Commentary:

In the last edition of our Monthly Insights, we provided guidance on four steps to follow when pursuing an outright sale or capital raise to maximize value. In this edition, we continue to build on that theme by offering some company-specific value drivers for healthcare organizations.

These five value drivers are based on our experience of what strategic and financial (private equity) buyers consider or emphasize when evaluating an appropriate valuation to place on a target. The more a company has of these factors, the more likely a company is to achieve a premium valuation.

1.Scale

Scale demonstrates a successful model that is working well and has likely been built over time. Size helps mitigate risk and volatility.  There is also scarcity value to scale as there are fewer scaled players in healthcare’s highly fragmented sectors. Buyers also typically believe it is easier to buy vs. build scaled businesses.   

2. Payer Mix

Payer Mix is important as it can indicate favorable or unfavorable reimbursement rates and the likely stability of a company’s revenue stream.  Typically, the market favors a commercial insurance mix as it provides for higher reimbursement rates and does not share the risk of CMS rate cuts that come with Medicare and Medicaid.

3. Margin

Margin is somewhat a “Goldilocks” factor where it needs to be “just right”.  Too high of a margin can be a red flag that appropriate staffing levels are not being achieved and clinical quality is suffering.  Alternatively, if margin is too low, it is an indicator of poor operational efficiency, and the new buyer will need to expend significant resources improving margin.

4. Diversification

Organizations with many service lines mitigate risk by providing a variety of focus areas that can offset each other when times become volatile.  It also represents the availability of multiple growth levers that can drive additional revenue opportunities.

5. Growth Rate

A company’s growth rate is an excellent indicator of strong upside.  It can also create the perception of a management team executing on well thought out strategic plans with substantial white space to capture additional market share.

Our active healthcare deal flow and our processes are designed to create competitive tension; highlight the critical factors that drive value in the market and are aimed at increasing a buyer’s willingness to pay premium multiples for our clients. If you are a healthcare business owner and would like to have a confidential discussion on your specific strategic options, please feel free to reach out to one of our healthcare team members directly.

Commentary:

• Founders and owners of Healthcare companies continue to see first-hand how strong the Healthcare M&A market has been over recent years simply by the number of inbound calls they are getting each day from interested strategic and private equity buyers.
• Valuation multiples continue to hold strong for the right companies across numerous healthcare sectors. However, oftentimes we see too many business owners leaving money on the table simply because they were not adequately prepared when selling their company.
• To avoid this common occurrence, we recommend the following steps when pursuing an outright sale or capital raise:

1.Get Your Financial House in Order

Companies with detailed and accurate financial statements always fare better than those with poorly compiled financials.  Buyers use poorly-prepared financials to their advantage when negotiating valuation.  Sellers should strongly consider using a reputable accounting firm to convert from cash-based to accrual-based statements, and invest in a Quality of Earnings Review ahead of a formal launch to the market.  

2. Metrics, Metrics, Metrics…

Alongside detailed financial statements, sellers should be prepared to provide detailed operational metrics to buyers.  This includes accurate billing and reimbursement history, changes in reimbursement rates over time across service lines, as well as any quality/outcome metrics appropriate for the practice going back several years.  Healthcare companies with more detailed and accurate metrics are typically cleaner for buyers to analyze and ultimately sell for higher valuation multiples.

3. Bench Strength

Many times private equity buyers will use perceived gaps in the management team as rationale to reduce the price they are prepared to offer to a seller.  Consider a company being sold for 10x earnings that needs to hire a key team member for $200k annual salary.  Many buyers will use that as justification to reduce the valuation by $2M.  Demonstrating that the right team is currently in place will help sellers avoid this situation.

4. Run a Process

This will sound self-serving coming from us.  But it is true.  Running a formal sale process will almost always yield a better valuation for the seller.  Even if you have only one chosen buyer in mind (as opposed to marketing the business to multiple potential buyers), the fact that you are working with a skilled M&A advisor and there is a perceived threat of competition, the buyer will likely end up agreeing to pay a higher valuation than they would have otherwise.

• Investment in mental health services in the United States has increased significantly over the past few years; yet there remains a gap between inpatient care and outpatient care. This gap has created in influx of interest and capital into the outpatient treatment modalities as M&A in inpatient facilities cools off.
• A growing number of providers are turning to acquiring intensive outpatient programs (IOPs) as an effort to provide sub-acute care after a stay in an inpatient program. Payors, who are looking to keep patients out of higher cost inpatient facilities, have expanded access to IOP programs, reducing the need for more acute care.
• In July of this year, the U.S. Centers for Medicare & Medicaid Services proposed a new rule that would allow Medicare coverage of IOP programs for both mental health and substance use disorder treatment. This proposed rule would create an opportunity for clinicians to step-down care. Well established IOP programs are poised to capitalize on the industry momentum, as strategic and private equity backed platforms seek to expand their portfolio of wraparound care services. This broadening of step-down service offerings has resulted in the majority of acquisitions completed this year being follow-on investments rather than platform acquisitions by private equity.
• M&A activity in the behavioral health industry peaked in 2021, with 266 transactions closed. 2022 experienced a modest decline in deal volume to 201 completed transactions coupled with an erosion of EV/EBITDA multiples paid for deals as the cost of capital increased and leverage covenants tightened. In 2023, deal flow has trended in-line with 2022, that said, we continue to see demand hold strong for outpatient treatment providers, including those offering IOP programs and a renewed interest in potential deals that didn’t make economic sense in 2021 when valuations were reaching frothy levels.
• Given the favorable industry tailwinds from both the provider and payor sides, we expect demand for quality outpatient behavioral health companies to continue and drive an active M&A market for the foreseeable future.