After an active 2022, this year has seen a shift in the PPM space. There are now challenges around the cost of capital, pricing, and labor. Some who raised a lot of capital in 2022 will still be looking for deals, while others are more cautious, putting more emphasis on valuation and financial performance.   

On this episode of The Banker's Corner, McGuireWoods' Geoff Cockrell sits down with Robert Aprill, Managing Director at Physician Growth Partners, to share insights on how the market might evolve in 2023 and beyond. Robert’s focus on helping physicians and physician-led businesses navigate private equity within their medical specialty gives him a front row seat to the headwinds this sector is facing currently. 

The aftermath of COVID has led many business owners to reevaluate the importance of size and scale in their operations; they are now more open to considering partnering with larger entities to navigate uncertain futures. 

The role of advisors in private equity is to educate clients about various compensation and alignment options when considering partnerships with healthcare platforms. The focus is on an equity perspective and a comp perspective to ensure that physicians are partners and are compensated based on their performance and the practice's performance, promoting alignment through incentives rather than punitive measures like production thresholds. 

“We spend a lot of time with our clients. I think oftentimes with us, we're presenting something versus having buyers present something to us,” explains Robert. 

The two also discuss areas of consolidation, interest in niche specialties, and aligning equity with compensation.  

Featured Guest

Name: Robert Aprill

What he does: Robert is a Managing Director at Physician Growth Partners. With prior experience as a healthcare investment banker, he now advises founder- and provider-owned businesses in the healthcare services industry as they prepare for and ultimately pursue a transaction. 

Organization: Physician Growth Partners

Connect: LinkedIn

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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 Banker's Corner, a McGuireWoods series exploring investment trends, solutions, and business issues relevant in today's private equity and finance 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 bring together thought leaders and deal makers at the intersection of healthcare and private equity. I'm really glad today to be joined by Robert Aprill, managing director at Physician Growth Partners. Robert, maybe give a quick introduction of yourself and then we can jump into some topics to discuss.

Absolutely. Appreciate that Geoff. Good to be here today. As you mentioned, my name is Robert Aprill, managing director here at Physician Growth Partners, and focused on helping physicians and physician-led businesses navigate and educate themselves on private equity that's happening within their certain specialty of medicine. I have been working with physicians for the better part of a decade, navigating these healthcare private equity transactions from some of the earlier deals in ophthalmology, dermatology, all the way up to some of the most recent sectors to feel the effects of private equity within from cardiology, urology, gastro, et cetera. So excited to share those insights and how the world's changing in 2023 and beyond.

So Robert 2022, still very active in the PPM space. 2023 has been a little choppier. The challenges have, in my mind, circled around the cost of capital has put pressure on pricing. There's been labor headwinds in some of these sectors. How would you describe the overall trajectory of the PPM market right now?

That's a great question. We know some of that. Some of it remains to be seen as we continue to see lender pressures on a lot of these platforms. Some of the really smart platforms went and raised a lot of capital at the end of 2022 and have big slugs of dry powder sitting on the sidelines from a debt facility perspective and are still aggressively targeting add-on acquisitions within their platform. Others, they have to go back to the well. Each deal are certainly getting more focused on historical performance, less willing to pay on future performance. Definitely more scrutiny from the lenders when it comes to underwriting new deals. So our shop here, because this is all we do, still expects to see higher level of deal flow moving forward, just because of all the capital that's been invested in the space over the last five years.

There's a lot of exits that were delayed because of COVID, so a lot of platforms are looking to check their final growth goals over the next 12, 18 months before they go to market and try to get that proverbial second bite, if you will. So we still expect deal volume to be high. What we do expect though in addition is higher scrutiny on valuation and higher scrutiny on the financial performance of the businesses. Really, the more quality deals will continue to still get done. Some of the deals that are more predicated on future growth and maybe have a little bit more hair on them you may see a little bit harder time trying to get done, whether you're a seller or an advisor.

The cost of capital definitely put some pressure on the valuation models. Buyers immediately reran their spreadsheets with a higher cost of capital and those spreadsheets spit out a little bit lower purchase price. That was a tough pill for sellers to accept. Has that bid ask been closing any?

It depends, and I think that the quality practices, the ones that have scale, have leadership teams, have good geographic presence, are in some of the sectors that are, quote unquote, more interesting right now, we're still seeing aggressive valuations. We're still seeing from a multiple perspective at near all time highs, maybe a little bit of a pullback, but not a meaningful bid-ask spread. And even with that, if you're able to hire a good advisor, there's some creative things you can do with structure, whether that's playing with rollover equity, whether it's playing with some level of earn-outs that are from a compliant perspective. There's some things that you can do to close that bid-ask spread, but we really haven't seen a huge change in value. It's been a lot harder to get the same valuations we have, and instead of maybe five LOIs at that top tier end of the range, maybe now, we're only seeing one or two when it comes to the options our clients have when deciding a partner.

So just more challenging. There's more turbulence, but I think at the end of the day, we're still getting very similar results. Maybe there's a little creativity in the structure, higher rollover to bridge some of that cost of capital gap. Maybe there's some earnout because we're not able to underwrite the same level of proforma, but at the end of the day, the floor is not falling.

You mentioned that an A plus asset, you can still transact on and you're not seeing any material reduction in valuations. Not every deal is an A plus asset. Are those deals happening at lower costs or just harder to get done at all?

Those are the ones where you definitely feel less as far as just general buyer interest. I think, again, where if I'm sitting here with a group that's got a little hair on it, maybe a little smaller, maybe there's some retirements, maybe there's some reasons why, let's not, quote unquote, that a plus asset. Again, instead of getting 5, 6, 7 different types of offers, maybe we're only getting one to two because we're only getting offers from the groups that there's a tremendous geographic alignment or they're targeting that geography. There's a really good reason that that partnership makes sense. Maybe some of the peripheral partners aren't submitting or taking really deep dives, so I think it's less about, hey, it's not closing at the same value, and more about there's not less options. There's just less interest from groups that maybe look at that deal as a little bit of a stretch.

And do you see any bifurcation in the frothiness of the market at different size scales, meaning upmarket platform sales, let's call that the top end of that, but then down that size scale, you've got add-ons of scale and small platforms, and then below that, again, smaller add-ins. How would you describe the frothiness of the market at those three levels?

So I think the bookends there are probably where there's the most to talk about. The larger assets, we're still seeing get done and we're still seeing buyer stretch for them, depending on the specific sector that we're talking about. But just speaking in generality, the five, six, 7 million EBITDA businesses or larger are still getting done. You're still going to have the same level of buyer interest from a supply perspective. There's not as many of those, and so just naturally, those processes are more competitive. Again, maybe you see some more scrutiny on some of the proforma adjustments and you really have to make sure you're buttoned up in your model when you're in our shoes, going out to the buyer universe, getting through a Q of E, providing an underwriteable model, but those are still there.

I think on the smaller side, deals under a million in EBITDA are really challenging, because those are deals in a lot of instances buyers just fund exclusively through debt. They'll just completely leverage those deals, and because of that, obviously a hundred percent of it is impacted by the cost of capital, so I think those are deals that are really challenging to get done right now.

Some others may disagree. There's certainly some platforms that pay all cash for those types of deals, and in those instances, no real issue, but from my experience, a lot of these platforms look at those as just paying debt, and so those are probably the first to go as those onesie, twosie doc deals that are a million in EBITDA or less that are a little sticky. Those middle ones, that's probably where I'm thinking like a million to 6 million in EBITDA. That's where it really focuses on is there a strategic fit? Is this a quality asset? Is this a good business that's invested in growth? Is the profile attractive? That's where size alone doesn't bifurcate the deal and it really is devil in the details.

And obviously, a more stressful environment can put more acute pressure on some platforms, whether that is labor pressure pushing their costs on that end, or just as their 90-day interest rates continue to creep up and they have to absorb more of that in the cash flow, a stressful environment can become acute very quickly. We're seeing incrementally more stressed exits. Are you seeing much of that in the distress end?

Yeah, as far as exits on from sellers or from second bite platforms?

From sellers.

Yeah, I think it's funny. So coming out of COVID, we're still sitting here in 2023 talking about it a little bit, but there's a lot of sellers that that was a real humanizing period of time as a business owner of like, "Maybe my business isn't completely insulated from the outside world. For the history of my ownership, we've always had more patients that we can serve and we've always been able to recruit," and so on and so forth. I think coming out of that period, a very humbling experience and I think you had a lot of sellers that realized, "Hey, size and scale can be beneficial here because we don't know what the future holds." And that continues to today, but I think now, you're in a point where labor costs have been exceptionally high. The idea of going out and getting a loan that you're personally guaranteeing to fund any growth has become less appetizing than it ever was, even if it ever was appetizing.

So there's definitely different opinion of a lot of groups that we're working with that are maybe approaching a transaction from the standpoint of, "I want to continue what I've been doing historically, and I think the best way to do that is partnering with someone with some size and scale." Versus maybe 3, 4, 5 years ago, people much more commonly looked at a transaction as, "Hey, I want to take over the world. I've got all these growth aspirations and I think private equity is the launching pad to do that." I'm not saying those companies don't still exist and we don't still do deals like that, but I definitely think, to your point, there are definitely more deals where people are looking at it from the framework of, "Scale is going to help me be competitive moving forward. Medicine is more difficult to practice tomorrow than it is today, and I need to position myself to make sure that I can continue to compete moving forward, and this is a dynamic model that would allow me to do that."

One more forward-looking question. As I talk to private equity funds, many of them would expect to hold maybe four or five platforms in their portfolio, and right now, they're holding eight or nine. They'd expect the hold period to be two to four years and they've held assets for longer than that. It feels like there's a bit of a wave that is crusting. Market conditions not withstanding, there are a lot of platforms that are just going to have to transact on account of fund dynamics. Is that consistent with what you're hearing from sponsors?

Yeah. Look, I think when you look at, and not to zoom out too much, but when you look at the evolution of investment into physician services, there was a lot of investment between 2014 and 2019 across a lot of specialties, and to your point, a lot of these groups look to hold from four to five years. And so when you time that out, 2020, 2021 fell in that sweet spot and not a lot of platforms are doing second bites during that COVID period. Not to keep bringing COVID up, but it is still leaving some scar tissue in the market today. What's happened then is you saw a lot of groups pause their thought process around second bite and going to market platforms specific during that period, and I think they were planning on 2022, 2023 being the year that they go back out, test the market and explore that liquidity event from a private equity perspective.

And interest rates raising right at that point has created an interesting influx where you've got a lot of platforms that have been held for longer than they expected because of more broad world pandemic issues. Now, you've got more economic issues that are making exits less interesting, and so I think you're going to have a lot of leadership at these private equity funds sitting there thinking, "Do we continue to hold long on this position because we think the market could stabilize in 2024, or do we stick to our guns, focus on a late 23, early 24 exit because that's what our investors want? They want to see that return from this asset we've held since 2018, 2017."

So we're in an interesting point, but there is a huge buildup of platforms that have been held for five years, four or five years, that are ready to explore a second bite, and I think it's going to be interesting watching as some of these fund professionals decide the best course.

Maybe pivoting to some of the sub-sectors in provider services. The interest level is never uniform across all sectors of providers. What are some of the sectors that you are seeing more interest in, and what are some of the unifying characteristics of those sectors that are hotter?

We're seeing a ton of work in urology, gastroenterology, cardiology, ENT and allergy. Interesting enough, oral surgery. Sectors that have not seen 10 years of consolidation have only seen a couple, so there's a big supply of really quality potential partners out there in the market. The commonality between all of them is they're very procedure-based. They are in a lot of ways very commercial, payer driven. There's very frothy or profitable ancillary services that can be coupled with those, whether it's cardiology or gastro or euro. There's a lot of benefit to scale and the ability to drive profitability through the addition and investment in ancillary services. There's a lot of fragmentation in those sectors. So while yes, of course, you're going to continue to see the same level of deal flow that you have for 10 years in things like ophthalmology and derm and pain management, pain to kind a lesser extent, but still, we're definitely seeing a big piece of our shop is that third wave, if you will, of consolidation within physician services.

Ortho, I'd throw in there a little bit, but that's been a little bit slower to take on in that space. Similar in the fact that you can have very profitable ancillary services from PT to DME embracing and surgery centers as well. Groups love private equity platforms and consolidators love those spaces right now, because there's a lot more ancillary services you can support with 20 providers in a market than five, and so if you can build that regional density, the value per physician can grow meaningfully and really be good for the patient too, because you can start to build that one-stop shop instead of having to refer out all your physical therapy and your radiation oncology or whichever sector we're talking about.

Yeah, it definitely is an amalgam of factors from where I sit. Sometimes, it's new driver like cardiology as the reimbursement, or site of location has changed such that you can do more things outside of the hospital. That opens up new revenue streams that can be captured if you consolidate with a little bit of scale in those areas. Or it might be sectors that lend themselves more to more creative value-based contracting like orthopedic, or areas where if you get a certain level of scale, you can do different structures and relationships from an ASC perspective, but there feels like there's always a few drivers that make certain sectors more interesting.

Yeah, absolutely. I think particularly the platforms that have really experienced private equity platforms, those are the ones that are going to be successful when it comes to some of the nuances you just mentioned, right? You're not going to have a guinea pig private equity group come in and be exceptionally successful and bundle payments within ortho, right? So I think the ability to some of these blue chip private equity groups as they built thesises in these new sectors, those are the ones you're going to see be successful because they're going to be able to think about, within cardiology, you can think about more managed care and taking risk, and the same with primary care.

It's a little bit more complex than just rolling up optical shops, and so both can be successful. One is a little bit more in the weeds, so I think there's going to just naturally be a little bit of a separation between the groups that are successful and some of these newer specialties versus some of the more med spa type things that are a little bit more simple, a little bit more franchise model type businesses that are strip mall models as we call them in PGP.

There are some areas where hyper specialization has gotten a lot of interest. You mentioned oral surgery. Obviously, oral health generally has had a long run of consolidation. Where do some of these more hyper-specialized specialties fit into the picture?

Yeah, it's interesting. Yeah, hyper-specialized, I think specialty dental. Dental has seen consolidation for a very long time. Only recently have you started to see consolidation in some of the specialty niches of dental like endodontics, perodontics, orthodontics, like I mentioned, oral surgery, so you're starting to see consolidation there. Other things a little bit outside of healthcare, but like vet, you're seeing consolidation and that's a smaller, more niche space. I think of, again, like ENT. That's pretty specialized because there's a nuance there between ENT or straight allergy platforms. Things like neurosurgery versus neurology. Very niche, not a ton. You're not going to see 40 platforms in that space, but you are seeing some private equity groups dive into some of those areas because there's some similarities to other sectors that they could be successful in.

So I think those like podiatry. Again, very hyper-specific spaces where it's not the same level of overall healthcare dollar spend as some of the other sectors we've mentioned here, but there's a lot of fragmentation and there's a lot of opportunity to really build a platform, but you're just not going to see the same number of platforms that you see in derm and ophthalmology. You may see four or five groups out there ruling up podiatry at the end of the day.

Maybe pivoting again, let's talk a little bit about physician and provider alignment. We spend an enormous amount of time and effort around creative structures and ideas around comp models as it relates to profitability metrics and comp models. A lot of time on equity alignment and what those can look like, and threading some tax and regulatory needles. From a sell-side advisor perspective, how often do you find that the sellers have a pretty concrete idea of what they're looking for from provider alignment versus open to lots of ideas?

I think that's a big piece of our role, is to help educate them on the different options. When you think about alignment, the best way you do that is from an equity perspective and a comp perspective. If you make sure they're partners and you make sure they're compensated based on the performance of themselves and the practice in which they practice, that is your ultimate alignment. And you can align via the carrot versus the stick, which is you have production thresholds and you have some of the scary buzzwords that I think platforms of the past had that you don't really see at all anymore. So whenever we're advising our client, we're huge advocates for scrape model compensation where physicians continue to benefit from the growth of their elected practice or their affiliate practice within the platform. Certainly rollover equity and having meaningful rollover equity in the platform.

A big piece of our education on the idea that this isn't a one-time transaction. This is certainly a liquidity event for you, but also a meaningful rollover event into the broader growth of the platform and the opportunity as a physician to own equity in a larger regional or national platform. We think those are the ways to go. There's other models out there. Some groups, especially in certain sectors, do percent of collections comp, which is prevalent in certain sectors. I don't necessarily think that drives alignment in the same way that some of the other newer comp models do. So we spend a lot of time with our client. I think oftentimes, with us, we're presenting something versus having buyers present something to us. I think we really sit down with our client, figure out what they want, and we basically present that to the buyer world as this is what we're positioned as, this is what we're looking for, and really be the driver of that conversation.

Both the equity and compensation alignment structures can be focused at a super local level or incrementally wider levels. Maybe just the practice that was sold, maybe the entire state. Maybe equity doesn't connect at any sub-level at all. How do you think about the level at which equity and compensation alignment should attach?

It depends on the size of the business. So the larger the business, the more we look for particularly around the comp and the equity exclusivity over that market. So if we're representing a business in Michigan, they're the largest provider in Michigan, they're the first entrant of the buyer, the platform into Michigan, then we're going to position it like, "Hey, we want exclusivity over the state of Michigan. We want to be your platform in this market." If we go out and do tuck-in acquisitions, we want them rolling under our comp model, rolling under our local platform. Smaller deals tend to be a little bit more tuck-in, don't necessarily have the same leverage to negotiate something like that.

From an equity perspective, it's interesting. We're definitely starting to see a little bit more variability in how these platforms are looking at the levels of equity. So traditionally, you really saw portfolio level or platform level equity. You did your deal, you rolled 30% equity into HoldCo, the same level as all the other physicians and that was the tried and true model. I think what we're starting to see is, particularly in some of the older sectors where they may be stuck on the 35% of collections or 30% of collections model where there's not that same alignment we talked about, you're starting to see a little bit of a JV model start to pop up where if you roll a hundred dollars of equity, $60 of that goes to the holding company equity, but 40 of it stays at the local level and you still own 40% of your local level. So it has equity sitting at different levels and it allows for a seller to continue to see value in their own smaller local entity as it grows over time.

It counterbalances that percent of collections comp model versus the scrape model, if that makes sense. So you're seeing some more creative structures for alignment, particularly around equity. Again, I see it most often within the sectors that have historically been a percent of collections comp model, and all of the equity is sat at the highest level.

The JV model is certainly getting more popular. I'll say that as an attorney, it layers in a ton of complexity. It brings to bear questions around, well, yes, this is a JV, but what are you thinking about enterprise level debt? How are you thinking about allocations of value on a sale? Those are all very complex questions, and the mid or local level alignment, but the complexity can just go through the roof.

That's why you guys are paid the big bucks, right?

On that wonderful note, I think we should probably cut it short. We could talk all afternoon here, but Robert, thanks a ton for joining me. This was a great time and we'll have to have you back sometime.

I appreciate it. It's a great conversation. I look forward to coming back.

Thank you for joining us on this installment of the Banker's Corner. 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.