Volume 10 Issue 8, April 11, 2023

by Rachel Boynton, MBA, CM&AA and Kim Harrison, MA, CM&AA, CPA

Double-digit multiples are often the buzz around healthcare conference room floors. "I just heard someone got a 15x for their business!" a business owner will exclaim — a multiple far exceeding the industry norm of 4-8x. Is such an astonishing multiple merely an urban legend or is it possible for a middle-market healthcare business owner to achieve double-digit multiples? 

The answer is … it depends. The deal structure is an important consideration when discussing the plausibility of these thrilling business valuations. The terms a seller is willing to entertain can drive multiples higher, as double-digit multiples are rarely achieved without seller's notes, equity rollovers, and/or earnouts — terms and concepts sellers should know about when they're working with an M+A advisor to bring their business to market.

Selling your business can be confusing and complicated. A skilled advisor can help you receive multiple offers to choose from and help make sense of them. When offers are made, they can be as straightforward as a dollar amount you will receive at closing, which is based on your adjusted EBITDA times a multiple, or they can be much more complex, with seller financing, equity rolled, or earnouts. The latter scenario is often when we start to see deals approaching and achieving double-digit multiples.

So, what does a double-digit multiple mean, and how can a seller get one? 

To help gain a better understanding of what's required for a company to receive a double-digit multiple offer, here is an example: A buyer presents a letter of intent (LOI) to an owner of a company with $2.5 million adjusted EBITDA. The buyer offers $25.5 million, which breaks down to a 10.2 multiple — a double-digit offer! However, to achieve such a multiple, the offer contains $1.5 million seller financing, a $3 million earnout, and $3.5 million in rolled equity. Here is what such an offer looks like in a chart: 

Let's break down the key terms and components of the offer as identified by the bracketed figures in red.

1. Adjusted EBITDA. Starting with your profit and loss (P&L) statement, an advisor like those with VERTESS will take your net income and then add back interest, taxes, depreciation, and amortization to determine your EBITDA. EBITDA is an approximation of a company's cash flow from operations. To more accurately reflect a company's true operating cash flow available to a buyer, we adjust EBITDA for any expenses and revenue deemed discretionary, non-recurring, and/or non-operating to calculate adjusted EBITDA. 

On the revenue side, we are now at a point in time when we are typically removing COVID-19 relief loans/grants, stimulus payments, investment income, or one-time gains. On the expense side, we might be removing an owner's inflated salary, travel expenses, or car reimbursement as well as the specific COVID-19 expenses tied to the revenues received. Adjustments made depend greatly on each owner and how their business was run. Adjusted EBITDA is a pivotal number on which many deal points originate from.

As stated earlier, the company in our example has an adjusted EBITDA of $2.5 million 

2. EBIDTA multiple. This is a number that is multiplied by the adjusted EBITDA to determine a purchase price. As noted, most multiples in a healthcare M+A transaction will be between the 4-8x range, but this is a very general range with many outliers. The multiple will be determined not only by the company's industry, but its location, solidity of operations, payor mix, services/products offered, revenue, profit margin, and growth potential. In our example, the offer is 10.2x of the $2.5 million EBITDA. This value is usually calculated before any interest earned on the seller note, which equals a $25.5 million offer. 

Now let's break down the elements of the offer that took us to that 10.2x multiple.

3. Cash at close. This concept is exactly what it sounds like: the amount of cash transferred to the seller at the time of closing. A seller will need to keep in mind that from this cash received, there is often a holdback for 12-24 months, and they'll need to pay expenses like taxes, lawyer fees, and M+A advisor fees. Notice that cash at closing is only a 7.00x multiple of EBITDA, which might be the current industry average, but the offer doesn't stop there. The buyer uses other mechanisms such as earnouts, interest, and rolled equity to drive up the multiple, as represented in the chart. 

4. Seller financing. Some sellers are willing to "loan" money to the buyer by holding a note, usually paid at the end of the earnout period. This is known as the seller note and is often a great way for a seller to profit from this transaction if the seller feels confident with the buyer. It's important to understand that the seller note is most often secondary (subordinate) to any loan the buyer takes out from a bank. Sellers can earn interest over the time they are holding the note, which can add to the cash flow received by the seller. 

The offer provided in our example has a seller that has financed $1.5 million of the total purchase price, which adds .60x to the total multiple. Now we're up to a 7.60x multiple.

5. Earnout. This is an incentive payment for future performance of the organization. The buyer will set goals they hope to achieve with the seller's help following close. Buyers use this to further assist with the transition of leadership, with the hopes of incentivizing a seller to help maintain stability of the organization during the transition. The ultimate goal of an earnout is to base it on stability or growth of revenue as a measurement. Buyers prefer to base the earnout target on net profit because of the need for additional spending to support growth. Sellers want to move that target as high up on the P&L as possible since once they are no longer the owner, they have less control over expenses moving forward. 

It's important to set clear guidelines for the earnout and how the goal will be accomplished. We often see deals with cash at close and an earnout (again, to help incentivize future success after the transition). The deal in our example has a $3 million earnout, which alone adds a 1.20x multiplier to the deal, bringing the multiple up to 8.80x. If the offer was simply $17.5 million cash at close with a $3.5 million earnout, it would then become an 8.2x (7.00x + 1.20x). 

6. Equity rollover. This is the cash amount a seller will invest in the new company after close since the company will now be owned by someone else. In the example provided, the buyer is offering $25.5 million as the enterprise value of the transaction and the seller is giving the buyer back $3.5 million to invest in the "new" company. 

This rolled equity means the seller is now a part owner of the new organization. When they sell it in future years, the seller will again have an opportunity to make a gain on the investment. This "second bite of the apple" often yields even higher returns because of the company's increased size. 

For example, assume the seller’s equity rollover of $3.5 million translated to 10% of the new company. A subsequent sale for a purchase price of $60 million would mean an additional $2.5 million in the seller’s pocket, above and beyond the initial rollover of $3.5 million, upon the future close date. 

How much equity the seller will be allowed to hold in the new company depends on the buyer's specific capital structure and strategy. For buyers to pay a premium price, they want the assurance that the seller has some "skin in the game" and is committed to the business's continued success. In short, shared risk drives higher valuation multiples.

In our example, this investment carries with it a 1.40x multiple and gets us to the 10.2x multiple. But the multiple can get even higher because…

7. Seller notes are interest bearing. This is an important negotiation point since a seller can determine the interest rate they feel is appropriate. In the example provided, by holding a $1.5 million note and receiving 9% interest for three years, an additional $405,000 will be paid to the seller. This amount accounts for an additional 0.16x added to the multiple total and is usually not considered in the original calculation of the enterprise value, which is why it is calculated last. Payment of the note and interest is not contingent on any performance, unlike an earnout. 

8. Total. Thanks to the seller financing and seller note interest, earnout, and equity rollover, the seller receives a 10.36x multiple and a sale of their business for nearly $26 million. 

All Multiples Are Not Created Equal

As you can see from the example, there are many ways you could calculate the multiple, such as before or after the earnout and after the interest on the note is paid. One key element not included in this analysis is revenue size. If this company is a $5 million company, then the adjusted EBITDA margin of $2.5 million reflects 50% of revenue. 

Higher-than-industry-average margins may cause buyers in the healthcare service delivery space to question whether the bottom line is sustainable. We often see offers of a 5-6x multiple in such scenarios, whereas if the adjusted EBITDA was in the 20-30% range, a seller is more likely to get an offer closer to or possibly into those double digits. 

What This Means To You and Your Company

When you decide to take your company to market, it's important to understand your financials and have a realistic valuation in mind. It's easy to assume that because a competitor received a 13x multiple on their business that you will as well. However, as we discussed, there are many factors, both internally and externally, that determine valuation, as does the manner in which it is calculated. Offers with outlier multiples typically include many of the deal elements highlighted in this article and require shared trust and risk between the buyer and the seller.

If you want to gain a better understanding of the value of your company and whether a double-digit multiple could be in your future, please reach out to a member of the VERTESS team.

March 1, 2022

By: Rachel Boynton

Volume 9, Issue 4, February 22, 2022

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If you are looking to acquire or sell a healthcare business, something you will quickly find is that there is a lot of terminology and lingo specific to mergers and acquisitions (M+A). M+A has its own diverse vocabulary. The more you understand these terms, the easier it will be to engage in the transaction process. Even a surface-level understanding of key concepts will at least provide a foundation to better participate in conversations and ask more in-depth questions.

Below is a list of some of the most common terms and acronyms you are likely to encounter in your discussions and review of documentation. If you come across an unfamiliar concept, do not hesitate to ask one of your M+A partners, such as an advisor like VERTESS or your healthcare attorney, to explain it to you. During the M+A process, ignorance is definitely not bliss.

General M+A Concepts

M+A — Mergers and acquisitions (M+A) is the broad term used to describe what a company like VERTESS helps facilitate. The term is used to describe the consolidation of companies or assets through different transactions, including mergers, acquisitions, consolidations, recapitalization, and purchase of assets. VERTESS will sometimes represent a buyer that has hired us to find acquisition opportunities specific to their industry, but most often we represent a seller. We may also work with two companies of similar size to help them merge into a single organization.

NDA — Signing a non-disclosure agreement (NDA) is the first step in engaging with an M+A advisor. An NDA is an agreement that certain information shared between parties will remain confidential. An NDA binds an individual who has signed it and prevents them from discussing information with any non-authorized party. NDAs are commonly used to protect trade secrets, client information, and other sensitive or valuable information.

At VERTESS, both the client and advisor sign an NDA to ensure confidentiality of shared information even before a formal agreement has been reached. Note: The term "confidentiality agreement" can be used interchangeably with NDA.

BOTE — To inform owners of the estimated transaction value of their company, we provide them with a free, detailed, back-of-the-envelope (BOTE) market valuation. The BOTE approach establishes the estimated transaction value of a company by comparing its financial performance to similar companies that have recently sold.

EBITDA — Earnings before interest, taxes, depreciation, and amortization (EBITDA) is a measure of profitability. This is the ultimate measure of a company's success in the eyes of a bank or investor. A business is much more than its profitability, but when it comes to purchase price, that price is primarily based on profitability — or at least the potential for the company's profitability.

Adjusted EBITDA — This is an area where an experienced advisor can be particularly valuable in helping a seller. In preparation for the sale, the seller will want to identify all one-time expenses or those that the buyer would not incur to run the business successfully following the transaction. Business owners often run personal or extraneous expenses through their companies that may not be necessary. Another example is investments in more personal protective equipment or excessive overtime expenses brought on by COVID-19 that are not likely to be necessary in the months or years ahead. These expenses are added back to EBITDA to create a more realistic adjusted EBITDA on which to base the purchase price.

Fee agreement — Once a client has decided to engage VERTESS for our services, a fee agreement is circulated and signed by both parties. This agreement specifies the relationship between parties, the agreed upon fee structure, and the exclusivity with tail (i.e., how long the commitment remains if the agreement is terminated). These facets of the fee agreement can vary greatly between different advisors. It's important to find an advisor and agreement that best suits you and your transaction goals.

CIM — When a seller client of ours is ready to hit the market, we email a blind executive summary teaser to our extensive mailing list to notify buyers of the opportunity. This summary has no identifying information about the company. It includes general geography, the nature of business, high-level numbers, and some other non-identifying details. When a buyer is interested, they respond with a request for further information.

After signing a confidentiality agreement, we grant them access to our data room. This contains the seller's confidential information memorandum (CIM). It's a robust marketing packet containing a full description of the seller's organization, what makes the business unique and special, the seller's intentions, the current market for the type of business, and opportunities for growth. We pair this VERTESS marketing book with a robust financial analysis to answer questions that we know from experience will likely be asked by prospective buyers.

IOI — The indication of interest (IOI) is the document provided to a seller by the interested buyer to indicate their genuine interest in purchasing the business. The IOI is the first formal document exchanged during an M+A transaction. This document provided by the buyer suggests a valuation range they are willing to pay for a company.

Typically, a seller receives IOIs from numerous buyers. If a buyer's indication is acceptable, the next step is for them to attend a management meeting, which usually includes the seller and interested buyer, and submit a "letter of intent" (defined next). Not all sellers will include the IOI in their process. For those that do not, they go straight to a letter of intent.

LOI — A letter of intent (LOI) is essentially an M+A form of a marriage proposal from the buyer. As the name implies, the LOI lays out the intent of both parties: The seller states they are willing to sell for the proposed terms, and the buyer states what they are willing to pay.

The LOI is an important step because it lays out the basics of the final deal: the purchase price and terms, anticipated leverage closing date, length of exclusivity, required approvals, and more. However, the LOI doesn't necessarily reflect the final deal. Rather, it's the framework or roadmap for that final deal. Based on what each side discovers during "due diligence" (defined below) and/or whether the profits of the company decline, the structure of the deal may change. The LOI is not legally binding, and either party can walk away from the deal, but it often contains an exclusivity clause that can restrict a seller's next steps if the agreement is terminated.

Exclusivity clause — An exclusivity clause in an LOI prevents a seller from engaging in M+A talks with other buyers. When an LOI is signed, it almost always includes an exclusivity clause that not only restricts a seller and their representation from shopping for alternative buyers but may also determine how long this restriction is in effect.

Multiples — To determine valuation, we use a common industry standard of taking a multiple of the adjusted EBIDTA. Textbooks will tell you that the average market multiple is between 4-6x, which means that if your adjusted EBITDA is $2 million, then we would expect offers to come in between $8 million and $12 million.

The key word here is "average." Some multiples will go higher depending on the industry, size of company, and demand. We have recently seen multiples exceeding 17x for larger, established companies in durable medical equipment, staffing, and applied behavioral analysis services while some very small provider agencies have received offers as low as 2x. Such a substantial range of multiples shows the importance of having a knowledgeable advisor who can help determine a strong adjusted EBITDA (knowing the appropriate add-back expenses), understands the industry and its multiples, and can sell the value of the organization beyond its profitability.

Due diligence — Once an LOI is signed, the due diligence process begins. This is when the buyer conducts its complete investigation of a prospective acquisition, including gathering more intimate details of the company such as full financials, employee breakdowns, customer concentration, contracts, and any skeletons like lawsuits and potential liabilities. Most of this information is provided by the seller via the uploading of supporting documentation as requested by the buyer into a secure data room. The buyer will often submit several different lists of requests covering everything from finances to regulation and compliance reports. The due diligence period is when the buyer discovers if it is buying what was represented through the CIM and management calls.

QofE — Quality of earnings (QofE) is the process through which a buyer verifies that the financials represented in the financial analysis matches tax returns, billing reports, payroll reports, and other documents. QofE is part of the due diligence process and usually completed before other members of the buyer's team perform their review.

QofE is often performed by a third-party accounting firm or agency. The buyer will want a level of assurance that the financials determining the price are accurate and acceptable. Some buyers need to present this report to a bank or investor to receive approval for the funds to complete the acquisition.

SPA/APA — What exactly is a seller selling? It's not simply "ABC Company." Rather, it's either the stock that controls the company or the assets of the company. Simply put, selling the stock or equity of a company means one is selling their role as the owner and the buyer will step into the owner's shoes and continue running the company. On the other hand, an asset sale means the buyer is buying everything the company owns or controls, from the furniture and tangible items to the contracts and delivery of services.

A final contract for an acquisition will either be in the form of a stock purchase agreement (SPA) or an asset purchase agreement (APA). The nuances of the contracts will be similar, but the stock versus asset will affect the level of liability the buyer assumes and the tax burden to each party.

Buyers tend to prefer asset deals because it is easier to clarify what pieces of the company the buyer wants to assume, and they do not assume the potential liabilities from years past. If the buyer acquires the stock, any past misdeeds of the company are a liability for the new owner. In some cases, an asset deal may help shield a buyer from the past misdeeds of the seller, but that's not always the case. Stringent representations and warranties and an escrow account help mitigate this concern, but the risk never completely goes away. The biggest benefit to a stock deal, specifically in healthcare, is that many licenses are easier to transfer while the organization remains intact.

Seller's Trusted Advisors

CMAA/CM&AA — Most VERTESS staff, including those working in our back office and our development team, have earned the certified mergers and acquisitions advisor (CMAA or CM&AA) certification. Our advisors also have operations experience. Many of us have exited a company through the acquisition process, so we understand not only the M+A process but the emotions, investment, and culture of owning and operating a healthcare business.

Lawyer with M+A expertise — For the same reason you wouldn't use your corporate lawyer for a car accident, you will need a lawyer with M+A experience when you sell your company — and one specifically with experience in your healthcare vertical. This will not only save you money but will save you from a lot of headaches. A lawyer can make or break a deal, so finding someone who understands the process and your space is essential. Not all M+A lawyers will have the regulatory expertise of your state, but they should have access to someone who does.

Accountant — Some sellers will lean on their chief financial officer during the sale, but there are many financial questions about past reporting and decisions that will affect your tax basis post close for which you may need further guidance. It's important to have a financial advisor who can help you make the best-informed decisions based on your numbers and performance.

The Buyer Types

PEG — Private equity groups (PEG) (i.e., private equity firms) are investment management companies that raise money from investors and purchase companies with the intention of generating a financial return. Many of the PEGs VERTESS works with are looking at acquiring smaller to middle-sized healthcare services and then adding them together to create economies of scale. Some PEGs also own parts of large organizations to further help them grow. Some of these buyers have a clear intention of growing a company and then selling it after 3-5 years while others are more committed to a longer-term engagement.

Family office — Family offices are private wealth management advisory firms that serve ultra-high-net-worth individuals (HNWI). They are different from traditional wealth management shops in that they use the funds collected from a small number of people to directly invest in companies.

Search fund — A search fund is a specialized private equity fund formed by an individual or multiple individuals. The fund is used as an investment vehicle through which an entrepreneur raises funds from investors. This money is then used to acquire a company in which the search fund's principals wish to take a day-to-day leadership role. Once the acquisition is completed, the search fund's principals step in and operate the company.

Search funds are distinct from traditional private equity funds in that the search fund's principals take active operating roles following the acquisition, and the search fund only acquires one target company and not a portfolio of companies.

Strategic buyer — Strategic buyers are those companies that operate in the same field as the seller and provide a similar service. This might be a large hospital, clinical practice, or direct service organization looking to grow its company through acquisitions. We will often see a private equity-backed strategic buyer as this enables the strategic provider the ability to compete with private equity buyers. It is also commonplace for an existing organization to acquire a provider of complementary or additional services to help expand service offerings (e.g., a home health agency buying a hospice provider).

Overcoming the Learning Curve

When I get to know a new business owner, I often face a learning curve as I work to get caught up on the company's lingo. Participating in M+A is no different. A good advisor will understand that this is most likely the only opportunity to sell your company and that it's probably unfamiliar territory for you. A trusted advisor will help you navigate unfamiliar terms, translate your lingo to an unknowing buyer, find synergies between parties, and ultimately negotiate the best purchase terms.