What Private Equity looks for in Acquiring a DSO

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Recently, my partners and I all attended the McGuireWoods Healthcare Private Equity Conference here in Charlotte. While most of the southeast was still battling the remnants of what was Hurricane Irma, we had an opportunity to listen to sector experts as they tried to navigate the swirling winds of the healthcare industry. Make no mistake – healthcare is hot. There is a lot of opportunity, but it doesn’t come without an equal amount of risk. Here’s what we learned…

Private Equity Activity Overview

Overall activity has been very robust over the last several years. 2016 saw $270MM additional invested over prior year, and 89% of funds raising capital hit their targets – an all-time high. This has resulted in a very favorable environment for sellers. Buyers, on the other hand, find themselves in a highly competitive market, which leads some to consider newer sectors where there is still much consolidation to occur. Healthcare is one of those general sectors, but specific markets with a lot of highly fragmented opportunities are: behavioral health; physical therapy (including staffing); dentistry and dental practice management; and healthcare technology. All of this forecasts coming trends of consolidation with a high degree of certainty.

The year 2016 saw record highs for overall M&A activity in terms of both total capital and total number of deals. While 2017 has seen higher dollar amounts, there have actually been fewer numbers of transactions completed. This year we have seen an overall Debt:EBITDA multiple around 5.9X and a valuation multiple around 10.5X (EBITDA). Key takeaways are: robust access to capital; multiples continue to remain high; it’s a seller’s market; and it’s a very competitive scenario for buyers.

Considerations for Entrepreneurs who are considering Private Equity

I always find it fascinating to listen to panel discussions when the question is asked: “What do you look for or consider when you’re evaluating businesses?” Sometimes you never know what kind of answers you’ll get. Thankfully the panel in Charlotte was willing to share a lot with the audience.

Here are their Top 10 responses:

1. Be realistic about whether you’re growth-oriented versus value-oriented. PE is almost always focused on growth-oriented opportunities because initial valuation matters less as long as it meets with (growth strategy) return requirements. The goal is to double or triple the size of business in 4 to 6 years.
2. Can founders articulate a vision for the next 3-5 years? And what are the strategic moves you need to make to get there? If you say you’re growth-oriented, but you can’t clearly communicate your vision or how you intend to make it a reality, then you may not have many investors who are interested in your business.
3. Are you aggregating for aggregation’s sake? Or are you aggregating to operate (and build a platform)? When it comes to being growth-oriented, you have to be disciplined in your approach. And after you open new locations or acquire existing ones, you have to prove that you have the ability to operate those businesses effectively.
4. Many entrepreneurs take on debt to fuel growth, but be wary of using too much leverage to get a deal done. Don’t let your debt load constrain your ability to operate the business. You should be able to model these scenarios quantitatively.
5. Can you accurately assess the competitive landscape? And can you clearly communicate your point of differentiation? In other words, what’s your “secret sauce?”
6. Your clinical providers are the key to your growth and production. Do you have a strategy to attract clinicians to join you? And what is your turnover rate compared to industry norms?
7. What is your formal operating structure for your business? Do you have monthly reporting, quarterly board meetings, etc.? Or are you running your empire as if it were still a start up?
8. Is your house in order from a regulatory compliance standpoint? And do you have established, documented and monitored procedures in place to handle everything from a patient complaint to a state audit for billing fraud?
9. Is your leadership team consistent or do you have turnover at the C suite level? The PEG wants to know what kind of leadership turnover should they expect over the 4-6 years of their investment.
10. How fragmented is your ownership structure overall? Do you have 100 owners each owning 1% of the business or is equity concentrated in fewer individuals? Is decision-making based on simple majority or unanimous vote? This has a dramatic impact on how quickly decisions can get settled on major issues, but it also has an impact on smaller, day-to-day aspects as well. In short, who really cares about cost-cutting initiatives if they only own an inconsequential piece of the pie?

As an aside, if you’re an Emerging DSO (2-8 locations) and are struggling with any of these points above, we cover all of them in varying detail during our full-day “deep dive” sessions with our clients. Contact us for more details or download our Blueprints for Success startup package here.

And to answer the question: “What advice would you give someone who is considering a deal with a Private Equity Group?” Here are a few quick gems:

Look for a partner with an industry focus in your space. Yes, they’re going to buy your business, but they’re going to want you to stay on to help grow and operate it, so you want a partner who can bring some experience to the table.

1. Ask PE firm for their references. You should want to talk with those who have gone down your path and are “on the other side” now.
2. The closing process is never smooth. Be ready for an emotional roller coaster that takes twice as long as what you expect. Pick a trusted advisor to guide you through that process.
3. Ask about the day-to-day life with a PE partner after closing the deal. What’s it going to be like? What’s their playbook for the first 100 days after closing? Do they operate in a very formal manner or are there more loose constraints? And can you function under that structure?

Key Takeaways

I think the most important aspects of the conference for me were that so many people remain so bullish and optimistic about the healthcare industry and specifically the dental sector. However, that continued optimism is borne out of the ability to establish, grow and operate successful group dental practices. Excitement abounds, but this is not a case of a rising tide lifting boats with holes in them. The ability to execute is more important than ever. Operational details matter now and at the closing table.

To continue discussion on these topics or any others related to trends in our industry, please feel free to contact me at perrin@tuskbrokerage.com. TUSK is the leading dental middle market M&A advisory firm providing best-in-class services and flawless execution for clients worldwide. Advising Industry Leaders on growth opportunities, capital sourcing and exit strategies are what we do best. We combine historical experience with a progressive vision for our evolving industry in order to create the greatest value for our clients.

Special thanks to Bart Walker and all of the great people at McGuireWoods for hosting us in Charlotte. We look forward to seeing everyone at the conference again next year.

TUSK will be a featured presenter at the DEO Associate Summit in Houston, TX on November 4th where we will share “Compensation & Equity Structures for Associate Retention.” We hope to see you there as well!

Written by Perrin DesPortes, Jr.
Co-Founder & Partner at TUSK
perrin@tusk-partners.com