From a seller’s perspective, how does a provider group get ready for a sale process? 

In this episode of The Corner Series, McGuireWoods’ Geoff Cockrell interviews Marc Anderson,  Managing Partner of The Belay Group, on the nuances of preparing companies, particularly in healthcare services, for a sale process. The discussion highlights the importance of professionalizing back-office operations and financial reporting, and the potential pitfalls around ownership structure and economics. Marc and Geoff also discuss the variables in strategic decisions, such as consolidating smaller entities to gain scale and the role of tax planning. The conversation provides valuable insights, essential for any healthcare provider group considering a sale.

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This podcast was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this podcast, you acknowledge that McGuireWoods makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in the podcast. The views, information, or opinions expressed during this podcast series are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This podcast should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.

This is The Corner Series, a McGuireWoods series exploring business and legal issues prevalent in today's private equity industry. Tune in with McGuireWoods partner Geoff Cockrell as he and specialists share real-world insight to help enhance your knowledge.

Thank you for joining another episode of The Corner Series. I'm your host, Geoff Cockrell, partner at McGuireWoods. Here at The Corner Series, we try to bring together deal makers and thought leaders at the intersection of healthcare and private equity. Today I'm thrilled to be joined by my longtime friend, Mark Anderson with The Belay Group, investment banker that I've done a number of deals with over the years. Mark, maybe give a little intro of yourself and The Belay Group and then we'll talk some about from a seller's perspective how to get yourself ready for a sale process.

Yeah, sure. Well, first off, thanks for having me, Geoff, great to always chat with you and I'm excited about this podcast today. So just quickly on us, The Belay Group is what you'd consider a boutique investment bank. We mostly provide M&A advisory services, mostly on the sell side, predominantly focused on healthcare services. You and I probably did one of my first full completed deals where I think I would've considered myself a banker after that one way back in, what was that, 2012?

Something like that. We looked a lot younger then.

Yeah, a lot. That's right. That's right. But yeah, that's us in a nutshell. We're based out of Charleston, South Carolina. We spend time across all healthcare services, lots of practice management work, lots of post-acute care, lots of outsource service stuff. So great to be here and looking forward to our conversation.

Yeah. Mark, so when, let's call it a provider group approaches you and they're thinking about a sale and let's say there's no institutional investors in there, it's just operating as a practice, maybe a little bit of scale. In what ways are they mostly not ready?

That's a good question. And so just to maybe full circle on us a little bit more, that is our bread and butter client. We work with mostly non-institutionally backed companies, founder-led, closely held in their various phases of scaling or being scaled, and that can be anything from a couple million in EBITDA to eight to 10. But I think they tend to share common characteristics and that is that they've been most of the time bootstrapped up and with an owner that's deeply involved, they're focused on the right things operationally, making sure people are doing their jobs and whatever may be clinical care is excellent, et cetera, et cetera.

But I think we find, and what you probably do as well on the legal front is maybe that back office stuff that is really important to investors has lacked a little bit in professionalization or sophistication. And so for us, I think what we tend to find ourselves doing is helping shore up from a presentation standpoint a lot of that, I guess lack of robust reporting. That is pretty typical. I think on the legal side it's something we also see when we get further down into diligence and a potential transaction. There's a lot of data gathering. Would you agree with that?

Absolutely. And one of the areas where they're often the least robust in that kind of back office functionality is in financial reporting. They all know loosely what EBITDA is and what their friend from the club's practice traded at, but they often don't have any semblance of accrual financials. Their understanding of working capital and how it's going to play out in the transaction is not fully cooked and backfilling that in advance is often a necessary process.

Yeah, I think so. And we were briefly bantering about this a little bit before. I mean, do you take the time and do it before you go to market? Do you spend that time and cost and effort? Do you rely on your banker? I'd be curious on the, and we get this all the time too as we're prepping someone for market, one of the heavy lifts is getting to market, but the clients never realize as much as you tell them how heavy of a lift it is, once you get into the market and you go under LOI or you're dealing with someone exclusively, the amount of effort that's required to get through that diligence phase. In some circumstances, we do think it makes a lot of sense for people to spend time upfront before they're headed to market. In other cases, I see some value, but maybe not a ton. And spending your EBITDA to get something that you're not going to get credit for.

I would probably put them into some different buckets. On the financial reporting, the need to be ready on that is going to come crashing on them like a freight train. Like you said, the minute you sign the LOI and a buyer, especially a financial buyer is rolling in with QAV analysis, you're having to figure out working capital target numbers. And if that is not anywhere near being ready, it can be a material and very material friction and getting through the initial stages of the deal. I think probably advise people to spend the time, effort, and money to shore up the financial reporting as best they can. We often get asked a question of, "Well, should we be putting in place an MSO structure?"

Right.

They know some semblance of what that looks like and they're wanting to get it all ready. And on that, I would usually almost always advise not to do that unless you need to that to solve a particular problem, like bringing in an executive management team where they need to have equity and they can't be direct owners in the practice. So there can be reasons why you need structurally to put that in place, but to do it specifically as a preparation for a transaction, I don't think is a good idea for a couple of reasons.

One, you alluded to that you're spending money that is going to hit your P&L and ultimately that's going to be discussion in the pricing and you're probably not going to get credit for it. But maybe more specifically, you also don't know exactly what structure a buyer is going to be interested in. They may not have much interest in your MSO. You may end up being not a platform but an add-on acquisition where in particular like a medical practice, they may already have a practice in that state and their intention is to consolidate the providers within that single practice. And so all of that work would've been for nothing. So I usually advise folks not to do a lot of reworking of their structure in preparation for a transaction unless it's needed to solve a particular problem.

Yeah, I think I agree with all that. On the financial side, it depends. It depends on what we're trying to, the goals of the client, who they're trading to potentially, how much we would recommend the back shore, some of the maybe weaknesses. But on the structure side and what the ultimate deal looks like, I think we always get that question too, "What should we do?"

And we've had it more recently with a couple groups that are looking to maybe merge together to go to market together to do all the things that they hope that scale can achieve that they can't do on their own. And I see limited value in putting together all that time and cost to have a formal organization, if you will like you said, not knowing what one, may happen, right? There may not be a transaction. Unfortunately, M&A is hard and maybe half of it gets done, but secondly, like you said, who knows what the buyer wants. I think it's a good exercise to do to think about more so from how do we operate when we're combined with somebody else or how do we operate these two groups until the time of a merger or something like that, if you're talking about merging two groups for a process.

Yeah, that's a real complication. The main reason that I find folks wanting to do that is, like I said, they may have some rough sense of what EBITDA is, but the one thing they know is the multiple is bigger if you're bigger. And if you can squish together four semi-related things and get bigger scale that it'll be worth more money, sometimes that works. I think what people lose track of and why scale trades at a higher multiple is that usually when you've amassed something of, let's call it $8 to $10 million in EBITDA, you probably have put in place the elements of a bigger business, centralized command and control, centralized financial reporting, compliance, structures that are stretched out across multiple locations maybe, and just the ability to operate as a larger organization.

And that larger EBITDA in that format has already absorbed the cost of those things. And what people are often wanting to do is squish things together and get that higher multiple and not recognize that well, just squishing them together didn't really create a bigger thing and the market may or may not give you that kind of credit for bringing those things together.

In essence, you take all these smaller groups and you're thinking, "Hey, we combine them and they're synergy or there's going to be operating leverage from this new big entity." But I think that the issues we always see is that great companies, but they're all lacking in a robust back office infrastructure. And so we get the same thing. "Hey, there's my buddy in this state and I'm next door to him and his friend next door to him. We are complementary together and with our EBITDA together now we're 10 and shouldn't we get a 10x or whatever the multiple is." And I think what they fail to recognize is that maybe on a piece of paper they're 10, but like you said, centralized accounting function and finance function, no centralized compliance department, those are real costs and they're going to impact EBITDA until they're actually occur and implemented. And then you get that operating leverage that like you said, a scaled operator would have and therefore would deserve or maybe not deserve is the right word, but would elicit higher multiple.

If on the other hand you can pull those things, those disparate companies together and prove out the theory a little bit, then you're something different. Then you are the bigger thing. You've shown that you've been able to operate as a single combined entity, forces you to make some everybody in a single pot sort of math. Whereas before each of these separate businesses were rising and falling on their own P&L, if you put them together, then everyone's going to be in it together and you got to live with those dynamics, but if you can go through that process, then you might be able to achieve much higher valuations. I've seen some transactions of this variety. They're very difficult to pull off live fire with a buyer, and I've been on the buy side of those and you're herding cats. It's a little bit of a central deal, but it's a lot of trying to do four deals at once.

That can be a challenge. I've seen versions of this transaction where rather than a sale event, they're doing a bit of a debt recap in the midst of that, and I think that's an interesting approach because you let the owners take a little bit of chips off the table, maybe through a debt recap, you give them a little bit of working capital to implement some of those strategies and if you put a little bit of distance between that sort of transaction and a sale event, it gives you a little opportunity to prove out the theory. And I think that's an interesting way to go about it.

I definitely think so, and we've got similar scenarios and conversations with clients currently where there's a group that really wants to merge their businesses. They see a lot of value and combining not just for valuation purposes, but there's crossover. They're in similar geographies or close by, they all have a decent back office infrastructure. There's no need for three. They all have a robust billing department. You can probably combine those and create some synergy, and they obviously are doing it to generate additional value by having a scaled business, but they're willing to wait. They actually are taking the approach where you said if you put some distance behind you, do proof of concept, there's value, and I think there is for sure, and they believe that too. But that is not a six-month thing, right? They're committing to a year plus process in my mind. Would you agree?

Yeah, totally. The one area where I've seen folks have some success, even though it's a difficult transaction to put together where you're pulling together multiple smaller things, is even if you're not going to get multiple lift from the exercise, you may bring yourself into the zone of a size that is an executable transaction that even if the private equity fund or the financial buyer is going to come in and build out more of the centralized functionality that a larger organization needs, even if they're going to do that, you do have to have some baseline mass of just revenue to be able to absorb that process. And so if it's an area where in particular things of sufficient scale are really, really hard to find, then pulling together some things that are not fully congealed can make sense. I've done transactions in physical therapy where there's a ton of difficulty in finding things that have enough scale to be actionable, and I've seen folks dance around putting together a few somewhat disparate pieces to just have enough mass to be executable so it can be done. It's just hard.

Yeah, no, I think that's a great point, and I think that's where we tend to find conversations or people wanting to do it and where it does make sense. PT is great example of it where we're actually in conversation with a couple groups now that they're million to million and a half EBITDA each on a standalone basis, but you combine three of them and all of a sudden you're talking a number that's close to five that gets a lot more parties interested. And like you said, I don't think they're probably going to generate the consolidated multiple that would traditionally happen for a five million EBITDA business or PT business, but they'll get a deal done. They'll be able to either in this scenario, one group wants to take most chips off the table, another group doesn't really want to take any and the other's in the middle so it can satisfy everybody's goals if done right.

It's certainly a ton of work. In some cases, I think it's almost easier if you can find the private equity group that's into doing it than it is the going together and combining first. The issues we've had when people are like, "Hey, let's commit to combining first, get some proof of concept and then we'll go get our 10 times multiple." It's really hard for them, and it's really hard to advise on with the groups involved. They're all leaning on you for guidance and advice, and they're asking for valuations. They've got to create a baseline of what's the value of my stock versus yours. And sometimes I find that that's harder versus let the market dictate it and maybe let's come up with a mechanism of how each group gets value on a transaction or let the buyer, the private equity group tell you what each group's worth. But at the end of the day, it's a supposedly independent third party, right?

Right. Another area where I find folks are not necessarily ready is in lining up the economics with their ownership. So you're going to have this meaningful event, and there are a couple problems that I encounter. One is that you have some people that are not owners in the practice and they're really, really important. And you get down the road with a transaction, you got LOI in place, you've pegged a value on it. It gets really difficult to fix the issue of having someone who is almost a partner but doesn't have anything to sell. You can give them equity at that point, but once you've pegged a number on it, you are running some risk that could be material that you just did a really bad and painful ordinary income event to those people when you give them more percentage points maybe from zero or just reshuffling them.

But if you do that stuff early with a little bit of distance and a transaction is not at all certain, and you're more talking about the traditional economics of a practice where you buy in and if you leave, you're going to get your 30 grand or whatever back, and there's not a $5 million payday on the horizon yet, you can fix some of those issues for the almost partners.

And then the other issue that we often encounter is that they're set up as, let's say, an S corp, but they're comping out all the money each year based on production. And so you've got very wildly disparate economics going to them on a year by year basis, but it's all just comp money going out on the shares. And the shares, let's say, are all kind of equal. You get to a transaction and you're going to be some scrape and they'll want the money to follow the scrape, but the money has to follow the shares. And so you've got some real issues that can be tricky to navigate. And again, there's some ways to navigate it, but that's another area where if you're a little thoughtful upfront, you might be able to reorganize yourself a little bit closer to what the economics are going to be in the deal and avoid some tax pain. So tax planning early is another bugaboo of mine.

Yeah, it's interesting. Good segue. How in these sort of scenarios, what is your recommendation? Obviously on our end we're the bankers, we're involved in the front end, so we're guiding like, when the client says, "What should we do about these scenarios?" Sometimes it's like, "Let's let the transaction figure it out." Sometimes we're like, "Let's at least talk to attorneys and get a cursory view." What is your perspective? Are you thinking like, hey, whether it's a short term we're going to, I'll call it for better term, a merger recap, right? We're going to just merge on paper and get somebody to come in and recap the whole thing. Do you think that planning should be done even at the onset prior to going to market, or do you think that you'd recommend this, wait till the process unfolds?

I would generally say wait for the process to unfold, but the one issue is the one I was alluding to is that if you've got a tax problem that is going to be very, very painful and very, very difficult to solve, you may have a closing window of time to solve for that in a way that's way less painful. And so that's the one area that I would say right out of the gate, and I've had this conversation if I'm pitching the work and I'll talk to them and do my little song and dance, but I'll usually end it with, "Even if you're not working with me, you need to have someone look at this stuff and you need to have them look at these issues right now." You really can't fix things that will be problems later, but by and large, for the rest of the stuff, I'd generally say, wait.

Yeah, and you guys do a good job of hopping on and having an informal call about tax, at least ideas like, "Hey, be thinking about X, Y, and Z." So that a client can at least, or potential client can at least hear it from somebody whether they decide to do something or not. We had to reach out to you about an ASC client a while back, and we were basically wanted them to get in front of somebody about one, contracts like tough sector to deal with contracts and change of control and stuff in some markets, I think, but also you've got unique tax things, and that can happen depending on how they're set up and where people are invested in the ASC.

Yeah, those are a web of weighty topics that all kind collide at one spot. You've got tax issues that you're trying to solve for, you've got payer contracting issues you are trying to solve for, and in the midst of that, you have a very loaded regulatory analysis that you've got to solve for all of those at the same time. And the solutions can be difficult and sometimes complex, but it's definitely an area where with a little bit of planning, if you know where you're trying to land, it might help you make some of the front end decisions.

That's right. Going back to, we were talking about the groups that are potentially merging, are you seeing areas where it doesn't make any sense or maybe said differently, do you see areas where there's lots of success in it? Besides PT?

The areas where there's not a lot of things to buy or the things to buy are all really small would be the areas maybe like ENT often has a bunch of little small things and you can cobble together enough scale to be executable. I find that more often than not, just the difficulty and execution risk is why people do less of that. Coupled with the fact of not wanting to be married to someone unless there's going to be a check involved and it's hard to do that in advance. Those are hard deals to pull off, and for that reason, I think we see less of those than you think.

We've talked about them a lot. Dentistry, we've talked to lots of dental groups about it. Optometry is an area I think that makes a lot of sense for, areas that pretty sticky customers. Brand I think is important, but it's not that big of a deal. It's just I think creating some scale and operating leverage can really create a lot of value.

I've also seen the structure in reverse. This doesn't help you given what you do, but I've done several deals, and dentistry is a good example where I've done this exact setup where the financial sponsor who's got, let's say, an executive that they think has got that multi-site healthcare background, those go ahead and build the apparatus of a bigger organization, so there doesn't need to be the opening salvo of a target.

Right.

You can just build your own apparatus and then start doing add-ons into nothing until you have something, that can be an effective way to go about it. If you're doing all the heavy lifting of a centralized organization anyway, there may not be a need for finding that elusive perfect vehicle. Just skip that step and start smushing things together on your own. That could be an effective idea. And the upshot of that as well, you've got an executive team that knows how to do that. I think that can be a successful strategy too.

Yeah, for sure. No, I agree. We get a lot of calls from operating executives all the time looking to, whether it be, like you said, dentistry, home health's a big one. People always looking for assets in there. That's one of those where you can with an experienced operator just bolt them on. Veterinary, another one where I think there's issues in that sector right now but experienced operators can do exactly what you said. And I think it's great too though, we don't typically advise on one-off practices or anything. It's tough for us, but I think it's great that there's options that are out there and we love to connect friends of friends kind of things for that. There are a lot of great businesses, good owners, good practices. It's tough when they're not a certain size-

For sure.

To get something done, but avenues like that can be an attractive outlet for them.

Well, Marc, we could talk about this all day, but let's bring this to a close. It's always a ton of fun to chat, and thank you for joining us in this episode.

Yeah, no, I appreciate it. Enjoyed it. Anything we can do to help your clients or anybody out there talking about these things or exploring these avenues, I'm happy to chat with them. But yeah, had a good time. So thanks for having me.

Thank you for joining us on this installment of The Corner Series. To learn more about today's discussion, please email host Geoff Cockrell at gcockrell@mcguirewoods.com. We look forward to hearing from you. This series was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this series, you acknowledge that McGuireWoods makes no warranty, guarantee or representation as to the accuracy or sufficiency of the information featured in this installment. The views, information, or opinions expressed are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This series should not be used as a substitute for competent legal advice from a licensed professional attorney in your state, and should not be construed as an offer to make or consider any investment or course of action.