By Franklin J. Rooks Jr, PT, MBA, Esq
At some point, practice owners inevitably think about what is next after private practice and start planning for retirement. It also may make sense for the private practice owner to think about pre-retirement plan- ning. While the private practice owner may not be ready to retire, he or she may want to consider options for exiting the ownership of the practice while continuing to work for the practice. In this regard, the owner is not retiring, but instead monetizes the practice by “taking some chips off the table.” It is pre-retirement in the sense that the owner continues to work—albeit under new ownership—and is able to invest sale proceeds to further achieve future retirement financial goals. The private practice must be a saleable asset—but is it? What do you have to sell? Some practice owners have been met with a rude awakening when they realize that they do not have anything to sell. That is, what they have built is not of value to any would-be buyer. As many practitioners have come to see, there is a tremendous distinction in the creation of a job versus the creation of a business.
Many private practitioners have outstanding clinical expertise and provide exceptional care, but that alone does not create a business. Many practitioners have been able to set up shop, design their own hours, control their vacation times, answer to themselves, and practice physical therapy the way they want. They are their own boss. Unless there is a significant earnings number created in the process, the private practitioner has succeeded in creating a job for him/ herself. Instead of working for a hospital or other entity, the practitioner has chosen to work for him/herself. This is laud- able, but not worthy of any financial consideration as part of any value-added transaction. Acquirers are not purchasing jobs, they are purchasing businesses.
Who’s Buying What
The physical therapy market has been active recently with a number of mergers and acquisitions taking place. Some of the acquisitions are strategic; others are financial. In a strategic acquisition, an entity that is already entrenched in the physical therapy space purchases a physical therapy practice that fits into its overall growth plan, making it a “strategic” fit. The purchaser is considered to be a “strategic buyer.” In some cases, a strategic buyer is a competitor of the target company. Other times, the strategic buyer is not a competitor in the target’s geographic marketplace, but wants to enter the region. The overall goal of a strategic buyer is to make a synergistic acquisition that fits within the acquirer’s growth strategy. Although, a financial buyer is generally one without any investments in the industry in which the target company is situated. A financial buyer looks at the metrics of the company—cash flow, return on equity, management sta- tistics—with the goal of increasing the financial performance of the target company.
These buyers typically determine the target company’s earnings, termed EBITDA. “EBITDA” is the acronym for earnings before interest, taxes, depreciation, and amorti- zation. This is a standardized measure used by buyers to assess the target company’s financial performance. The cal- culation subtracts the company’s revenue from its expenses, but the expense calculation excludes taxes, interest, depreci- ation, and amortization. The measure is intended to insulate the target company’s value from accounting treatments and accounting elections it may have made. EBITDA may be supplemented by certain add-backs, which serve to increase the EBITDA. Many times, add-backs are those expenses that are not required to run the company or those expenses that would not exist but for the current owners operation of the company. Examples may be the add-back of the owner’s automobile expenses to EBITDA, adding back any excess compensation or even the cost of tickets for sporting events that are not exclusively used for the business. These add-backs result in a higher EBITDA. Just as there may be add-backs that favor the seller, there can also be negative adjustments to EBITDA. For example, if the target company is under-insured and obtaining proper insurance results in a material expense, the application of that expense could lower EBITDA. Making positive and negative changes to the practice’s earnings produces an adjusted EBITDA.
Once the adjusted EBITDA is determined, the target company value is determined by using a multiplier. The multiple of EBITDA provides the enterprise value. For example, if the company has EBITDA of $750,000, and the multiplier is 4.5, the enterprise value is $3,375,000. Many factors influence the multiple. The buyer’s risk and the industry’s ability to grow are predominant factors. There are also “deal specific” factors that may come into play. Strate- gic buyers may pay a higher multiple than financial buyers. With respect to physical therapy, buyers may consider the following: How many clinical locations does the target company have? Does the target company have locations in more than one state? Is the EBITDA above or below a million dollars? This is not an exhaustive list. However, at the end of the day, you need to have EBITDA. EBITDA is typically the basis of any valuation.
Is There Enough EBITDA?
Simply put, EBITDA is what is left over after all expenses. For the solo practitioner, if all of the practice’s earnings are paid out in salary, an adjustment is made based on what the market compensation is for a person functioning at owner’s capacity. That is, if the solo practitioner pays him/herself $200,000 and the market price to replace that individual is $150,000, a rough estimate of the EBITDA is around $50,000. An EBITDA multiple of 5.0 would translate into an enterprise value of $250,000. Upon any sale, these proceeds would flow to the seller net of any debt that the practice has. If the prac- tice had $50,000 of debt, the proceeds to the seller would be $200,000. If a broker was used in the sale, there would likely be transaction costs. And, of course, the sale would be subject to federal and state tax. On the other side of the equation, there is a tipping point for which the sale does or does not make economic sense. Buyers in all transactions conduct due diligence on the entity that may be purchased. Getting the deal across the finish line requires accountants who assess the quality of earnings and lawyers who draft transaction documents and finalize the sale. All of this involves expense. The value proposition must be such that the deal makes eco- nomic sense. EBITDA of $50,000 may be too small. However, there is a point—which is buyer-specific—that determines whether or not to entertain the transaction.
Think about your exit strategy. Take a critical look at your business. As you plan for retirement at some point in the future, does your practice represent an asset that you can monetize? Does your perceived value of your practice mesh with realities of the market? What have you created? Your EBITDA is a great indicator of whether you have created a job for yourself or whether you have created a business.
Franklin J. Rooks Jr, PT, MBA, Esq, is a physical therapist and practicing attorney in Philadelphia. He was a founding partner of PRO Physical Therapy in Wilmington, Delaware. He can be contacted at firstname.lastname@example.org.