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New York Marriott Marquis
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2018 NY Metro ASC
Symposium
Physician Practice (& ASC) Consolidation
Henry Bloom
President
Michael Shapiro, MD MBA
Business Development
Brian Liberty
Senior Vice President
Today’s Presentation
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• Why are hearing about so much transaction activity and consolidation? What is driving all of this?
• What is Private Equity? Why is my email inbox inundated with interest from Private Equity?
• What are the economics of a private equity transaction and consolidating into a larger entity?
• I have been down this road and this type of deal doesn’t work for my practice. But I want to takes some chips off the tables and save on taxes. What are my options?
• Open Discussion
Mega Disruptive Forces Spurring A Consolidation Response from Providers
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CVS health to acquire Aetna ,Combination to provide Consumers with Better experienceReduced costs and improvedAccess to healthcare services
Davita Medical groupTo join Optum, Combination To improve Care Quality andPatient Experience, Through Multiple payor relationshipsAcross physician platforms.
Three Giant Employers, Amazon, JP Morgan Chase And Berkshire Hathaway, announced they are partnering to create an independentCompany aimed at reigning In healthcare costs for their US employees.
“The mergers reveal attempts to address market inefficiencies by combining business models and ecosystems to boost the quality of care while reducing waste and costs. The giants --Amazon, JPMorgan -- are new to health care. Walmart already has pharmacies, but with Humana, it would also be one of the nation’s largest health insurers. These companies are all sophisticated, data-centric organizations looking to transform every part of the health care ecosystem. Even supply chains, with companies like Amazon in the fray, will be disrupted.” – Forbes 2018
Haven’t we seen this consolidation already?
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• Yes, yes we have. The 1990s were boom & bust for physician practice management companies.
• We don’t profess to have the crystal ball. Nobody knows how this will play out. But we know the up front pricing & income repair opportunities are compelling.
• Very distinct differences between today’s wave of consolidation vs. the 1990s.
1. PE firms are “smarter” with their investments (i.e. productivity models, equity alignment / incentives)
2. Technology and “big data” analytics is making pay-for-value possible3. Costly investments into quality, executive leadership & technology not
feasible by small groups4. Patient demand outpacing provider supply more than ever
“Henry, where will these large groups be in five years?”
What is “Private Equity” exactly?
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• Broad Definition: Private equity is composed of funds and investors that directly invest in private companies, or that engage in buyouts of public companies. Institutional and retail investors provide the capital for private equity, and the capital can be utilized to fund new technology, make acquisitions, expand working capital, and to bolster and solidify a balance sheet.
• “So say it again, except this time in English, and as it relates to my practice or ASC, please?” –Most doctors (don’t be afraid to ask questions)
• PE firms are the “money people.” They want to pay you money up front (some of their own, and some borrowed from a bank) to buy a ownership position in your company.
• They want and need growth to succeed to get their target return on equity, which is typically at least a 20%+ IRR over a 3 -5 year period.
• To grow, they need to scale much larger. This is why they seek large groups aka “platform” deals that have infrastructure to use in growth
• Not all PE firms are created equal – they vary significantly on size of investments, industry expertise, experience, and deal structure.
• Most all of them have no interest in telling you how to run a practice. They want to “add fuel to the fire” to grow and then sell their position within 5 years
Which PE Firms are out there?
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• 2016 & 2017 recorded ~$600 billion worth of PE transaction value in the US
• Many hundreds of active PE firms active in healthcare
• Industry Specialists vs. Generalists
• Many “founder” practices in New York will attract small and mid-cap PE firms
• Experience & track records are very different
• Amount of leverage, control provisions, and rollover equity terms vary greatly amongst PE firms
Reasons To Consider Private Equity Investment
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Monetization
• Monetize portion of current income at preferential tax rate
• Opportunity for “second bite” transaction with experienced financial sponsor
Risk Reduction
• Status quo is a risky strategy; healthcare delivery will not remain static over time
• Reduces risk of change in reimbursement
• Aligns financial interests with financial sponsor that is motivated to continually invest in and grow the business during ownership period
Evolving Landscape
• Government, payors, and patients are demanding high quality medicine at a lower cost
• The shift away from traditional fee-for-service towards value-based medicine where providers receive incentive payments based upon delivering quality and value.
• Prepare and integrate the new bundled payment arrangements, and other innovative delivery models (e.g. direct to companies)
Growth Initiatives
• Not only provides access to capital but also to fundamental business resources to enhance efficiency and drive further growth. These resources include but are not limited to experienced management, legal and financial expertise
• Facilitates a successful physician recruitment and succession planning
Economies of Scale
• Greater buyer power when negotiating with suppliers, payors, and management services
• Facilitates Practice access to the ever-evolving technologies and higher quality services at a lower cost to a larger patient audience
• Leverage infrastructure and resources to grow physician base
Specialties Drawing Private Equity Attention
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Dental
Dermatology
Ophthalmology
/ Optometry
Orthopedics
& Neuro
First
MoversNewcomers
GI
Urology
OB/GYN
Pain
Management
What specialty specific characteristics are valued by private equity investors?
• Ancillary Income and/or Retail Opportunity
• Well positioned for value-based care
• Regional Consolidation Opportunities
• Provider Shortage
Transaction Structure –Practice & MSO
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$170 M Revenue
~$70 M Net Income
Care Center 1 Care Center 10
MSO “Newco”
Physicians Physicians
PhysiciansPrivate
Equity
~$21 M (~30%) to MSO
Thru Management
Agreement
~$49 M (70%)
$6.3 (30%) $14.7 M (70%)
ABC Practice
External
Entities (i.e.
ASC)
….
Physicians retain
control over
clinical practice /
“Care Center” level
decisions.
Investments outside
of the core practice
can be excluded (if
applicable).
MSO Valuation – Medical Group
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100.00%
Pre-Sale Cash Flow
Doctors
21.00%
9.00%
70.00%
Post-Sale Cash Flow
MSO - PE MSO - Doctors Doctors
MSO Acquires
30% of income.
Doctors roll
30% equity in
the MSO,
retaining 79%
of the total
income.
Collections 175,000,000$ 175,000,000$
Expenses (105,000,000)$ (105,000,000)$
Net Income 70,000,000$ 70,000,000$
Retained for Physician Comp 49,000,000$ 49,000,000$
MSO Contribution (30%) 21,000,000$ 21,000,000$
Multiple 8.0 10.0
Purchase Price 168,000,000$ 210,000,000$
% Cash at Closing 70.0% 70.0%
Cash at Closing 117,600,000$ 147,000,000$
Rolled Equity* 50,400,000$ 63,000,000$
*Amount reinvested by current partners into "newco" MSO.
MSO Valuation –Example Individual Physician
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8x Multiple 10x Multiple 8x Multiple 10x Multiple 8x Multiple 10x Multiple
Net Income 300,000$ 300,000$ 600,000$ 600,000$ 1,000,000$ 1,000,000$
MSO Contribution (30%) 90,000$ 90,000$ 180,000$ 180,000$ 300,000$ 300,000$
Multiple 8.0 10.0 8.0 10.0 8.0 10.0
Purchase Price 720,000$ 900,000$ 1,440,000$ 1,800,000$ 2,400,000$ 3,000,000$
% Roll Equity 30.0% 30.0% 30.0% 30.0% 30.0% 30.0%
Rolled Equity* (216,000)$ (270,000)$ (432,000)$ (540,000)$ (720,000)$ (900,000)$
Doctors Cash at Closing 504,000$ 630,000$ 1,008,000$ 1,260,000$ 1,680,000$ 2,100,000$
*Amount reinvested by physicians into "newco" MSO.
$300k $600k $1M
“2nd Bite” Transaction
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Growth of MSO through:
• Organic practice growth
• Add-on acquisitions
• Ancillary Expansion
• Payer contracting and new
revenue models (“Lift” from
leverage and size)
• Economies of scale
Collections 350,000,000$ 350,000,000$
Expenses (192,500,000)$ (192,500,000)$
Pre-Comp Income 157,500,000$ 157,500,000$
MSO Contribution (30%) 47,250,000$ 47,250,000$
Multiple 11.0 13.0
Valuation 519,750,000$ 614,250,000$
Cash out? ??? ???
Roll equity again? ??? ???
Income Repair & Effective Multiple
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• The ability of a large group practice repair at least some
portion income is almost always the case
• Income repair increases the multiple, creating a higher
“effective multiple”
• Time Value of Money, Tax Savings, Future Rolled Equity
“Bites” would further increase the “effective multiple”
5.0x 6.0x 7.0x 8.0x 9.0x 10.0x
0.0% 5.0 6.0 7.0 8.0 9.0 10.0
10.0% 5.6 6.7 7.8 8.9 10.0 11.1
20.0% 6.3 7.5 8.8 10.0 11.3 12.5
30.0% 7.1 8.6 10.0 11.4 12.9 14.3
40.0% 8.3 10.0 11.7 13.3 15.0 16.7
50.0% 10.0 12.0 14.0 16.0 18.0 20.0
Income
Repair
Multiple
Income 1,000,000$
Sold (300,000)$
New Income 700,000$
Price 2,400,000$ = $300k x 8
Repair (40%) 120,000$
Repaired Income 820,000$
Income Change (180,000)$
Effective Multiple
(Price / Income
Change)
13.3
Comparing The Future Value of Cash Flow –Private Equity vs. Status Quo
• Doc making $1 Million of income at an 8x multiple will receive $2.4 Million ($1M x 30% X 8 = 2.4)
• CASH - $1.68 M pre tax or $1.117 M after tax
• ROLLED EQUITY - $720k (tax deferred)
• Scenario assumptions…
• Assumes all after tax $ invested at 5% compounding (conservative based on historical S&P
returns)….
• 2.5 x return on rolled equity at 2nd & 3rd bite
• 20% Roll of Equity @ 2nd & 3rd bite
Year Event
Future Value
of 1st Bite
Cash
2.5x Return
@ Next PE
Transaction Rolled $
After Tax
Cash Value of
Future
"Bites"
Total After
Tax Cash
Value
After Tax
Cash Flow
Future
Value of
After Tax
Cash
Difference of
After Tax
Cash
0 "1st Bite" $1,117,200 $0 $720,000 $1,117,200 $0 $1,117,200
1 $1,173,060 $0 $0 $1,173,060 $162,090 $162,090 $1,010,970
2 $1,231,713 $0 $0 $1,231,713 $162,090 $332,285 $899,429
3 $1,293,299 $0 $0 $1,293,299 $162,090 $510,989 $782,310
4 $1,357,964 $0 $0 $1,357,964 $162,090 $698,628 $659,335
5 "2nd Bite" $1,425,862 $1,800,000 $360,000 $1,008,000 $2,433,862 $162,090 $895,650 $1,538,212
6 $1,497,155 $0 $1,058,400 $2,555,555 $162,090 $1,102,522 $1,453,033
7 $1,572,013 $0 $1,111,320 $2,683,333 $162,090 $1,319,738 $1,363,594
8 $1,650,613 $0 $1,166,886 $2,817,499 $162,090 $1,547,815 $1,269,684
9 $1,733,144 $0 $1,225,230 $2,958,374 $162,090 $1,787,296 $1,171,078
10 "3rd Bite" $1,819,801 $900,000 $180,000 $1,790,492 $3,610,293 $162,090 $2,038,751 $1,571,542
Status QuoPrivate Equity Transaction
Employee Stock Ownership Plan
A Tax efficient Alternative or Precursor to a Private Equity
Investment.
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ESOP – Employee Stock Ownership Plan
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What is an ESOP?
▪ Type of defined contribution employee benefit plan
▪ Enacted into law in 1974 as part of the ERISA legislation
▪ Advantages not found in traditional tax-qualified employee benefit plans:
- Can buy stock from owners
- Can borrow money to finance purchase
- Substantial tax benefits to selling shareholders and for the Company
▪ Over 9,400 privately-held US corporations have implemented ESOPs
▪ Must comply with various Department of Labor and Internal Revenue Code rules /
regulations
Mechanics of an ESOP
In exchange for transfer of ownership to an “ESOP” the seller(s), receive
compensation in the form of cash and
seller notes.
Seller(s)ESOP TRUST
The company is now a tax free entity* with an Employee retirement benefit that
typically outperforms the usual plan (401k, etc)
Seller debt repayments (notes) are taxed at capital gains
instead of ordinary income.
Tax Deductible
Cash Contribution
Internal Loan
Repayment
Bank or Lender is used to partially finance the
transaction
Benefits of an ESOP Transaction
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Transaction Overview
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▪ The Company will form an MSO corporation as either:
❑ A “C” Corp, enabling the shareholder to elect “1042 Rollover” and defer/eliminate
capital gains taxes on the sale proceeds; or
❑ An “S” Corp status with the shareholder electing for an installment sale, paying capital
gains taxes as sale proceeds are received
▪ Under “C” Corp above, the Company would elect “S” Corp. status at the beginning of the
following year.
▪ All non-physicians’ salaries, benefits, related payroll taxes, and malpractice insurance would
be covered under a third-party contract and moved into the new MSO. Services include
admin/management, billing/collection, bookkeeping/accounting and equipment /facilities
management.
▪ The physician practice will remained owned by the doctors. A contractual relationship will be
established between the two entities for the procurement of non-medical services.
▪ The entity being sold to the ESOP would be the MSO (either as a “C” or “S” Corp, depending
on structure); physicians could participate in the ESOP to the extent they received
compensation from the MSO.
Transaction Considerations
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▪ Business owners can sell a majority of their membership interest in the company with two
main options:
1. 30% Sale of Equity - Sell 30% of equity to the ESOP.
Sellers would receive a package including:
• Cash at closing
• Seller’s note
• Warrants potential
2. 100% Sale of Equity - Sell 100% of equity to the ESOP and receive warrants to buy
back 20 - 25%; sellers would receive a package including:
• Cash at closing
• Seller’s note
• Warrants of 20% - 25%
ESOP Economics – For illustrative purposes
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Scenario 1 Scenario 2 Scenario 3
EBITDA (after comp) 10,000,000$ 10,000,000$ 10,000,000$
Valuation Multiple (X) 7.0 8.0 10.0
Enterprise Value 70,000,000$ 80,000,000$ 100,000,000$
% of Value in Cash (2) 30% 30% 30%
Seller's Cash at Close 21,000,000$ 24,000,000$ 30,000,000$
Seller's Note 49,000,000$ 56,000,000$ 70,000,000$
Employees including Physicians 100% 100% 100%
Notes to Table
(1) For purposes of this simplified analysis, no existing debt on the business is assumed.
(2) In an ESOP transaction, the seller's receive a percentage of the sale price in cash at closing, with
the remainder received over a span of typically 5 years. 30% chosen as an example.
For Illustrative Purposes Only(1)
Post Closing Ownership
ESOP Features – Converting Ordinary Income to Long Term Capital Gains
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OWNER LIQUIDITY
ESOPs start with a liquidity event
for the selling shareholder(s).
Sellers, through the company,
borrow money to fund a portion
of the sales proceeds and then
sellers finance the balance over
time. In addition, sellers can
receive warrants to participate in a
second liquidity event at such time
as all the debt is paid off (i.e.,
typically within 5 years).
EMPLOYEE RETENTION
Employees of ESOP companies
receive initial and thereafter
annual share grants which can
provide for capital appreciation in
their retirement accounts over
time. ESOP companies often
have ownership cultures that
encourage employees to “thing
and act like owners.” This tends
to lead to more productive
employees and more profitable
firms.
TAXATION
Sellers can defer taxation on the
gain depending on the type of
corporation.
The business will also receive
numerous tax benefits depending
on the type of corporation.