I Just Received an Offer from a Private Equity Firm. What Should I Do Now?

The appetite of private equity (PE) firms for investing in health care assets has continued to grow in recent years and shows no sign of slowing. According to a recent Bain Report on Global Healthcare in 2021, the private equity industry set new records for deal volume, deal size, and total dollars raised for future healthcare investment. And even though billion-dollar deals dominate the business press, private equity buyers are eager to acquire the consistent cash flow and growth potential that health care practices can provide.

Dermatology and aesthetics practices are especially attractive to private equity firms since there is an imbalance of supply and demand fundamentals, benefits of economies of scale, and independence from hospitals. As a result, during the last decade there has been a significant uptick in physician practice M&A activity in the dermatology space. Our firm has advised many dermatology practices of this type and we often see physicians who have excelled at building and running their practices struggle to manage a private equity transaction on their own.

By now you’ve likely heard of peers or former colleagues receiving multi-million-dollar unsolicited offers from PE buyers (perhaps you’ve received one yourself), but the lure of a big payday can often obscure the many pitfalls and challenges that exist when considering such an important transaction.

Getting private equity involved in your medical practice comes with plenty of questions. Is it better to sell to a private equity group or to an area hospital? Can you maintain operational independence after selling to a private equity group? What are the regulatory issues? How are these deals typically structured and what is fair compensation?

All these issues, and many more can overwhelm even the best run practice group. Addressing this gap in the market is why we founded Physician Growth Partners (PGP) in 2017 and work to proactively advise and advocate for practice groups exploring a transaction with health care private equity investors.

What to look for in a transaction advisor

Because private equity transactions often begin with a physician practice receiving an unsolicited offer, some may think that hiring a transaction advisor is unnecessary. Some may think, “I have an impressive offer in hand” and not feel they need any assistance. Others may already have a relationship with the potential investor and believe that they can negotiate on their own to strike a good deal. Still another thought may be that the physician’s own lawyer or accountant can handle the transaction alone.

In fact, these beliefs can all lead to errors with potentially far-reaching consequences.

Just as you wouldn’t sell your house to the first person who knocks on your door and is willing to write a check, physician groups should never limit their negotiations to just one bidder, no matter how impressive the first offer is.

And what about the offer? How does a physician accurately evaluate what is a fair value for the practice they’ve built? Few physician organizations have the time and expertise to run a transaction process that will evaluate all their options, while also having the ability to complete the financial analysis, marketing, and negotiation of a private equity transaction without assistance.

For example, it is extremely important to understand the difference between EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) and multiples, as well as to focus on which offers more benefit to the selling physicians. When properly employed, advisors for an investment bank/health care transaction also negotiate key employment agreement terms that include maintaining comparable support staff and vacation days, as well as ensuring that appropriate protection mechanisms exist in the agreement to maintain clinical autonomy after the transaction.

There is a small cadre of health care transaction advisors who handle only deals involving physician practices. These firms have expertise in working with specialty physician practices, know how to uncover their appropriate market value, and are experienced in effectively communicating the practice value to a wide range of private equity bidders to achieve the best deal price and terms. Here are just a few of the key criteria a physician should consider when choosing a transaction advisor:

• The advisors’ relationships with and knowledge of potential private equity bidders
• Their knowledge of and experience within the dermatology or aesthetic sector
• Their ability to educate you to understand the deal process and your options
• A clear track record of success through past client references

Understanding the private equity perspective

When considering a private equity investment, one of the first things that can help a physician get their bearings is to learn more about what PE firms find attractive and how an acquisition fits into their overall strategy. By understanding the private equity perspective, a physician group can make better decisions throughout the process.

Private equity firms that are investing in health care, especially those focused on physician specialties, have adopted a “platform-based” strategy to organize and channel their approach. Firms begin by making an initial investment to acquire a large, regionally dominant practice in a specialty they are interested in. This acquisition is then used as a platform upon which subsequent investments in smaller practices are based within the region. In addition, they will seek to acquire like-minded sizeable practices in other markets depending on their overall strategy, which may be regional or national. Using this model, private equity firms can quickly establish multi-state and regional dominance, building scale while gaining operational, technological, and marketing synergies driven by geographic proximity.

In the dermatology space, there have been several platforms established since 2012 across the nation, including Forefront Dermatology, PhyNet Dermatology, United Dermatology, Aqua Dermatology, Advanced Dermatology and Cosmetic Surgery, and West Dermatology. This is by no means an exhaustive list.

The successful private equity-backed dermatology groups focus on acquiring strong, clinically driven practices, and establishing a brand known for exceptional patient outcomes. With a practice area like dermatology or aesthetics, where many procedures are elective and personally sensitive, establishing a trusted brand is even more essential.

Many physicians are worried that health care private equity investors will interfere with practice management, affecting patient experience while dictating to the physician how to practice medicine. The successful private equity firms are aware of this risk and try to remain in the background, working with financial and operational teams to eliminate inefficiencies and drive growth. Most prefer for the physicians to take leadership roles and be fully committed to patient care. With that said, it is essential to choose a private equity-backed group that will empower your brand and allow you to maintain clinical autonomy.

As such, health care private equity investors are looking for physicians who are strong leaders and have excellent reputations. Cultural fit is one of the most underrated yet important aspects of choosing a private equity partner. To ensure the continued success of a physician practice, it is crucial that there is strategic alignment and mutual respect between the parties. This is accomplished by fully vetting all possible partnership opportunities. To do this efficiently and effectively, the transaction advisors’ experience working with a range of PE firms is critical.

Health care private equity groups typically look to scale the physician practice platforms they invest in over a 3-to-7-year period before ultimately evaluating an exit, securing a healthy return on investment for all involved. These exits often involve moving the practice to a larger private equity investor or a merger of similar platforms. Successful private equity firms are building dermatology platforms in which any future transition to a larger private equity investor will be seamless to the operation. The buyer may also consider taking the platform public; however, this has not taken place yet.

There are three distinct phases to the work of an advisor during a private equity transaction process:

1. Preparation Phase:

• Educate shareholders on market conditions and jointly develop transaction goals
• Develop detailed marketing materials that highlight the practice’s components of value
• Analyze and present the financial/operational profile in optimal manner to maximize EBITDA
• Identify all potential parties with capital, interest, and experience to meet practice’s transaction goals

2. Marketing Phase

• Design and run a managed and competitive process with defined bid deadlines to increase quantity and quality of offers
• Manage data flow and ensure each group receives data/info necessary for an informed offer
• Substantiate forward-looking financial and operational representations to the market to ensure buyers pay a premium
• Act as an extension of leadership, taking lead on the process to convey value proposition of the practice

3. Closing Phase

• Oversee due diligence workstreams to expedite process and ensure efficient closing for the practice
• Negotiate and structure transaction documentation to maximize value and protect physicians
• Ensure the buyer does not re-trade the deal or change deal terms following the signing of a Letter of Intent
• Achieve goals & objectives of all practice stakeholders

Alternative to Selling to Private Equity

The alternative of selling to a private equity firm may be to consider a sale to a local hospital or regional health care provider. However, these transactions rarely deliver the independence, clinical autonomy, or the financial rewards that a private equity deal can offer. The sale price for a practice is often significantly higher when selling to a health care private equity group versus a hospital system. Typically, a health system will simply offer to purchase a medical practice’s fixed assets plus the offer of long-term employment arrangements for the selling physicians. By contrast, private equity groups can offer much more lucrative offers by applying a significant multiple of the practice’s earnings or EBITDA.

The other alternative is to sell your ownership to other physicians. However, the ability to reap the monetary rewards from decades spent building your practice will be very limited.

How can a transaction advisor help?

Not all private equity firms conduct business the same way. It is important to be comfortable with a firm’s approach to ensure the right cultural fit since this will drive the remainder of a physician’s career. There is much more to a PE transaction than pure economics, since the deal terms will guide the future of practice operations, how the medical providers work and are compensated, what additional investment will take place, etc.

Our advisory team helps clients explore all viable options, while running a competitive process to achieve the most favorable outcome from the perspective of both economics and deal terms. A good advisor has extensive experience negotiating against most of the platforms that PE firms have established within the relevant specialty, as well as the private equity groups behind these investments.

The ultimate goal of the advisor team should be to help physician groups develop a clear case explaining the practice’s appropriate value, market the package to attract the best investment partners, and evaluate the pros and cons of each potential deal before negotiating an excellent agreement that all parties are satisfied with.

Here are some of the key advantages that a good transaction advisor can provide to a physician group considering a PE partnership:

• Provide an understanding of “where the market is” in terms of deal price and structure
• Has knowledge of all potential buyers, their approach, likes and dislikes
• Can provide insight into negotiation strategies at the buyer level
• Can assure your practice that ALL appropriate buyers/investors have an opportunity to bid
• Can leverage the competitive process to ensure optimal financial return, operational terms, and partnership structure.