Optimize the Value of Your Urgent Care Center
Blayne Rush, President of Ambulatory Alliances, LLC, and Curtis Bernstein, Managing Director of Altegra Health, recently answered some important questions that every urgent care business owner should examine if thinking about selling their business. In this Q & A with The Ambulatory M&A Advisor, Rush and Bernstein clarify what investors examine when determining the value of a business, and how to ensure that your UCB is appealing through clear financial documents.
Q: How does a buyer or investor value an urgent care business?
Curtis Bernstein: A lot of businesses within healthcare and a lot of arrangements are generally affected by the Anti-Kickback Law and the physician self referral law, also known as the Stark Law. Under either of those there is concern with paying a physician that otherwise would refer business to an entity, for that business. Therefore, to offset that, the laws require that any transaction involving referral sources, be set at what is known as fair market value. Fair market value is defined as what a willing buyer and willing seller would pay for a business having knowledge of all the relevant facts.
The Stark Law was created in the 1980s. It started with the same definition as revenue ruling 59-60, but it added in without taking into account the value or volume of referrals. It applies only to the healthcare space where the Anti-Kickback Law and revenue ruling 59-60 applied to more than just healthcare. The Stark Law, only deals in certain arrangements called designated health services; to which a physician might have an ownership in an entity to which they refer.
By taking out the value or volume of referrals, what we generally want to look at from a valuation perspective is only the lost cash flow to the current owners and how the business runs today not accounting for what might happen after a company buys the business that might otherwise get the referrals from the prior owners of the business.
For example, a hospital is buying an urgent care center (UCC), and if the hospital is able to earn higher revenues related to the patients of the UCC, we’re generally not going to take that account in the value of the business because that is only generated by the ability of the physician to refer that business to that hospital and the hospital getting the higher revenue.
There are other standards of value as well. If that referral does not exist, you may follow another standard of value; for example, investment value. An investment value states what the value is to the buyer of the business. The Stark Law requires fair market value; it does not allow you to use investment value. However, with those referrals no longer involved with the business, for example, a physician retires or the entity is not owned by a person or entity that could refer any business;then the fair market value standard does not apply and you can use the investment value. When using investment value what you might look at are synergies. For example, I am able to get higher revenue from the provision of the services that an entity has provided in the past. As a result, the company may be worth more in a synergistic market than in a fair market value market. That’s not to say that they can’t be worth the same. In the fair market value standard, you still need to look at your world of hypothetical buyers and who is out there to buy your business. So if you’re selling a business of 20 UCCs, the buyer may not be the same as if you’re selling a 5% interest in a single UCC. If the hypothetical buyers are able to gain efficiencies from their purchase, the standards of value may overlap. Also, from the fair market value standard, you’re going to want to try to achieve your highest value for the business as well. You need to take into account what the returns on investment of the buyers are in the market and how to maximize that from the fair market value standard.
Blayne Rush: I’d like to point out, while investment value is the value that is only to one particular investor, in some cases we have urgent care platforms out there that would have unattractive contracts. Say you have a contract that says you will get $1.00 for a service but the one buyer happens to have contracts at $1.50. Under the fair market value standard you can’t just take that one investor and use those contracts as a way to recast your financials to capture that value in a transaction but if you have a contract that pays $1.00 for a service but a significant amount of buyers even under the fair market value standard receive$1.25 or $1.50, you’re way below. There is an argument that can be made that you can be bumped up, and can capture some of that value even under the fair market value standard. Under the investment value standard, those restrictions are out the window in the sense of you can capture all the synergies and the strategic value.
Let’s talk about the market value; the price at which a center or business would transfer for cash or its equivalent under prevailing market conditions in an open and competitive market. Prevailing market conditions is the current point in time. The open competitive market is all of the buyers competing for your business and at that same point in time.
If you market to all potential buyers at the same point in time, that is when the maximum value comes into play. Essentially, it’s an auction or competitive bid approach. You push the entire market up whenever you get competition going among the buyers. You are then able to shift the FMV spectrum of the buyer pool up, because now they are competing, you’re negotiating; you’re maximizing and capturing all of that value. All because you are going to everyone at the same point in time and making them bid against each other.
Q: How are Urgent Care Businesses Valued?
Bernstein: A couple of methodologies I use to value UCCs include market approach, usually using EBITDA, and, the discounted cash flow method (DCF), which is the time value of money. What you’re saying is, if I put a dollar in the bank today, how much I need to earn to get $1.50 back within a certain time horizon. A valuator will generally use a horizon of 5 years because it is the length of a general business cycle that an entity will go through. However, 5 years does not always have to be the model. If there is significant growth out 10-15 years it can be used. If the entity is currently at maturity, a valuation expert or buyer may take the earnings today and assume that the business will grow consistently at a mature rate going forward.
It‘s important to ensure that any amount communicated to a buyer is correct, based on what you really expect the UCC to earn going forward. Explain projected earnings and the expected rate of return that buyers are going to need on their investment.
The rate of return is will vary based on the buyer’s comfort level with the projected amount of earnings and cash flow that has been projected. They will ask if the projected amount is truly possible to earn. Once projected earnings and cash flow are understood, the expected rate of return is going to be much higher if they don’t believe the projected earnings and cash flow are possible.
Rush: It depends on the complexity of the business that’s being bought or sold and the complexity of the players within that transaction. There are two main formulas that they will typically use. One is the DCF, the other is industry standard multiple of trailing 12 months EBITDA. Either way, buyers will communicate a UCC’s value for the most part as a multiple of the trailing EBITDA.
The DCF takes typically 5 years and uses cash flow projections and discount that to the present value. A growth rate is added into the equation and the expected rate of growth is found. This is why your financial and operational data need to be clear and correct.
You need to know when a new service was started or when a new center was put into service because growth is different for new centers and new services.
You can add different growth rates to different centers and different services within a center. They’ll then reduce that by the cost of capital, and then reduce it by adding a discounted rate. There is a potential that we get the growth rate projections wrong. That’s why you have the discount rate in there, to discount the financial projections. They will reduce it by the cost of capital etc. then come up with the net present value. The challenge with the DCF is that essentially, “garbage in, garbage out”. The financials and other operational data cannot be garbage, or you’re inserting that into a formula that will end up with a much lower selling price than you could have if you would optimize all of the information. It needs to be clean and clear.
Also, you need to understand the adjusted EBITDA, because that is your best starting point. It makes all of this a little bit easier on both ends of the negotiation. This is because the financials are clean and clear and buyers get a better understanding of the company’s present value.
Q: How can your financial and operational documents be prepared in order to maximize value?
Rush: You want to have your financials in the easiest readable format for your potential buyers. They need to understand it in 15-20 minutes, just by glancing at your financials, whether or not your business is worth further significant time investment.
For example, if you own 5 centers with 5 services for each center, you want to have the centers presented in an organized manner. Each one of those centers need to have its own line within the financials and underneath that, each service has to have its own line with the income and expenses broken
In regards to operational data, you need to understand what patients are coming through the door for what type of services. This transparent view of your business makes the valuation process much easier and people don’t have to dig through the data you present.
This goes back to the growth rate. Some buyers use an industry multiple of EBITDA, or will go through the process of the DCF. Some will look at your EBITDA, look at your numbers, acuity of the cases etc. then project a multiple of EBITDA based on the information. If you have recast your financials, then you are in a much better position to capture a higher multiple of EBITDA of that higher EBITDA with those types of buyers.
Bernstein: You need to present the information clearly to the potential buyer. You may have various service lines within an organization. There may be different growth in different service lines. You may have recently added a service line and it is in a very early ramp-up stage. If all you present is just one professional collection of revenue line on an income statement the buyer is not going to know the current phases for any of your centers or services.
Q: How do valuation experts recast and normalize financial statements?
Bernstein: You want to recast your financial statements to show the different service lines over time and try to break that out using billing reports. If you’re thinking of selling, it makes sense to start tracking this information early so that it’s a lot easier to present on the day you’re looking to bring in buyers.
From a normalization perspective we look at expenses and make sure that all of them are reasonable. Anything that is a one-time expense that is not going to be recurring is generally normalized out of the financial statement. Once that financial statement is normalized the historical income statement is presented, the adjustments made are show along with an explanation of the adjustments, and an adjusted cash flow from a historical perspective is provided.
Rush: The industry is an emerging market because there are many inefficiencies that can be reduced by buyers. If you recast for the maximum value, you’re able to show a greater profitability, and can potentially capture high multiples.
Keep in mind positions or sellers will want to maximize the value capture and maximize the recasting, while buyers want to essentially minimize it. Buyers are going to scrutinize the add-backs, and the process is going to be a game of tug-of-war. That’s part of the due diligence process and you want to maximize your profits as a starting point.
If buyers do end up scrubbing your financials, they won’t tell you about it, and come back with their offer. If you have not properly recast and normalized your financials, they will, and you could end up leaving thousands of dollars on the table.
Q: How does a valuator assess multiples?
Bernstein: Multiples are currently higher in this market. With population health management, health systems generally see urgent care as a needed part of an accountable care organization that is managing their patients and will be reimbursed for keeping the cost of healthcare down.
With the valuation, what we are generally going to do is look to the market and understand what the multiples are. Looking at a valuation report, one of the biggest issues is not having a significant number of publicly reported transactions in a healthcare space outside of hospitals. A lot of smaller transactions do not present the information needed to assess comparability between one specific transaction, and the separate transaction that you are involved in currently. We have a lot of conversations with the buyers of these types of entities and get an understanding of where these multiples are. Most valuation reports that you’re actually going to see will use an income approach or DCFM and will determine a value. When that value is compared back to EBITDA, you see if the multiples make sense for what you’re buying. It also must be confirmed that the deal is of fair market value. In a fair market value setting, the particular deal will include the purchase of all assets including tangible and intangible.
Rush: Buyers go into a deal and havea number in mind based off of what type of buyer they are. They might have debt covenants, or contractual laws that say they cannot pay more than “X” multiples of adjusted EBITDA. The buyer will then recast the financials as if they are running that center and make an offer based off of what the profitability of EBITDA would look like if they were running the business.
Multiples are very deceiving in the sense that it’s a multiple of “what”. That’s the problem with comparables, is that you don’t have all of the information.
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