How to Sell Home Health Care Services

The only constant for home healthcare agencies is change. For many owners of agencies, change is both demanding and fatiguing. At some point, owners start thinking about exiting their company. Some owners elect to pass ownership down to their adult children. Some stop taking on new clients/patients and simply close their doors. Others seek to sell their company in the marketplace. This column is written for those owners considering selling in the marketplace.

The merger and acquisition (M&A) market for home healthcare agencies is currently very robust, with buyers eagerly gobbling up well-performing agencies. As such, this may be the best time to sell if you're looking to get the highest price, best terms, and well-suited buyers. 

Why are buyers eager to buy? Home healthcare agencies are one of the fastest-growing industries in the healthcare sector. Thanks to an aging population, an increase in chronic diseases, the growth of physician acceptance of home healthcare, medical advancements, increased demand for home-based care (especially for the elderly or in times of a pandemic), and a movement toward cost-efficient treatment options from public and private payors, the industry has flourished. Moreover, the industry is anticipated to grow over the coming years, which will allow providers to compete effectively with institutional care agencies, such as hospitals.

Home Health Industry at a Glance

According to the Medicare Payment Advisory Commission's ("MedPac") March 2019 report to Congress, between 2004 and 2016, the number of home health agencies increased by over 60%. Currently, there are approximately 12,000 active home health agencies in the market, and as of 2017, approximately 98% of Medicare beneficiaries lived in a zip code with a home health agency.

Total Medicare spending on home health services increased by 108.2% from 2000 to 2017. MedPac estimated operating margins for freestanding home health agencies to be approximately 4.5% for the blended all-payor margin.

The home health industry is highly fragmented, with Medicare spending per agency of approximately $1.5 million. According to a LexisNexis 2019 study, the top five home health operators based on yearly medical claims and patient volume data — Kindred Healthcare, Amedisys, LHC Group, Encompass Health Corp., and AccentCare — represent approximately 20% of the total home health market share. Industry fragmentation offers consolidators the opportunity to leverage back-office support functions, economies of scale, and market share expansion through acquisitions.

If you're thinking of selling your home healthcare company, you should know the following:

• The market is strong now because of the vast amount of money/capital searching for well-performing agencies. It's unclear how long this will last and when it will inevitably slow down. The market can change quickly, and you may lose your opportunity to sell at a favorable price.
• As acquisitions and consolidations continue, you'll likely be competing against larger, far-better-capitalized companies. The competitive landscape is changing. Larger competitors are likely to offer a broad range of services, a strong marketing campaign built around an established brand, efficient business processes, and the ability to bid for value-based contracts with large payors.
• Owners of home healthcare companies are aging. One estimate is that 60% of owners are over the age of 55. As such, we expect an increasing number of home healthcare companies seeking buyers during the next few years. 
• Many agencies have already found value in merging to create economies of scale and the resources to better compete with larger organizations.

Home Health Buyers' Concerns

Smart buyers weigh risks versus rewards when considering the purchase of a company. Some of the perceived risks in the home healthcare industry are as follows: 

• Despite strong growth, industry profitability has been under pressure.
• Reimbursement for home healthcare agencies has declined each year since 2014, preventing operating profit growth.
• Although healthcare reform expanded access to insurance for some industry patients, many states chose not to expand access to federal healthcare.
• While in-home healthcare agencies have always struggled with caregiver retention, the ongoing COVID-19 pandemic makes growing a workforce nearly impossible.
• In-home healthcare agencies must also learn how to recruit and onboard workers remotely — another difficult task.
• There is increasing hospital competitors, fueled, in part, by CMS recently approving a handful of new hospitals under its rapidly growing hospital-at-home initiative.
• Regulators unfunded mandates that home healthcare agencies electronically verify the services that they deliver in the field.

What Home Health Buyers Are Looking For

In our experience, the most crucial feature buyers are looking for in a company is profitable growth. Buyers want to know that they can take what you have built and build on it. But, in their risk/reward analysis, they'll want to see that your strengths far outweigh your weaknesses (i.e., opportunities for improvement). Most buyers have a checklist mentality, where they'll be looking to see that you have at least some of the attributes below: 

• Diverse reimbursement/payors
• Strong reputation and quality of services
• Expansion in chronic disease management
• Keen understanding of the current and future required level of staffing
• Relevant certificate of need (CON) moratoriums or other licensure requirements, where applicable
• Continued investment in infrastructure and actions to seek efficiency opportunities
• Low revenue seasonality
• High population base with the right client demographics
• Tenured, experienced workforce with low employee turnover
• Certificate of need in CON states
• Reliable and consistent referral source and/or contracts with providers
• Clean billing audit
• Good revenue growth
• Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) margins in the 10% to 30% range
• Understanding of subcontractor versus employee handling of service delivery
• Creative staffing with maximization of billable hours
• Multiple service delivery locations, including community-based access

How Much Will Home Health Buyers Pay (Market Multiples)

Typically, buyers go through their risk/reward analysis and come up with an offering purchase price. Usually, the offering price is based on a multiple of normalized or adjusted EBITDA.

Adjustments to EBITDA include nonrecurring expenses, such as one-time legal fees; discretionary expenses, such as charitable contributions; and owner-related personal expenses; such as excess owners' salaries and auto lease expenses. 

Market multiples refer to the estimated purchase price, or enterprise value, related to adjusted EBITDA. The typical range of market multiples for home healthcare agencies is 4x to 6x of adjusted EBITDA. A particular provider falls within the range based on quantitative factors such as historical and projected financial performance, and qualitative factors as highlighted above in the "What Home Health Buyers Are Looking For" section. Moreover, size matters, as larger revenue agencies attract more buyers than smaller agencies. 

The following are estimated market multiples for home healthcare agencies by revenue, assuming positive qualities related to "What Home Health Buyers Are Looking For" above:

• $1 million to $3 million in annual revenue — 4.00x to 4.50x EBITDA
• $3 million to $5 million in annual revenue — 4.25x to 4.75x EBITDA
• $5 million to $10 million in annual revenue — 4.50x to 5.75x EBITDA
• $10 million to $20 million in annual revenue — 5.50x to 6.00x EBITDA

For example, an agency with $4.5 million in annual revenue and $450,000 in adjusted EBITDA (10% adj. EBITDA margin) would have a market value in the range of $1.9 million to $2.1 million.

There are outlier market multiples in unique M&A transactions where optimal buyer/seller synergies push valuations above the norm. Moreover, market multiples change over time depending on the overall economy, regulatory and reimbursement modifications, and industry trends. 

Please note that using market multiples is an excellent way to estimate a company's value. It is most often accompanied by using a discounted cash flow approach. The discounted cash flow approach estimates a company's value by calculating the future cash flows expected from the company and putting the future cash flows into today's dollars. However, the market multiple approach provides a reasonable shortcut for estimating the value of a company.

What About My Home Health Company's Debt?

The market multiples above are used to determine the equity value of companies, not the enterprise value. Most small businesses are sold debt-free, which means that buyers assume that all of the company's debts (not to be confused with non-debt current liabilities) will be paid off by the seller at the time of closing. However, there are occasions where a buyer wishes to assume the company's debt as a way to finance part of the purchase price. 

Net Working Capital Adjustments to Price

Working capital is usually calculated by subtracting current assets from current liabilities. Net working capital is used to gauge a company's operating liquidity at a particular point in time.

While all the accounts that make up net working capital are listed on a company's balance sheet, inclusion or exclusion of individual accounts is often negotiated between buyers and sellers. Accounts usually included in the calculation of new are cash, accounts receivable (A/R), inventory, prepaid expenses, accounts payable (A/P), and accrued liabilities. Other current assets and current liabilities that may be included in net working capital include short-term investments, cash advances to employees, insurance claims, owner receivables, notes receivable, security deposits, A/R due from affiliates, 401(k) payables, A/P due to affiliates, customer deposits, and income taxes payable. 

Buyers expect a normal amount of net working capital at closing to ensure adequate liquidity the day after the purchase date. Buyers expect a normal amount of collectible A/R, sellable inventory, no past-due A/P, etc.

In the event that there has been a change in the amount of normalized net working capital prior to the closing date, the purchase price of the company is usually increased or decreased accordingly. 

Net working capital is an integral part of a company's overall value. As such, it's critical that a normalized amount of net working capital transfers to the buyer at closing.

Capital Expenditure Adjustments to Price

Capital expenditures that are not ongoing maintenance capital expenditures are expenses expected to generate future benefits, such as the cost purchasing vehicles, information technology equipment, etc. Future projected capital expenditures decrease cash flow to the buyers. Buyers typically subtract future expected annual capital expenditures from EBITDA to estimate future cash flows. A decrease in EBITDA will lead to a lower purchase price.

The Gist

About VERTESS

VERTESS is the advisor of choice for many home healthcare agencies/agencies business owners because of our track record of success and deep industry expertise. It would be best to speak with an advisor at least annually to understand the market and your options.

A visionary group of results-oriented professionals formed VERTESS as an alternative to traditional M&A firms and investment banks. We focus primarily on your personal and professional goals and help facilitate transactions that make sense to you for the long term. We guarantee integrity, con