PRIVATE EQUITY SALES: FACTS, FEARS AND MYTHS

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Independent practices are reacting with both excitement and concern in the face of new investment groups targeting offices operated by the three Os.

From a seller’s viewpoint, the thought of selling for an ultra-high premium is appealing. Rumors about very high multiples are making sellers feel like the old days when “dot.com” owners were selling their businesses before the bubble burst. However, independent buyers are nervous because they feel they can’t compete with private equity investors on pricing, and they expect that managing an office as an owner will be harder in the future. In addition to all that, vendors and suppliers are concerned about all of this consolidation and the effects it can have on eroding profit.

THE REAL STORY
Private equity groups see eyecare practices as fragmented and inefficient. Combine that with very low interest rates, and it becomes an attractive industry for investment. By consolidating multiple offices, efficiencies can be created by centralizing many administrative functions and making all the office “the same.” Billing, frame purchasing, marketing and human resources can all be operated from one corporate center and can serve multiple offices. These offices need to be within a certain radius of each other to obtain those efficiencies.

The problem is that every office needs to operate the same way, often with limited selection of products and services. Customized or outside-the-box services don’t always work with this model. Think of a franchise like McDonald’s or any of the regional eyewear chains. Like any large business, they are successful because their training books are uniform and every office operates in pretty much the same way. They have to carry the same frame, spectacle lens and contact lens brands, often in limited selections. Efficiencies often result in fewer choices for the customer. This isn’t necessarily a bad thing because a smaller selection allows the employees to be more knowledgeable about the materials and services offered. On the flip side they can’t offer “customized” options or unique products that some customers want.

MEASURING PROFIT
Of course, private equity groups want a return on their investment. They are not simply looking to make 5% or 10% yield. They want double digit returns . . . high double digits. To reach that level they need to purchase offices with a certain minimum revenue and net profit. Their definition of net profit is different than what most owners understand. Most owners see their net profit as 30%. That’s incorrect because it includes a salary to the owner for being a producing doctor. As an owner, after paying a reasonable salary to a doctor, the net profit is closer to anywhere from 10% to 15%. This is called EBITDA (earnings before interest, taxes, depreciation and amortization). Labor and rent are going to be the biggest factors in determining that bottom line.

Private equity buyers adjust (or “normalize”) expenses based on their own models, so their EBITDA might be different. Most people hear that private equity pays multiples of five to six times EBITDA. This sounds like a high premium, but it’s dependent on the normalized adjusted EBITDA. While your EBITDA may be 15% or 20% or higher, if their normalization results in an EBITDA of 10%, then paying six times multiples would be the equivalent of 60% of gross revenue. This 60% of gross is the average for practices nationwide based on the Goodwill Healthcare database of completed transactions. If they calculate an adjusted EBITDA of 8%, then that drops to 8% x 6 = 48% of gross.

Their EBITDA may differ from yours because of adjustments in their labor costs, doctor wages or capital expenses. For example, they may determine that it’s necessary to hire another manager, billing person or increase staff wages. The final sale structure may only be 80% cash upfront with the balance paid in the future. Additionally, private equity buyers often require the owner to stay employed for several years at a reasonable salary.

So, are sellers getting a good deal or not? It depends. If they want to continue working for three to five years, it offers the ability to cash out and still earn an income without the headache of ownership. This solution only works if (a) the seller’s personality works with the new “boss” and (b) if the practice net is sufficient to pay a salary and still have enough left over for the private equity investor.

MAKING THE CUT
If you’re grossing under $1 million, it’s less likely you are going to be purchased by a private equity group. The reason is because the investor needs enough money to earn a return. They are not always excited about businesses losing money. There are exceptions for strategic purchases in targeted markets, but the investor needs enough money to cover any initial losses until the practice grows enough to make a sufficient profit.

Individual and first time doctor/buyers are still able to get loans to purchase these larger practices. Numerous lenders offer 100% financing to buyers with little to no down payment. The loans are based on the time licensed, the credit score of the buyer and the cash flow of the practice. Seller’s still have choices in the sale of their practice.

INDIVIDUAL BUYERS/OWNERS
Is there still a market for individual owners? While consolidation gives the impression that the answer is no, reality tells us otherwise. For the larger practices, not everyone is going to be a fit for private equity groups, nor will every seller want to go that route. Also, the average practice revenue is still around $700,000 per year. Over half of the practices are not viable candidates for private equity investors because their revenue does not support that model (not enough profit). While some have potential to grow, it just doesn’t make sense for an investor to buy most offices of this size.

However, from an individual’s standpoint it still offers quality of life and income for those seeking to be their own boss. Business ownership (especially for a married couple) offers an excellent balance of work and play while allowing the owners to control the days they work and the style in which they treat their patients. Most doctors become owners because they are tired of being told how to treat patients, what hours they work or when to take a vacation. These medium size practices allow them to offer individual customer services, make a good income and take time off at their discretion.

While some aspects seem like a commodity, the business of optometry is still based on customer service. Individual owners can succeed and thrive by differentiating themselves from the large corporations and private equity groups. This is accomplished by offering unique products and providing custom solutions or specialty services.

Scott Daniels is the principal broker and co-owner of Practice Concepts along with his wife Alissa Wald, OD. Practice Concepts has completed thousands of successful practice transitions over the last 20 years, providing appraisals, buyer and seller representation and partnerships. Daniels is the CFO and helps manage two large practices with combined revenues of almost $5 million. He is a licensed real estate broker and has extensive financial background working with a variety of businesses and medical professionals. His expertise includes practice appraisals, commercial real estate sales and leasing, tenant representation, and brokerage. Wald is a managing investor at another location. Contact them at 877.778.2020 or ScottD@PracticeConcepts.com.

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