existing management stay in place?

Existing leadership may be an important component of a practice’s business value, but there’s no guarantee the PE firm will leave management unchanged. Even if the PE firm has a minority position, it may demand “step-in” rights to allow it to take control of the business if it is performing poorly. Several scenarios can trigger such action, including breaches of financial covenants in financing arrangements, failure to meet specified financial thresholds, material breaches of the shareholders’ agreement, and more.

How will capital support from the PE firm be established?

PE firms are adept at determining a company’s “enterprise value,” which assumes how it will perform after the infusion of capital and management resources. They also determine how to make the deal “financeable,” by pricing in risk factors associated with increased borrowing. Knowing how capital support works is key.

Will physician compensation and benefits change?

A PE firm’s main goal is to grow the business. Any increased margins must be derived, not from diminishing physician compensation, but elsewhere. That said, compensation could be out of step with the current economic market, and a PE firm may suggest ways to redesign it.

How will distributions of newly generated profits be shared with physicians?

The source of profit distributions will vary depending upon the nature of the business unit in which the PE firm has invested and how that entity affects the profitability of the medical practice.

What do restrictive covenants and non-compete agreements look like?

Sellers should expect non-compete covenants separately in connection with the sale of the business and, if any of the sellers stay on, non-compete restrictions as part of individual employment agreements. Attention must be paid to the scope of covenants’ geographic restriction both during and after the term of the physician’s employment.

Should you negotiate exit rights?

PE firms typically expect to have restrictions on transfer, put and call options, drag-along rights, and tag-along rights within their buy-sell or shareholders’ agreement. For example, a tag-along right might vest gradually to keep the selling physicians actively engaged in the practice. However, if the PE firm were to sell its interests sooner than the physicians would otherwise qualify as 100% vested, selling physicians should negotiate that their interest becomes automatically wholly vested at any time the PE sells all, or part, of its interest.

This article also ran in the Pennsylvania Medical Group Management Association's February Newsletter.