Where’s My Cash? Dispelling A Common Misconception About PE-Backed Acquisitions
by Dave Turgeon, Managing Director
Volume 6 Issue 6, March 28, 2019
Physician practice owners are often surprised to learn how private equity (PE)-backed companies structure their acquisitions and the relatively small amount of cash paid at closing. It’s significantly less than owners (sellers) expected.
Below is a simple breakdown of how the proceeds from a typical PE acquisition works. The selling price is generally paid in three parts. Understanding the timing of these payouts may influence when owners choose to sell their practices.
Cash at Closing: 40%
Less than half of the sale price may be paid upon closing. Practice owners should keep in mind that they will pay their transaction costs from this amount. These costs will include the fees for services provided by an accountant, lawyer, and advisor and may also include taxes.
Deferred Payments: 40%
Most states have strict laws prohibiting non-compete contracts for physicians. The justification is that prohibiting the practice of medicine in any form is considered to be against the public’s interest. The challenge for buyers is that they do not want to acquire a practice only to see its physicians walk away a short time after the sale and become competition.
PE-backed companies work around this by paying some of the acquisition price over time, i.e., deferring a portion of the payment. This amount — typically 40% of the acquisition price — is usually spread over three or four years. The payment is also predicated on the practice continuing to generate the revenue and cash flow (EBITDA) upon which the sales price was determined. This approach serves as motivation for practice owners to keep their team in place to sustain the practice’s financial performance.
During the deferred payments period, physician-owners continue to be paid on a formula based upon collections from services provided (e.g., 50% less certain expenses). They do not, however, share in the profits of the business post sale.
Note: Keep in mind that, in general, such deferred payments are treated as capital gains for tax purposes.
Rollover Equity: 20%
The concept here is that physician-owners are swapping stock in their company for an equal value of stock in the company acquiring their practice. The physicians are not paid cash for this portion of the sale. The stock can usually be monetized upon the sale of the buyer’s company.
The incentive for buyers is they want their new physician partners to be aligned with the parent company’s interests. By accepting stock in a buyer’s company, physicians become financially invested in that company’s success.
A seller may find this offering very attractive for a couple reasons. First, accepting stock rather than cash defers any taxes on the gain from the transaction. Second, the buyer is likely to sell the company at a significant gain. As a shareholder, the seller will participate in that gain. It’s not unreasonable to expect a gain of 300-400% over a period of just 2-4 years.
To better ensure such an optimal outcome, it is imperative to work with the right buyer and PE group. An advisor can provide the best direction on this matter.
I often get calls from business owners considering retirement who believe it may take just 3-6 months to sell their business. They’re surprised to learn that buyers expect owners to remain with the business for the time periods discussed above. This misconception — and others as well — can create significant challenges that have the potential to derail an owner’s plans and expectations for selling a business. Such a scenario is avoidable.
Surrounding oneself with experienced people is critical for a successful sale. If you envision possibly selling your business within the next few years, begin researching and identifying the team members who will support you now. They will help dispel any misconceptions you may have about the sale process and better ensure that the exit you envision is the one you actually experience.