By Howard Bogard, Burr Forman
A growing number of physicians are selling their medical practices to private equity firms in order to “monetize” their practice, as well as to access capital and obtain operational efficiencies. In the Southeast, we are seeing consistent private equity activity in the specialties of anesthesiology, gastroenterology, dermatology, ophthalmology, oncology, ENT, and internal medicine, as well as others.
Private equity firms generally use capital from wealthy individuals, pension funds and university endowments to invest in various industries with the goal of obtaining a return on investment of 20% or more. To start, the private equity firm will purchase a large, well-managed (“platform”) medical practice and thereafter will acquire additional practices in order to increase the number of employed physicians throughout a defined geographic area. The goal is to grow revenue and decrease cost and then sell the practices within three to seven years of acquisition.
If you are considering a sale to a private equity firm, there are several things to consider:
- Valuation of the Practice. A private equity firm generally determines the purchase price for a medical practice based on a multiple of EBITDA (earnings before interest, taxes, depreciation, and amortization) as a measure of the operating performance of the practice. The multiple can run anywhere from 4 to 12 times EBITDA, with a platform or larger practice obtaining a multiple on the higher end of the range.
- Payment of the Purchase Price. The purchase price is typically a combination of cash plus “roll-over” equity in the buyer from 10% to 30% of the total purchase price. For example, if the total purchase price is $10 million, $8 million could be paid in cash at closing and $2 million paid as equity in the buyer. When the buyer sells, the physicians receive a return on their roll-over equity. A portion of the purchase price may also be paid by a promissory note with payment contingent on the physicians meeting certain revenue benchmarks.
- Expect a Change in Compensation. After closing, the physicians will become employees of the private equity buyer. In return for a large up-front purchase price, typically a physician will be paid less in annual compensation as compared to pre-closing compensation amounts, although “guaranteed” salaries for a period of time can be negotiated. Compensation is based on a variety of factors, including collections from personally performed services, plus a percentage of ancillary revenue and/or a percentage of overall profits. Physicians considering a private equity sale should analyze and compare their expected compensation over a three to five year period in private practice versus the same period under a private equity model, to include the up-front payment.
- Penalties for Early Departure. Typically, a private equity firm will require the selling physicians to sign a five-year employment agreement. In the event a physician leaves employment for certain reasons within a defined time period, the departing physician will be required to repay some of the purchase price he or she received (a “claw-back”). Typically, the claw-back period runs from three to five years after the start of employment, with more money repaid in the first year of the claw-back as compared to the last year. In addition, the selling physicians are required to sign non-compete and non-solicitation/no-hire agreements that restrict the physician’s ability to compete with the private equity buyer in the event the physician leaves the practice.
- Loss of Control. One of the benefits of being in private practice is that the physician owners make the decisions. If a practice sells to a private equity firm, a management company (owned by the private equity firm) will manage the practice and will have authority to make essentially all operating decisions, other than clinical/medical decisions, which remain within the control of the physicians. Oftentimes, there is a clinical management board or committee comprised of physicians and private equity representatives that has authority to address certain issues. However, if the practice is well run and profitable (hence the reason the private equity firm is interested in the practice), in my experience, the private equity firm does not make significant changes without first consulting with the physicians.
Howard Bogard is a Partner at Burr & Forman LLP and chairs the firm’s Health Care Practice Group. Howard can be reached at 205-458-5416 or at hbogard@burr.com.