Develop a list of potential buyers, and perform your own initial due diligence

July 20, 2020

This month, Todd Peterson, CEO of VitalSkin Dermatology, focuses on how to identify potential buyers and perform your own initial due diligence on them before putting your practice up for sale.

In our previous months’ Selling Your Practice articles, we discussed why so many physicians are doing so, how to make a decision on whether to sell your practice, why it’s helpful to continue running and growing it, how to prepare early, and assembling a team of experts. We also suggested educating yourself on various issues, starting with the difference between the two most common type of transactions—capital sales and asset sales. We covered the need to complete an objective analysis of your practice, and develop a financial pro forma. Last month, we discussed the need to prepare for negotiation by understanding what you want from selling your practice, and the importance of truly understanding its value. This month, we’ll turn our focus toward identifying potential buyers, and performing your own initial due diligence on them before putting your practice up for sale.

Potential Buyers

When considering potential buyers for your practice, it may help to separate them into two categories; financial buyers and strategic buyers.

Financial buyers are often private equity firms or venture capital firms looking to generate a financial return by investing in practices with a positive cash flow, sustainable competitive advantages, significant growth prospects, and a clear exit strategy. Financial buyers often acquire practices using a leveraged buy-out, where debt capital is used to finance as much as eighty percent (80%) of the acquisition price—meaning the purchased practice must generate enough cash flow to service the debt load. Financial buyers spend a significant amount of time and money learning and coming up to speed with the target industry. As a result, the transaction can often take a little more time as the buyer learns the opportunities and threats provided by the industry, and analyzes the strengths and weaknesses of a practice. Often, the first several practice acquisitions will provide a business platform for subsequent such investments by a financial buyer. However, the opportunity to become a platform investment becomes significantly reduced once the industry becomes saturated with similar buyers. Because their initial investments will become a platform for a financial buyer, the purchased practice(s) must have strong and scalable back-office capabilities, and able to increase efficiently as more practices are acquired.

The time horizon for financial buyers is almost always short-term, meaning an investment of three to five years. They’re often looking to grow their platform investment through additional acquisition activities—referred to as “roll up” strategies. Usually, these add-on acquisitions are smaller and command a lower price or multiple. But when added to the larger platform, they immediately become more valuable because the parent company then commands a higher value or multiple. This is referred to as an “arbitrage” strategy. At the end of its investment horizon, and after growing its business, the financial buyer will want to unlock the value of investments through a liquidation event. This is when its assets are sold to another financial investor, a strategic investor, or the practice is taken public.

Strategic buyers are ones who are already operating in the industry. Often, they’re competitors who are interested in horizontal or vertical integration. Examples of horizontal integration might include accessing new geography, new product lines, or new distribution channels. For instance, a dermatology practice in a nearby suburb could be interested in acquiring your practice to provide it with access to your particular market, or your cosmetic dermatology expertise. Vertical integration occurs when customers or suppliers integrate their company into your market space. For instance, a primary care physician group that has historically provided you with patient referrals may be interested in acquiring your dermatology practice to capture that referral revenue for itself. Recent examples of vertical integration include national health insurance companies, medical suppliers, and retail pharmacy companies or regional hospital organizations acquiring physician groups.

Strategic buyers will often be focused on maximizing their acquisition’s value by achieving synergies where overlapping capabilities exist, in order to improve operating cash flow. When one physician group acquires another physician group, for example, this often means the “back-office” functions of the acquired practice will be eliminated, including accounting, information technology, human resources, compliance, marketing, and other such support functions. Furthermore, the acquiring company will move quickly to convert you to their operating system, including their practice management system, electronic health records, human capital management systems, and accounting systems. Strategic buyers usually have a long-term investment horizon, and because of this can extract more intrinsic value from the acquisition over time—so they are often willing to pay more for a transaction.

Identifying Potential Buyers

Using a solid understanding of financial and strategic buyers, it’s helpful to map out potential purchasers. As noted, strategic buyers are the most likely buyers of your practice, and are the ones willing to pay the most, so are the ideal starting point. Therefore, we recommend you start by considering strategic buyers as follows:

  1. Which physician practices in your specialty already operate in your market?
  2. Which multi-specialty physician groups already operate in your market?
  3. Who are the referring physicians for your practice?
  4. Which local hospitals operate in your market?
  5. Which physician practices in your specialty operate in nearby markets, but do not have a geographic presence in your market?
  6. Which multi-specialty physician groups operate in nearby markets, but do not have a geographic presence in your market?
  7. Which suppliers in your specialty may be interested in purchasing your practice? For example, McKesson is one of the biggest acquirers of oncology practices in the U.S.
  8. Which health insurance companies may be interested in purchasing your practice? (e.g. United Healthcare’s OptumCare division employees 48,000 physicians in fifteen states)?
  9. Which private equity or venture capital-backed practices operate in your space across the country? These practices are often looking for attractive practices to tuck into their existing geographical footprint, or with which to establish a new geographical beachhead.

If you have a large enough practice—twenty or more physicians being a good rule of thumb—and back office-functions that are both well-developed and scalable, you may be able to attract the attention of a financial buyer. A typical profile will be a small- to mid-market private equity or venture capital firm that has invested in other medical businesses. Your financial team (discussed in a previous article) will be able to help you determine whether your practice is an attractive platform practice, and the most likely financial investors.

Perform Your Own Preliminary Due Diligence, and Refine Your List

Once you’ve developed a list of potential buyers, it’s worth doing preliminary due diligence on the potential buyers. Doing your homework and learning more about them will help you qualify possible investors, determine the best fit, and provide a list of open questions—all of which will give you increased leverage at the negotiating table.

Due diligence can be performed in multiple ways. We suggest that you start by investigating online resources, including websites, blogs, social media sites, online reviews, trade publications, and other such sources. Once these have been explored, use your personal network to reach out to individuals who do business with the targeted buyer (i.e. customers or suppliers), who are employees of the potential buyer, or are physicians who have already been acquired by the buyer in question. Using this information, you can prioritize your list and know the most likely and most attractive buyers to approach.

Next Steps

You’ve spent several months educating yourself and preparing to go to market. Now the time for action arrives. Next month we’ll discuss how to develop a confidential information memorandum (CIM), approach potential purchasers, and sign non-disclosure agreements with them.

Todd is the chief executive officer of VitalSkin Dermatology, a world-class dermatology and aesthetics practice management firm., Mr. Petersen has over two decades of C-suite experience, including CEO, COO, CFO, and CHRO roles. He is a growth expert with a passion for new entrepreneurial challenges, revenue growth, improving operations, and building teams and partnerships.