Creative Structures Capture Value for “Embedded Growth” Potential in Desirable Practices. Lock in Values Now to Reduce Risk.
Summary: Your rapidly growing practice can be monetized at today’s value, yet still pay you for value not yet realized in a creative structure based on your results AFTER the initial closing.
In the booming economy we are experiencing, many doctors have embarked on strategies to expand their practice with hopes of rapidly increasing collections or EBITDA. This could be via new marketing initiatives, additions of associates or the opening of new offices. Others have implemented strategies to grow internally and decrease expenses to boost their near future EBITDA levels. And still others, typically orthos, have experienced recent case start growth which results in embedded future EBITDA growth not counted under cash accounting methods in the current EBITDA calculations.
These various initiatives cause doctors to delay entering into the monetization process with the notion that now is not the right time to begin the search for an IDSO partner. The doctor’s wait theory is that their earnings will be much higher a year from now than they are today, thus their value realized will be significantly higher if they wait to start the process.
The various risks of delaying the start of the process are outlined in more detail in the memo THE RISK OF WAITING. These real risks include natural disasters (floods in Houston, fires in California) health risks in single doctor practices and the onslaught of unexpected competition or loss of key referral sources. (See Risk of Waiting Memo)
While waiting is certainly a logical strategy in many cases, it is also high risk. The safe solution is a creatively structured transaction which will both enable a doctor to benefit from today’s bubble values and still get paid for FUTURE growth in EBITDA or top line revenue, after closing. We have done it.
One thing to keep in mind is that LPS engineered transactions typically tie the final purchase price/practice value to a calculation based upon the Trailing Twelve Month’s (TTM) EBITDA ending the month prior to closing. A typical LPS process will take about six months from the date that full data is provided to us to cash in your bank account. What your EBITDA is on the start date is a guide to value, but those practices with rapidly growing EBITDA will benefit from that growth at closing due to the value determination measurement date typically at five months after the start date.
LPS Transactions where the Doctor’s Embedded Growth Potential was captured for the doctor via creative deal structures:
#1: GP in a Southwest state.
This young doctor had admittedly been “coasting” in his practice for the two years prior to engaging LPS to monetize his practice. He was only chair side two days per week on average and while still the primary doctor in the practice, he was spending more time vacationing than working. His value based on TTM EBITDA was not as strong as it should have been solely due to his lack of time invested. The potential IDSO partner was eager to partner with him, but could not justify the value level he desired to complete a transaction.
LPS devised a structure that had an initial closing based upon the then TTM EBITDA, but the agreement stipulated that the transaction would be repriced on the 12 month anniversary after the initial closing at the same multiple on the THEN trailing TTM EBITDA. This structure would increase the value received by the doctor by about 30% if he went back to work. The doctor worked and earned an extra $1,000,000 in practice value, paid on the one year anniversary of the initial closing.
The key to this structure was that it was NOT a bonus, but rather a repricing of the original deal. The difference being that a BONUS would be taxed at ordinary income rates and a repricing payment was at Long Term Capital Gains tax rates.
This structure also gave the doctor the benefit of the resources of his new partner in those 12 months to reduce his administrative burden and benefit from the IDSO’s far superior marketing prowess. His growth rate was far faster than had he simply gone back to work in his own singly owned and managed practice. He captured his embedded growth potential in the sale value and actually increased it considerably due to the benefits of his new partner.
Example #2: Multi-Specialty Group in a Western State
An IDSO was eager to acquire a rapidly growing group of young specialists. The IDSO offered an extraordinary value based upon historical earnings, but the doctors wanted to wait to harvest the value from their rapid growth. We knew that this particular geography was about to have a very large new competitor. We felt the doctors should transact now, not after the competitor had arrived and changed the dynamics of the market significantly, thus potentially deterring future buyers in the area at all. Waiting was a large risk for these doctors.
To convince the doctors to transact NOW rather than later, we structured a part of the purchase consideration to include a component that increased the doctors’ value and cash received by 1.25X the growth in collections in the first and second years AFTER closing. After the initial closing, the doctors received additional cash equal to 1.25X their TOPLINE revenue growth at the end of year one and again at the end of year two.
This structure enabled the doctors to fully harvest their embedded growth in full, while not taking the risk that their practice values would decline precipitously if the new competitor arrived as we expected. Their new partner would also give them the resources to compete more effectively and possibly even deter the new competitor from coming to the area at all.
When a doctor is highly attractive to an IDSO, the IDSO will get creative and agree to structures for the doctor to benefit from his/her embedded growth as long as that growth can be defined. It does not usually work for practices with flat revenues who have not created a story and a realistic plan to justify an upward purchase price adjustment post-closing.
Waiting is risky. If you can get paid for the embedded future EBITDA growth and lock it in at today’s values, it is the best of both worlds.
Chip Fichtner, Principal
Large Practice Sales