Experts tell: Is your practice ready for sale?

Amid the ongoing amalgamation of Australian medical practices into corporate groups – from general practitioners to specialists, cosmetic clinics to dental surgeries – earlier this year the Australian Society of Cosmetic Dermatologists (ASCD) Symposium asked 4 experts to highlight the key challenges facing any practice considering a potential corporate sale.

Having a ‘profitable dermatology practice’ is significantly different from having ‘a profitable dermatology practice that is ready for sale’.

That was one of the key themes explained by Dr Patricia Manoharan – who sold her Brisbane Skin practice to the Aura Medical Group in 2021 – at the ASDC Symposium at Melbourne’s Crown Conference Centre from March 24-26.

Other key ‘tips’ and ‘warnings’ from a panel of experts included:

• A sole practitioner business is the least attractive target for corporatisation – the fewer professionals you have, the less potential revenue for a buyer from multiple and/or diverse income streams.
• Conversely, multi-practitioner and/or multi-discipline practices are the most attractive – offering greater diversity of revenue streams generated by other staff with their own patients; ie, other doctors (especially aesthetic/cosmetic practitioners), nurses (injectables), nurses and therapists (peels, laser), product sales.
• The purchase price is not a simple multiple of current revenue – it will be subject to both:
  • ‘adjustments’ – for example, employee leave liabilities; and
  • ‘warranties and indemnities’– statements about the affairs of the practice at time-of-sale regarding accuracy of financial data, condition of plant and equipment, any historic claims by employees or legal disputes.
• Practitioners fulfilling post- sale ‘earn-out’ components to the purchase price will no longer maintain full control – and therefore be reliant on the performance, actions and decisions of others (for example, the former owner now has to report to someone; there will be new rules regarding spending decisions within the practice).
• Practitioners will also be subject to post-sale ‘restraints’ – involving non-compete obligations and termination rights.
• Corporate buyers often want to pay the purchase price as part-cash/part-shares (in their model it takes less cash flow out of the new entity) – this has numerous positive and negative aspects, as well as significant taxation implications.

In a session specifically devoted to the ‘challenges of commercialisation of cosmetic dermatology’, a diverse panel of professionals dissected the key issues – from 4 very different perspectives – for practices contemplating joining commercial cosmetic dermatology groups.

Sale agreement risks

Gregg McConnell, a partner at legal firm Lander & Rogers with experience in mergers and acquisitions explained that, upon an approach from a commercial dermatology group, they will simultaneously begin ‘due diligence on your financials, premises and plant and equipment’, while also negotiating ‘potential terms of sale’.

Typically there are two methods for sale:

• Option A: sell both the assets plus the business – this option usually applies when a family trust exists and the sale needs to proceed into a new structure.
• Option B: sell the specific legal entity your business is currently operating from – the buyer is required to pick up ‘legacy issues’ plus the history associated with that entity (and is therefore open to any potential liabilities).

The sale agreement sets out the purchase price (what you will be paid): it will be a multiple of normalised earnings, less any ‘adjustments’ (for example, employee leave liabilities).

Typically there will be an ‘earn out’ component. During that period:

• you’ll be reliant on the performance/actions/decisions of others (for example, the former owner will now report to someone);
• you will no longer have full control of either:
  • your practice (for example, there will be new rules re ‘spending’ decisions); or
  • elements of your own working conditions (for example, unfettered flexibility with your hours of work).

The purchase price will also be subject to ‘conditions precedent’ – these involve satisfying a list of topics flowing from the buyer’s due diligence (for example, if the buyer has identified issues which need to be fixed).

McConnell emphasised any sale agreement ‘involves certain categories of risk’.

The first risk involves the requirement that you provide ‘warranties & indemnities’ – legally binding statements about the affairs of the practice at time-of-sale. These will pertain to the accuracy of financial data you have provided, the practice’s current plant and equipment, and assurances on issues such as absence of any historic claims by employees or pending legal disputes.

A purchaser ‘can seek recovery in future if any of the warranties are not correct and the purchaser suffered loss as a consequence’.

The second risk involves post-sale ‘restraints’. You will be required to provide both non-compete obligations (which specify where you can and can’t work in the future) and termination rights (which set out a required ‘term of notice’ to leave the practice after the ‘earn out’ period expires, plus another non-compete obligation operating once you finish the ‘earn out’ term).

The third risk will be in the form of a ‘personal guarantee’ – in support on those first and second risks. It guarantees that if the purchaser suffers loss due to either of those risks, it can recover its losses personally from you.

Once a practice is sold, the aggregation group is now the legal owner of the practice going forward: it provides services to the acquired practice and charges a fee.

In the sale agreement, the practitioner can be either an employee or (more likely) a consultant, and the relationship shifts to a ‘service agreement’ or profit share arrangement.

Post-sale, the operation of the practice will involve several key obligations: the services agreement (regulating fees and services); practitioner obligations (minimum hours of work, ongoing duties, revenue targets) which provide the purchaser with a ‘right to terminate’ if you don’t meet them; termination conditions (the required ‘term of notice’ after an ‘earn out’); and restraints (post ‘earn out’ non- compete obligations).

Most importantly McConnell warned: ‘The aggregation groups are used to conducting these negotiations. They have specific financial parameters within which they can acquire a practice.

‘You will not have this same level of experience or expertise. So seek external advice from the start of any negotiation.’

A PURCHASER CAN SEEK RECOVERY IN FUTURE IF ANY OF THE WARRANTIES ARE NOT CORRECT AND THE PURCHASER SUFFERED LOSS AS A CONSEQUENCE.

Purchase price valuation

Adam Murray, a partner at accountancy firm Findex who has been involved in a number of these transactions, provided an accounting and equity finance perspective.

He noted that while ‘corporatisation is relatively new to cosmetic dermatology, there’s a growing demand’.

He explained the potential corporate buyer ‘aims to consolidate and do things ‘one best way’ – with the goal to achieve economies of scale, plus potentially stronger branding’.

Murray said the purchase price will be a multiple of EBITDA (earnings before interest, taxes, depreciation and amortisation) and is usually ‘partly cash and partly shares’ (equity financing).

He said that ‘in their model, corporates want to pay the purchase prices as part-cash/part- shares, because that method takes less cash flow out of the new entity.

‘So if the purchase price was $2 million, they might seek to divide that into $1 million cash and $1 million share value.’

The potential ‘positive’ of this model is that, if the post-sale business does well, the seller earns a better return – because the shares are worth more than the original price.

However, for a seller taking part of the consideration in shares, usually you will pay tax on the whole value received ($2 million) at time of sale – even if you sell shares in the future at a decreased value (when you may later claim a tax loss).

At this point, Murray emphasised, the buyer ‘is coming from a place with greater knowledge of doing this type of transaction’. So you need to check the track record of the potential purchaser – preferably by talking to someone who has previously dealt with them.

You also need to examine and understand: How did they calculate the value of their shares?

Where did their share valuation come from? And how long ago was that valuation made? It’s extremely important to have their ‘valuation’ looked at and reviewed independently.

Meanwhile, in determining a valuation for the practice, the buyer will attempt to approximate future maintainable ‘normalised’ earnings (needing to add back any ‘out of the ordinary’ items) – by looking at a number of years and averaging the key figures over them.

They are specifically looking:

• for trends over the past 3-5 years (an important factor is ‘before’ and ‘after’ Covid); and
• to break down where the revenue is coming from.

In examining revenue streams, they are asking:

• Who at the practice is generating more income?
• Which services at the practice are generating more income?
• Is there currently a supplier exclusivity agreement? (They are looking for economies of scale).
• Do you, for example, currently have an internal IT staff member at the practice? (They will already have their own IT resource acting for the whole entity.)

Once they have an approximate figure for future maintainable ‘normalised’ earnings, they will apply a ‘multiple’ to it. But another important question for your advisers is: Where did that ‘multiple’ figure come from?

Importantly, the corporate buyer ‘will be looking for the former owner’s commitment to stay in the business for as long as possible, unless retiring – because doctors have the key relationships with patients’.

The former principal is now confronted by the issue of ongoing ‘integration’, warned Murray: the corporation wants to integrate you into how they do things – and that necessarily involves taking away lots of your former control.

‘Now that’s happy days if: (a) your shares go up in value; and (b) you also want someone else to deal with day-to-day practice issues – if your priority is I don’t want to do the administration/paperwork/etc.

‘But the negatives can include: the buyer may want to rebrand the practice; the former owner now has to report to someone; there will be new rules re ‘spending’ decisions within the practice.

‘And additionally, there will be an earn-out figure to be achieved, of which the practitioner now needs to be extremely careful and aware – especially in making judgements about how actively they have to keep managing things, including maintaining awareness of changes the buyer wants to make to internal practices, suppliers and staff.’

Murray summed up bluntly: ‘Take advice – and take it EARLY!’

He also answered a question about the frequency and/or likelihood of a practitioner’s colleagues potentially buying the practice. In his experience, in a world where corporate entities are increasingly entering the bidding arena, ‘former colleagues may initially be keen to buy your practice, but then when they see the realistic price, plus understand the administrative burden the owner has been carrying re HR/payroll/ etc, they simply don’t want to take on that level of debt’.

Making practice ‘ready for sale’

Dr Patricia Manoharan (managing director of Dermatology Clinics Australia, which includes Psoriasis Clinics Australia, Eczema Clinics Australia, Vitiligo Clinics Australia) detailed her journey:

• from establishing a clinic in 2015,
• building an industry-leading dermatology practice,
• planning and taking the steps necessary to make a profitable dermatology practice ready for sale,
• to successfully completing its corporate purchase by the Aura Medical Group in 2021, and
• now ‘thoroughly enjoying and being invigorated by the continual learning curve that comes with successful business development’ in partnership with her new corporate employer.

Dr Manoharan emphasised that – from the start – in order to make a profitable dermatology practice ready for sale you need a good lawyer and accountant. ‘They simply can’t be undervalued – especially because YOU, the main practitioner, are a very big risk factor in any potential sale’.

She explained ‘reputation definitely brings something to the table, which is why the key dermatologist is both a key asset and a potential risk if they leave’.

In addition, the corporate buyer usually wants ‘all the key people to stay; as much as possible, they want everything to keep working well and little to change.

‘Usually company executives will work closely with your practice manager: if you’ve got a successful and profitable practice, then the corporate preference is definitely for things to stay as much the same as they can.’

Dr Manoharan explained how ‘when we started out, like most practices, we wanted to build something ourselves. You are full of energy and enthusiasm; you want to make your own decisions; control what you are doing; buy your own equipment; keep your own income.

‘Then as you build the practice, you get busy and it’s hard work; and at some point your work/life balance becomes important, especially when you’re missing the kids – and so maybe there’s a point where you want to exit or want to retire.

‘It was just like that for us: we got very busy much earlier than we expected, and we wanted more time for kids and holidays.

‘When we reached that point, we asked ourselves: What’s our exit strategy going to be? That’s when we took the time to make a good decision based on facts.’

The usual options are:

• close the practice – and either retire or go and work for someone else;
• sell to colleagues – who, at any time, may also be thinking about simply setting themselves up in opposition just around the corner;
• sell to a company – depending on how much value they see in the practice, and then also decide whether to continue working for them or working for someone else?

Dr Manoharan noted that, if you decide to sell to a corporate buyer, then yes, there are things you now can’t do. ‘But the many benefits include: a better work/life balance; I’m still busy doing something meaningful, but less stressful; I’m definitely less tired and stressed because I’ve rid myself of many of the worries associated with practice administration and HR management; and I now have the flexibility to work when I want and plan regular holidays’.

In determining the sale price, she noted the buyer will determine a ‘multiple of your profit’ – but they will look very closely at the ‘main risk factors for them’, the most important of which is ‘you, and whether you want to retire or keep working?’

The buyer will determine:

• Are you reputable?
• How much previous profit was due to you personally?
• Is the business really profitable? Without you, will it be profitable in the future?
• Risk diversification: the ‘diversity of your profit and loss’ in terms of revenue generated by other staff with their own patients: other doctors, nurses (injectables), nurses and therapists (peels, laser), product sales.

Dr Manoharan emphasised ‘the more staff and diversification – especially nurses and therapists doing injectables, lasers, peels, etc – the less risk for the buyer, because everything doesn’t depend largely on the dermatologist’s revenue’.

She also advised that ‘if you are considering a future sale of your practice’, you need to institute a plan in advance for where to spend money to ‘expand the practice’. Her priorities would be: staff education (including regular audits and reviews); staff expansion; practice safety and reputation; and practice internal systems, processes and documentation.

On staff expansion she emphasised: ‘The fewer people you have, the less potential revenue from fewer income streams; therefore the higher risk your business is regarding potential profitability, etc, from multiple income streams to drive up EBITDA.’

Additionally, the higher the proportion of non-dermatology income, the less risk in the business that increasing overall revenue is not reliant on just the dermatologist’s income.

Finally, Dr Manoharan acknowledged that a major concern for many practices considering
a corporate sale is a ‘fear of the post-sale’ world – and conceded ‘anything new is always difficult; it’s a scary thing for people; change is scary.’

However, she had found that ‘I’m a strong believer in KPIs: they have given me something to tick off and work towards – targets to aim at and achieve.’

Know the buyer’s key criteria

Dr Adrian Lim, director at uRepublic Cosmetic Dermatology & Veins, analysed the many dilemmas facing a practitioner who is both pondering a possible future corporate sale and, at the same time, ‘working towards maximising the value of a potentially saleable practice’.

He has been personally considering the pros and cons of joining a corporate group for several years and said the first step for any practitioner is to start by asking yourself two questions:

• ‘What’s your greatest regret? For example: is it not having enough time with your family? I’m still working on Saturdays!
• What’s your ‘end game’? And how would you optimise your situation in that end game?’

Dr Lim emphasised that it is important to ‘know the criteria which the potential corporate buyer will be looking for – and start planning early for those issues’.

He listed 11 characteristics of a saleable practice:

1. A multi-partner group – as opposed to a sole practitioner with a limited revenue stream.
2. A multi-discipline practice – the more ‘multi’ the better.
3. Multiple revenue streams generated by allied health professionals.
4. A good practice manager – who can easily, confidently and regularly liaise with accountants and lawyers.
5. A developed, loyal and engaged referrer network.
6. Patient engagement.
7. Current marketing activities.
8. The retail component of the practice – sales of skincare, etc.
9. Current revenue.
10. State-of-the-art premises.
11. Multi-premises – currently practising from more than one location.

Dr Lim summed up: ‘To realistically have a saleable practice, you need to fulfil as many of those as you can.’

He also noted that some corporate buyers (for example, Sonic) have ‘a model to maintain your own brand; so you don’t have to suddenly disappear under a new corporate identity’.

Finally, Dr Lim listed some key ‘selling issues to consider’:

• Is the offer a suitable exit/wind-down strategy?
• Are clinical/ethical standards compromised in the new entity?
• What restrictions are placed on the practitioner?
  Will the positive culture of the current practice be maintained?
• Who are the corporate participants and is the new arrangement a comfortable ‘fit’ for them?
• Is the sale/new arrangement in the interests of your own existing partners? AMP