What to Look for Beyond EBITDA

EBITDA FamilyThe valuation of a business in healthcare is a game of risk and returns.  Usually the returns on an investment or purchase are shown through the EBITDA multiple that depicts historical success and predicts potential growth going forward.  Though EBITDA is clearly a major factor in determining the risks and returns to a potential buyer, valuators also tend to identify other areas of the business beyond EBITDA, outside of financials, where risk and returns can also lurk.

Jim Lloyd, Principal with PYA says that a key factor influencing the valuation beyond EBITDA is the market in which the business operates.

“Things that are important to an investor would be, obviously competition; both competition currently and what may be perceived in the future.  Therefore, consideration of whether the business is protected by a Certificate of Need, if applicable would be important,” Lloyd says.

Lloyd says that demographics are also a market factor that should be considered by investors.  Investors should determine whether the market (i.e. population) is growing or shrinking and the related demographic mix to evaluate future demands for medical services.

Lloyd also says to examine the strength of the current job market and the ability of people with health insurance that are able to pay for their health services.

“The market is very important from a competitive standpoint and from a patient based standpoint.  Whether the market is rural versus urban obviously makes a big difference,” Lloyd says

“The payer mix is also critical and generally influenced by the market.  For example, certain markets  will typically have a much higher percentage of Medicare and Medicaid patients; whereas other markets may have a better concentration of patients with commercial insurance.”

Lloyd also explains that patient concentration in the market is also a key risk factor.

“If you are in a market that has a high concentration of employees from a small number of employers, that is an important risk factor that should be taken into account. For example, if that employer were to downsize, some of the patient base could lose their health insurance benefits which could negatively impact the business.” Lloyd says.

“So, if you’ve got a patient base that is highly concentrated from the perspective of who pays for their insurance, for example, then you should factor that risk into the valuation process, such as through the discount rate or cash flow projections.”

When evaluating a company’s growth potential, Lloyd says it’s very facts and circumstances.

“Revenue is key and generally impacts value more than anything else.  Expenses and everything else should fall in line with the revenue base.

If revenue has grown substantially, then there are certain underlying things that would have caused it, such as expanded services or providers, etc. It is important to closely analyze the revenue base and develop a clear understanding of what’s driving the growth,” Lloyd says.

Lloyd explains that if there is rapid growth in a practice, it is probably not because of demographics, because demographics typically change more slowly.

Hunter Outcalt, manager with HealthCare Appraisers says that even the concentration of how much work is being done by the current owner/operator is important.

“I think, especially in valuation, we are looking at an owner that is also an operator or provider. If that owner/operator really is performing the majority of the duties or really is the draw that makes the business accessible; knowing that either they wouldn’t be signing on in a post-transaction setting could really impact negatively on the value of the business,” Outcalt says.

“We want to look at it not only quantitatively but also qualitatively and take into account these factors that we can’t see on paper and in a financial statement.  There should also be consideration of things like succession plans, do they have a partner that has been with them for 10, 15, 20 years that also has a relationship with these people? Are they bringing in someone that is just brand new? Will there be a transition period where the owner might stay on and help out a while?”

Outcalt says there are multiple factors to consider, but ultimately, there is additional risk surrounding an owner that might leave a practice that is very productive or very popular.

Vincent Kickirillo, managing director at VMG Health doesn’t stray too far from this topic when he discusses the importance of evaluating the current established management team.

Kickirillo says that having an established management team assists in reducing the risk of the go forward profitability, and therefore increases the value.

“To have an established management group, that is a positive risk factor.  This team knows what they are doing, they have operated in this industry before, have negotiated contracts, obtained volumes, know how to get capital deployed for any needed equipment, etc,” Kickirillo says.

Cohesiveness of the management team and the ability of them to show that they “get along” as experts in their field is very important, Kickirillo says.  On the opposite end of the spectrum, a management team could be a detriment if the seller has weak players or players that don’t get along with each other very well.  These types of management traits are something that would be a detriment to the excitement of the potential suitor.

“If you are the owner of a management company, and the accounting officer is not getting along with the staffing manager, and I, as a buyer am going to provide these management services on a go forward basis; that wouldn’t bother me too much because I would just, after a period of time, reassign or terminate the employment with the trouble makers and resolve the issue in-house,” Kickirillo says.

Outcalt says that capacity of growth in a business is something to always examine with growth projections.  Capacity in this sense can mean the physical capacity of growth for the building, or even the capacity for productivity growth.

“Whether it is a surgery center, physician practice, or hospital, nearing the building capacity really does constrict that high level growth that might be available.  I think part of what is also looked at would be, is there the opportunity to expand the current location, or if growth does happen, do you have to completely relocate?” Outcalt says.

Outcalt says when looking at a physician practice, valuators will calculate a business’ productivity and in the process, there are many benchmarks and surveys that can be used to assess where this physician falls.

Outcalt says if a business is off the charts in productivity, a valuator will want to know why a business is so productive and how this productivity looks for the future.

“An important factor to consider is if the owner/operator is approaching retirement age.  Are they still motivated to work as hard as they have historically?  A valuation really is forward looking, and the historical trends can be very telling and can help predictions.  With that said; historically if someone has been working off the charts and they don’t have much capacity left, is it really feasible enough for them to project growth in the business,” Outcalt says.

Fred Lara, partner of the Philadelphia office of HealthCare Appraisers says that this understanding of the physician lifecycle is important to a valuation process as are other factors associated with the sustainability of revenue.

“As you project, since valuation is always forward looking, you want to consider whether or not historical revenue is sustainable.  You want to consider whether your primary referral sources are near the end of their career and what might happen to volume thereafter.Similarly, if there is any out-of-network revenue historically, you’ll want to consider the sustainability of that revenue into your discounted cash flow model – either in your projections or discount rate.”

Out-of-network revenue relates to reimbursement obtained by ASC’s, typically at levels well above in-network centers, which may not be sustainable.  A final issue that Lara says is looked at though is not scrupled over is the current benefits plans of employees with the potential to stay on-board.  Lara says during a valuation there would be a review of what benefits are currently being provided to staff members.

“I don’t think that we would get into the granular level to determine whether or not there is compliance with ACA, but what we have seen and expect to see is that the ACA may be driving certain smaller employers such as ASC’s to adjust their benefit offerings to staff,” Lara says.


If you would like to learn more about the concepts covered in this article, want to sell your business or discuss how Ambulatory Alliances, LLC might be able to help you out, contact Blayne Rush, (469)-385-7792, or Blayne@ambulatoryalliances.com.

If you have suggestions for future topics, email Blayne@ambulatoryalliances.com.

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