June 15, 2016
For virtually all sellers of healthcare companies, the most important concern is: How much money will I get? This is understandable – sellers want to be rewarded monetarily for the hard work required to grow their businesses. The issue of deal value is raised in almost all early discussions. Healthcare buyers are similar: they quickly want to know what sale price a seller is expecting, so they don’t spend time pursuing a deal which is ultimately priced above their resources or valuation parameters.
However, we always encourage our clients to look well beyond the numerical value of a deal. There is so much more that must be considered when choosing the best offer. In fact, despite being frequently asked, we do not list an “asking price” for our clients who are selling their companies. To do so would not only focus too much attention on the value, but might also scare away suitable buyers who initially would submit offers of lower value but better overall terms.
We agree that the value is important, and always strive to obtain the highest price for our clients. But, ultimately, we strive to find the best overall offer, and such an offer must satisfy a large number of additional concerns. As our clients begin the process of marketing their companies and evaluating offers, we ask them to consider the following important transaction variables.
Terms that Affect Monetary Proceeds
Healthcare sellers usually want the highest “sale price”, but when considering value, ultimately what matters is the net present value of what they will be left with after the sale is complete. This is determined by several terms of an offer.
Deal structure. In general, there are two ways a deal can be structured: asset sale or stock sale. (A detailed description of these two deal structures is presented in a separate Fleetridge blog post). The post-closing proceeds to a seller can be greatly influenced by which structure is proposed by a buyer. The reason for this is mainly due to taxation. In general, a seller usually benefits more from a stock sale, since the proceeds of the sale are often subjected to a lower tax rate. This is especially true if the seller’s business was established as a C corporation. Buyers, on the other hand, often prefer asset sales, because they can record the value of the assets being purchased at fair market value and therefore benefit from higher tax deductions.
Liabilities of the seller are also handled differently based on the deal structure. Again, sellers usually prefer a stock sale, because the buyer is essentially acquiring the entire entity and this includes the risks and exposures from actual or potential legal problems. Buyers often benefit more from an asset sale because they don’t assume these liabilities. Purchase agreement terms usually attempt to reduce the exposure of a stock sale to buyers, however.
For these reasons, the seller of a home care or hospice agency, clinical laboratory, or medical practice may accept an offer with a lower sale price if that offer is structured as an stock sale. The seller may actually have more money when the process is completed.
How the Sale Price is Paid. Usually, the best payment method for a seller is to receive all the sale proceeds at closing in the form of cash. However, this virtually never happens in healthcare acquisitions. The goal then becomes to maximize the amount of cash paid at closing while accepting some, or all, of these additional payment terms:
- Holdback: some amount of the sale price is usually set aside in an escrow account, to be paid to the seller at a later date. The purpose of this holdback is to provide funds out of which unexpected liabilities of the seller can be paid post-closing. Usually this holdback does not earn interest. But, it is real money that is dedicated for the seller, and there is no risk of non-payment (except for deductions if required for liabilities). Sellers need to consider how much money is being set aside, and when its transfer will occur.
- Seller Financing: Some buyers may ask for, or be required to obtain, seller financing. This is basically a loan from the seller to the buyer to help pay the purchase price. This loan will earn interest, but does involve a risk of non-payment if the the buyer is struggling financially at the maturity of the loan. Sellers need to consider how much money is allocated to seller financing, the interest rate, the term of this loan, and if they are willing to accept the risk of default.
- Earnouts: Occasionally, the overall value of an acquisition will include future payments made to the seller based on the performance of the acquired company post-closing. These are called “earnout” payments, and can be based on many parameters such as future revenues, profit, cash flow, maintaining contracts, keeping key employees, and so on. Earnouts are sometimes not popular with sellers, because the final sale proceeds depend on future events that are controlled mostly by the buyer. But, if the acquired company is growing quickly, or has not yet realized the benefit of new business, then earnouts may benefit the seller.
Treatment of Working Capital. Working capital is generally defined as current assets less current liabilities, but the specifics of this definition vary from deal to deal. Many buyers will allow a seller to benefit from the amount of working capital at closing, and this may provide additional money to the seller beyond the actual price. For example, if a home health agency gets multiple new patients before the close of its sale, and hasn’t yet been fully paid for this work, the seller will often receive compensation at close for these receivables. But, this is not always the case. Sellers need to evaluate each offer to calculate how much money they may receive in addition to the sale price from receivables, cash on the balance sheet, and so on.
Method of Determining Price. In an offer letter (letter of intent), the method of determining the purchase price is often described, and the amount actually paid at closing can deviate from this based on the outcome of due diligence. Sellers need to consider how much the price could drop by the closing date. For example, the price may be based on cash flow, the retention of key contracts, maintenance of patient census, and so on. If there is less risk of a price change at closing, a seller may accept a lower offer.
Paying Debt. In almost all deals, the buyer will require that debts of the seller be paid at closing, out of sale proceeds. Sellers must therefore consider that the post-close proceeds will be affected by their level of debt, and exactly how each buyer wants that debt handled.
Considerations Other Than Deal Value
Healthcare sellers may accept a lower value offer if that buyer is qualitatively more suitable than others. Of course, even a good offer is meaningless if the buyer is unable to close the deal. Also, the seller must consider what steps will be needed before closing and what is likely to happen after the close. The following represents many, but not all, of the subjective considerations of which a seller must be mindful.
The Future of Patients and Staff. Healthcare business owners are all motivated by compassion and caring for their patients and staff. They always consider what will happen to these people after the close. Sellers also want their personal legacies to continue, and strive to maintain the good reputation of their agencies and businesses post-closing. When selecting the best offer, sellers therefore must question which buyer will be best able to support the well-being of patients and staff.
Buyer Financing. If a buyer lacks the financial resources to complete an acquisition, then all other considerations are irrelevant. Sellers need to do their own due diligence into each likely buyer’s cash on hand and need to obtain financing, regardless of the deal value proposed by that buyer.
Need for Approval. Some buyers need to obtain approval from another person or group prior to completing a deal. For example, a board of directors or other associates of a buyer may be able to block a transaction from closing after due diligence. Sellers need to determine who will make the ultimate decision to proceed with a transaction.
Buyer’s Intentions. Sellers of healthcare businesses should consider why each particular buyer is interested in acquiring the company. Some reasons may be more compelling than others. A buyer may cancel a deal at the last minute if their motivations are not strong.
Thorough Due Diligence. While infrequent, some buyers do not plan on doing complete due diligence. While arduous and frustrating, thorough due diligence represents an important part of a transaction. It protects the buyer from acquiring a company it does not fully understand, and it protects the seller from being blamed for providing incomplete information. Healthcare companies require especially careful diligence, given the complexity of having third party payers and the potential for regulatory and legal challenges. If a buyer claims to be able to close a deal in a very short time, without doing complete diligence, the seller must be wary.
Non-Compete and Non-Solicitation Clauses. Most buyers will require the seller to refrain from competing after the close, and refrain from soliciting the services of nurses, therapists, administrators, and other employees of the company being sold. Sellers need to consider how long they will be bound by these clauses, and what geographic region will be restricted.
ADR’s and Other Regulatory Issues. If a seller is working through ADR’s, audits, ZPICs, and other regulatory challenges, a buyer who understands these issues and is not threatened by them is often the best buyer.
Exclusivity. Any legitimate buyer would require that the seller be “exclusive”. That is, the seller could not look for other potential buyers until the offer expires. Some buyers are willing to be “mutually exclusive”, which means the buyer will also honor the offer by not looking for other sellers. If the buyer is a very large company or group, this bilateral exclusivity is not needed. But, if a seller is looking for bilateral exclusivity, a buyer who agrees to it is often favored.
Termination Prior to Close. Any offer can be terminated prior to the close, if a good reason becomes apparent. However, sellers need to consider who can terminate the agreement. In some cases, either the buyer or the seller can independently cancel the deal. In other cases, the decision must be mutual. When mutuality is required, and the buyer refuses to agree, it is possible that a seller could be restricted by exclusivity for a prolonged period. This could mean that the seller could not legally look for other buyers until the period is over.
As the above considerations show, the asking price or offer price are just numbers that do not tell the whole story. Sellers of healthcare companies, like any company, must consider the entire set of terms offered by the buyer before deciding which offer is truly the best. At Fleetridge, we insist that buyers submit written and complete offers early in the process, before too many discussions occur about the simple price. That way, our clients can evaluate the complete strength of each offer. Often, sellers are happy to accept less money in return for a large number of agreeable terms.
About the Author:
David Hicks, M.D. is the Vice President at Fleetridge Pacific Healthcare Mergers & Acquisitions. He gained significant investment banking experience while working for the high technology mergers and acquisitions group at Morgan Stanley in New York City. David’s understanding of the goals of Fleetridge clients is augmented by his clinical healthcare experience, which includes earning a medical degree, briefly practicing clinical medicine, and conducting award winning basic science research. He earned a Bachelors degree in biology at Harvard College, and an M.D. at the Columbia University College of Physicians and Surgeons.