To sell or not to sell ... that is the question

Dermatology practices are attracting private equity buyers who have the potential to swoop in and make problems like heavy debt vanish. But there are important considerations to take into account before signing away full ownership.

David Wagener, M.B.A., C.P.A., presented on the variety of options that physicians have to select from at the AAD 2015 annual meeting in San Francisco.  Wagener is CEO of the Miami, Fla., group practice Skin and Cancer Associates, and president of the practice’s management firm, Advanced Dermatology Management.

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Investor-owned group practice

Being part of an investor-owned group practice is among the choices open to practices and is something relatively new to consider, he says.

To accomplish this, private equity firms partner with dermatology and other practices in a transaction that optimizes alignment between the practice and investor, maximizes financial flexibility and positions the newly formed company for financial growth, according to Wagener.

“[Private equity firms] acquire a platform group and then acquire complimentary add-on practices and open offices de novo to grow,” he says. “Dermatology is thought to be sufficiently diversified to have upside potential even in difficult times.  We have the ability to provide both medically-necessary services that are covered by third party payers (which are always at risk of payment reductions) and non-covered elective services that are cash on delivery.”

NEXT: What makes a practice valuable?

What makes a practice valuable?

Practice valuation drivers include:

• Offering general and cosmetic dermatology

• Offering Mohs surgery

• Using nurse practitioners or physician assistants effectively

• Having in-house pathology

• Being located in a geographically desirable place

However, when it comes to valuing a practice, things aren’t always black and white, according to Wagener.

“A more diverse and sophisticated practice that is large is attractive as a platform investment.  Small practices that are diverse and sophisticated may actually be less attractive as add-ons than less diverse practices, because the name of the game with add-ons is to grow them and expand the service offerings and improve them to create value,” he says.

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Investors determine a practice’s value based on a multiplier, which can vary, applied to Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA).  Wagener explains that EBITDA is an industry standard measure of free cash flow.

“In most physician practices there is no EBDITA per se, there is only physician income.  The amount of income a physician or group of physicians earn above and beyond the norm (whatever that is) is what can be re-characterized as earnings and sold,” Wagener says.   

NEXT: Finding a business partner

Finding a business partner

Financial buyers interested in dermatology practices include firms looking to acquire platforms in the dermatology space and existing companies wanting to build scale, according to Wagener. While small practices are likely to sell to established consolidators, a platform level dermatology group has the option of aligning with a new entrant. 

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“There are lots of other private equity firms who want to get in the door.  You want to sell to a group that has plenty of capital in reserve to continue to invest in growing the business,” he says.

Dermatology practices that want to sell might also turn to sell side advisors. “These are folks that will work for the sellers (the dermatologists) to help them find the best partner …, and/or help them negotiate terms when a specific deal is being done with someone that approached them out of the blue. Sometimes a practice that gets an unsolicited offer may choose to shop around for a better offer,” Wagener says.

NEXT: The Big decide

The big decide

There are advantages to partnering with a growth equity firm. Among them: it can position physician partners to monetize equity value in the practice, according to Wagener. It might free dermatologists from debt or from concerns about the future of medicine and provide a more predictable career journey. Sellers may retain some ownership and thus have the opportunity to participate in the increased equity value as the group grows in size and profitability.

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But that’s not always the case. Like with any partnership, an unhappy union can lead to trouble.

“I know physicians who sold their practices and when the buyer later failed they bought it back for pennies on the dollar.  Unfortunately they also experienced disruption in their practice and their cash flow during the transition.  I know physicians who have been left in a lurch when their employer went out of business,” Wagener says. “That said, I don’t mean to suggest that all the deals are going to fail. I do think it should be pointed out that if things go sour, the doctors’ entire world is disrupted.  For the private equity guys, this is just one of a hundred things they are involved in and they go on with their lives without looking back.”  

NEXT: Five good reasons to sell

Five good reasons to sell

• Principals are within a few years of their target retirement date and like the idea of monetizing their equity in the practice.

• Principals are carrying heavy debt loads.

• Principals built their practice with such a transaction in mind.

• Principals are worried about the future and see safety in aligning with business partner who can provide capital and share risk.

• The business operations are faulty.

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NEXT: Five good reasons not to sell

Five good reasons not to sell

• Suitor’s business plan seems incomplete, is not understandable or just does not seem viable.

• Lack of consensus in situations where there are multiple owners.

• Principals are optimistic about the future and believe they can achieve their goals without aligning with business partner who can provide capital and share risk.

• Principals are unwilling to cede control to new owners.

• Business terms are not considered favorable (price, post-acquisition employment contract terms, employment agreement renewal terms, control issues, etc.).

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NEXT: Five steps for the sell

Five steps for the sell

“Different dermatologists will have different goals,” Wagener says. “Someone older may want to sell and retire ASAP.  Someone younger may have the goal of being part of building a big business and making money on the stock play.  Someone else might be so pessimistic about the future they just want to pass the risk to someone else and just be an employee.” 

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If you decide to sell, there are five clear steps.

• Determine compensation and ownership structures.

• Value the practice.

• Perform due diligence, including getting a handle on a number of important practice aspects, from having a detailed review of the business to coding and compliance, to accounting books and records and more.

• Agree on a price with an investor for a percentage of the practice, and execute the sale, distributing the money to physician partners. “These are basically ‘scrape deals,’ meaning the physician or physicians sign a long-term agreement to work for less and leave earnings on the table.  Those earnings will be the basis of the valuation.  The valuation goes up and down with earnings,” he says. “Sellers and buyers also need to agree on whether the payment is all cash or part cash and part stock in the new company.  Sellers who take stock are betting that the company will be a success and the value of their stock will appreciate and make the value of what they received for their practice that much higher.”

• Grow the practice and ultimately exit.