Breathe New Life Through Recapitalization
Recapitalization is a great way for a healthcare business to breathe new life and funds into a business during a specific point in its life cycle. The Ambulatory M&A Advisor examines the ins and outs of recapitalization in the current market and where groups like Private Equity come into play for business owners looking to recapitalize.
Steven Berger,President of Berger Healthcare Executive Training and Consulting says that in the best definition, a recapitalization is a restructuring of a company’s mix of equity and debt. This would allow an organization to take new money in to pay off old debts and if they are a for-profit entity, potentially allow for the owners to “take out” money for themselves. Essentially, they are creating new debt (or equity) to pay off old debts, and generally will want to do this at a better financial rate.
“If you had money at capitalized at 4 percent and could get money now at 2.5 percent, you could be a winner, especially for the exact same amount of money. It is like a mortgage refinancing for a home owner in that you would refinance your mortgage if you could get better rates. Often, you can also take out more money, so it would allow you to have additional capital for the business,” Berger says.
As far as when a company should decide to move forward with a recapitalization, Berger says that he doesn’t know of anything being typical as far as when to capitalize. According to Berger, everything is fact based and every single organization is going to be different.
“If rates have gone dramatically lower, there is no question that a business would want to do it. The real issue is, why wouldn’t you do it? You can get cheaper money. I would simply put it that way,” he says.
“Depending on the life cycle of the organization, that matters too. You may be at a point where you need more money, and recapitalization makes more sense than just taking out a new layer of money. Let’s say you have 20 million dollars of financing already out there at 6 percent and the rates are now 4 ½ percent and you project needing an additional 15 million dollars; You would want to refinance the entire amount of 35 million dollars at the lower 4 ½percent, using the first 20 million of proceeds to pay off the prior debt. It all depends on where the company is and what its future needs are as the owners determine them.”
The Good and The Bad
Berger says the positives of recapitalization can be seen with expansion through recapitalization as part of a business’ strategic plan.
“You really want to have a strategic plan and a strategic financial plan. This way, you know why you are taking additional money, what you plan to do with it and what kinds of earnings you plan to make by investing this additional money. It should all be part of the organization’s plan,” he says.
Daniel Frier, founding partner of the Healthcare Law Firm of Frier-Levitt adds that there are financial risks involved with a recapitalization.
“With debt, one of the risks is signing personal guarantees, and if you can’t pay the debt, the bank is going to call the loan. If you choose the equity financing route, and take on a private equity group as a partner through the MSO model, the risk is that you dilute your ownership,” Frier says.
Berger echoes the risk factor by stating outright that after a recapitalization the business could fail, and therefore, all the money that needs to be paid back would not be able to be paid back.
“Keep this in mind, depending on where you are recapitalizing from. The people or organizations giving you the money are going to want some assurances. In some cases, depending on the size of the organization, they may ask for personal guarantees. It may be an organization like an ASC or physician practice and they may be sheltered by an LLC, C-Corp, or S-Corp. The owners may be sheltered and the lenders may not be willing to lend to the organization without personal guarantees. If you have to give personal guarantees and then the plans don’t succeed, the personal guarantees will come into play. Lenders will want guarantees that the money will come back to them,” Berger says.
Berger’s position on private equity involvement in a recapitalization is that wherever a business can get money at the best rates, with the best terms, then they should go for it.
“Banks have been the original lenders of money, but recently banks have had to become much more conservative in their lending habits and now we have private equity firms that are willing to either lend money or take an equity position in the organization,” Berger says.
“The ASC or physician practice has to decide whether or not they are willing to, on the equity side, give up a piece of their equity. In which case, the private equity firms may want to put one or two people on the organization’s board or they might be willing to lend it in a debt capacity. Private equity by the very nature of the name is more likely to want to take equity in the organization. You will have to be able to show earnings now and earnings in the future. If you are in that position then you are in a position to borrow money. The old adage is always true; lenders are more willing to lend money to organizations already making money than to organizations that are not.”
Jack Eskenazi, managing partner at Healthcare Advisory Partners says that typically in a recapitalization where a private equity group is investing and taking a control position in a platform company, management usually stays with the company.
Eskenazi says there are some occasions where a private equity group has already developed a relationship with a very strong executive and that executive is going to lead a platform investment.
However, even in that case, Eskenazi says private equity typically looks for strong management in an acquisition candidate and looking to incentivize strong management to stay.
According to Eskenazi private equity keeps management on by allowing them to retain equity, and so, if ownership is management, then they are probably going to retain, plus or minus 20 percent of the equity of the new company.
Frier says that when a recapitalization involves a medical practice and private equity the situation is different from a lot of businesses. Frier says that in this situation, business owners can’t have private equity investing in the medical practice. It has to be a licensed physician. Frier says that this limits the ability for medical practices to expand and secure capital.
“The way that I have seen practices get around that problem is for them to form what is called a Management Services Organization, which manages and runs the practice. That can be a regular business entity, which does not need to be owned by physicians,” Frier says.
He says the management fee pulls some of the profitability out of the practice, and that profitability can then be used to enhance the earnings of the management company.
If you have an interest in learning more about the subject matter covered in this article, the M&A process or desire to discuss your current situation, please contact Blayne Rush, Investment Banker at 469-385-7792 or Blayne@AmbulatoryAlliances.com.