Crucial Questions

Podcast 18.5: How Does Life Change For Physician Partners After A Transaction?

podcast_GEORGIA ARIAL18.5After years of running their own practice, building a solid team, investing in new technology and growing their practice, physicians are faced with a new reality. The transition from physician-owner to a physician partner is a major area of concern to our clients ... and it should be.  Hence the question, "How does life change for physician partners after a transaction?" 

Existing physicians are considered one of the most important assets in the transaction and their continued dedication and support is critical to future success and an enjoyable future. 

  • Can I continue to work for the practice after it’s acquired?  0:44 - 2:56
  • How does my post-sale physician compensation impact the transaction valuation?  2:57 - 9:46
  • Is it smart to lower my compensation going forward to drive a higher sale price?  9:47-14:21
  • Will a sale change my practice into something I don't like? A new name, new culture, new staff,  new operations, etc?  14:25 - 17:20


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 Transcript

Andy:

These investors are doing things very, very differently than what was done in the '90s with Physicians Research Group and many of the those other companies, where everything was going to a centralized office. The name was changing, the physicians were losing the personality and that was a huge mistake. The investors learned from that.

 

Welcome to PF Insights, hosted by the Leadership of PhysiciansFirst, Healthcare Partners. If you're a physicians practice owner, or an ambulatory surgery center owner, and you're wondering how to navigate the mergers and acquisitions ecosystem, this is the podcast for you.

 

Welcome to PF Insights, episode five, brought to you by the Leadership of PhysiciansFirst Healthcare Partners. I'm your host, Andy Snyder, partner at PhysiciansFirst, and with me as always, I have our managing partner, Eric Yetter.

Eric:

Hello Andy.

Andy:

How you doing, Eric?

Eric:

I'm great.

Andy:

Good. So today, we are continuing our series of answering crucial questions brought to us from many of our ophthalmology prospective clients as we focus on ophthalmology acquisitions across the country. And today, we are going to answer the question: “How does life change after a transaction for physician partners?”

 

We often get that question first and one of the-

Eric:

Huge topic-

Andy:

Huge topic, and one of the more humorous takes I have on that is when a physician asks you, “Can I continue to work for my practice after it's acquired?”

Eric:

No, of course not. No.

Andy:

You have to go home.

Eric:

Yeah, I mean, it's not an unreasonable question. I understand why people ask that. Because a lot of acquisitions and partnerships that people hear about, they get rid of the management. They bring in their own people, and they turn it around. It's part of a larger questions about, “What kind of an investment is this by private equity people.” They hear about these turnaround situations. They hear about things like Staples and Hurts and some of these bigger investments.

 

This is not that. This is a stability investment. And part of a stability investment is that the key people have to stay. The physicians have to stay. If you're a physician and you're hoping to sell and retire day one, probably not gonna happen. It might at a very reduced valuation, but it's not gonna happen on the terms that we talk about and the things that we talk about on this podcast.

 

Typically, you want to stay. They want you to want to stay-

Andy:

There will be legal agreements asking you to stay.

Eric:

And there will be legal agreements that essentially require you to stay of at least probably three years. It's probably the usual minimum. We've seen it be less, but you're gonna sacrifice something to get that.

Andy:

Right. So, after acquisition, you are going to stay with the practice. All the physician partners and the key members, and the associates, everyone is invited and expected to stay. But what will change is your compensation, after the practice has been acquired. You're no longer receiving ownership distributions, and so can we go into a little bit about the compensation of the partner physician, post-acquisition, because that is a good question.

Eric:

Yeah, absolutely. And we talk about this a little bit, on the last episode, but when one of these deals happens, the owner physicians are gonna change how they make money. Right now they're making money as an owner, which means that they essentially get a portion of whatever the practice makes in profit. Some of that might come through a salary, some of the might come through benefits, some of it might come through the Range Rover lease they have. Whatever it is, they're getting money through the practice some way. And there's probably some left over at the end, that just get divided up by the partners, and if you're a sole partner, you just keep it. But you're getting paid as an owner. It's different then what you're gonna be paid after the transaction.

 

After the transaction, all that goes away, and you are paid, in almost every case, based on your productivity, based on the professional revenues, that you generate for the practice. Typically, doesn't include revenue generated at a surgery center, doesn't include revenue generated at whatever plethora of ancillary services there are, unless it's specifically negotiated. Usually it's just based on your professional revenue.

 

And sometimes, optical revenue that you generate as well, but you're paid a percentage based on that productivity. And there are rules in place for what that is. And it's kind of established within the industry. It's probably less established at the beginning, but now the investors are starting to be more sophisticated, there’s starting to be more consensus about this. And, it probably lines up very well to what physicians pay their current associates. And as a production-based figure, that's usually somewhere between 30% or production and 40% of production, and there's some margin outside that, maybe going down to 25%, etc.

 

But there are rules. You can't go way, way, way below normal and you can't go way above normal, because it creates adverse incentives, between the parties, between the investor and the physician, and you need to be replaced eventually. You won't live forever; you're gonna have to be replaced with somebody else, and that somebody has to be comfortable and attracted to working on the same terms that you're working.

 

And those are the terms that you should expect to work on after the deal.

Andy:

You said it's gonna create adverse incentives if you're paid too far outside of that generalized range. I mean, I think of it as 30%, and before I start throwing out numbers and people start saying, "No, I get paid, this and this and this here. And people get paid this and this and this here," these are not hard and fast rules.

Eric:

No, this is extremely market-dependent.

Andy:

It depends on geography, it depends on the practice, but from what we've seen, we're talking about 30% of production for ophthalmologists and the different specialists-

Eric:

Generalizing it, and for different, for retina guys, maybe they're paid a little bit higher percentage, you know. It's different.

Andy:

You said you don't wanna create adverse incentive between the physicians and investors. What do you mean there?

Eric:

Well, let's talk about a situation where a physician is earning above market compensation, based on productivity. The new owner of the practice would have an incentive to replace them with someone who would work at a lower rate, and you may not want that. You may want to stay around, and you may want everybody to be happy about you staying around. And vice versa.

 

So that's why, we think you wanna stay within market. And then also, you need to be replaceable. It creates a huge risk for the investor if they're paying you well below market, and then when you leave and they have to hire somebody at market, what the practice that they bought, the investment that they made, is based on what you're going to be making, and that changes when somebody else has to come in and be paid a lot more than you.

Andy:

And that's kind of another topic. We can go into that now, but it's a big driver into the valuation. What the owner physicians are paid post-transaction.

Eric:

Right, I think that is a good topic to go into. Even tying back to the conversation we had in the last episode, you know, “What are these private equity investors, other types of investors, what exactly are they buying and what numbers are they using to get to that acquisition price,” and we stated, it's the saleable EBITDA, it's the bottom line profitability, the cash flow. But you have to take into consideration what the providers, the owners, previous owners, are getting paid as compensation going forward.

 

So, with that in mind, the key formula is the difference between what the owners were making as owners to what their compensation is as employees, after the acquisition. That number can be used as a lever, and that directly affects that purchase price.

Andy:

Yeah and-

Eric:

The simplest way to think about this is that all of the money that the owner group is taking home right now, lump that all together, let's say that's a million dollars. And then, post transaction, we want to think about, “What is the owner group going to be paid?” So, let's say their annual production is a million dollars, and their percentage compensation rate is 30%. That means they would be paid $300,000 on a go-forward basis.

 

And then we look at the difference. The difference between what everybody is taking home right now, we said before that was a million, versus what they are gonna be paid going forward, we said that's $300,000. There's $700,000 there that we call saleable EBITDA. That is the EBITDA that the investors are interested in.

 

And it's very common to have confusion about is, a lot of physicians have the impression that the EBITDA includes everything that all the owners are making. And I understand that. However, the investors cannot invest in that, because the owners have to be paid something, after the deal. And that's why we look at that go-forward compensation and we're really interested in the difference, when we're thinking about the saleable EBITDA of the practice.

 

So, that gets back to the fact that if you're paid more, post-transaction, that number is gonna go down. If you're paid less, post-transaction, that number is gonna go up. It's one of many levers that physicians have and that investors have and that they kind of work out together, as part of these transactions, that gets to the ultimate deal.

 

And it's part of why we think too that this really isn't just about the money. There are a lot of things going on. There's the money that people get paid upfront, there's equity that people get upfront, there's what physicians are paid after the transaction, there's management style, there's what's gonna happen to the employees, all kinds of things that are important, and that's why we pay attention to all of them.

Andy:

Right. You threw out the term saleable EBITDA. I did too. Sometimes people called it, I've heard it been called, normalized EBITDA. We talk about it in our firm, normalized compensation, calling about that change from ownership to employed compensation going forward.

Eric:

Correct.

Andy:

But the scenario you just laid out, we'll get the question, wait, so you're telling me that in some situations, I might want to lower my own compensation going forward, to create more saleable EBITDA, for the upfront purchase price? And yes, in some cases, that makes sense.

Eric:

Yeah, and it wouldn't always make sense. It makes sense in these situations because the prices being paid are so high. The valuations that are being put on ophthalmology practices right now are great. Physicians have not had that opportunity. And now, these valuations are being exercised by investors, and physicians have an incentive to look at this in a different way, probably, than they have in the past.

 

So, when you talk about lowering your compensation, let's say that you have the opportunity to either be paid 35% of production post-transaction, or 30% of production. If you produce a million dollars, that's a difference between a $350,000 go-forward salary and a $300,000 go-forward salary. So we're talking about $50,000.

 

Let's say that the multiple of EBITDA, and I know everybody talks about this:
“What multiple of EBITDA did you get?” People are almost competitive about it. But, and I just wanna say this because I've got a microphone in front of me, physicians need to be careful about being competitive about that.

 

Because it is one of a hundred factors. And somebody might tell you that they got 15 times EBITDA. Well, you don't know what EBITDA is, you don't know how it was calculated. There are a lot of things going into this, so you've gotta be careful about measuring it, and whenever you talk to anybody about that, about their specific situation offline, but EBITDA multiple is a thing that people talk about, they probably talk about it a little too much. But, it's the thing that determines these evaluations, ultimately.

 

So, getting back to where we were, $50,000 difference between go-forward compensation options. Even the EBITDA multiple being applied on this is eight times, which is typical, for kind of, a mid-sized practice, eight times 50 is what, Andy?

Andy:

400.

Eric:

$400,000. So, you can either chose to make $50,000 more, or going forward, whatever that timeline is, depends on your situation per year, $50,000 more per year, or you can get $400,000 now.

 

The $400,000 you get now is probably gonna be taxed at capital gains rates, although we do not give tax advice. I'll say that again, we do not give tax advice. But that $400,000, will be taxed at capital gains rates, probably. So there's an advantage there on the tax side and there's just the advantage of having money upfront.

 

And that's ultimately a decision that physicians have to make, is do they want money now or do they want money later? It's a personal decision.

Andy:

That was a very good example. It was a lot to take in, too, so if you didn't quite catch that, just rewind this podcast for about three minutes, listen to it again, internalize it. If you still don't get it, we were either unclear, or you just need to call us.

Eric:

Yeah, and I may have talked fast. You can put it on slow mo.

Andy:

Well I think another thing, another variable into that whole equation is the age of the physician.

Eric:

Oh, yeah.

Andy:

Physicians with a shorter career runway, post-acquisition, probably gonna wanna take a lower salary going forward and take more into the multiple, so to speak, the 400 side. And those who have a longer career runway, if you have a physician owner who's 45, wants to work another 25 more years, maybe they're more interested in having a higher percentage of compensation going forward.

Eric:

Unless you have a great equity situation. Unless you're really excited about the equity that you're gonna get in the global ophthalmology company, you think it's really gonna go places, and that's gonna turn into a huge number, you might want to put more in that bucket.

 

Or, let's say you have great personal investment options where you have a great advisor, you have great opportunities, through yourself or your contacts, to put the money that you get now to work, you might want more money now. But it's a personal decision.

Andy:

Right. All right, well we ran a little long on the compensation side for this podcast, but to be honest, that's how most of our conversations go with the physicians. Talking about the money involved is important, and we'll go through it again and again.

 

But to go through some other factors of an acquisition, I mean we are talking about in this podcast, “How does the life of a physician partner change post-acquisition?” That includes compensation, but it also includes things like: “What about the name of the practice? Is the name on the door gonna change?”

Eric:

Probably not.

Andy:

In fact, almost certainly not. These investors are doing things very, very differently than what was done in the '90s with Physicians Research Group and many of those other companies, where people were partnering, everything was going to a centralized office, the name was changing, the physicians were losing the personality, they were losing the essence of their practice. And that was a huge mistake, and the investors learned from that. They're being very careful not to repeat it again.

 

A lot more of these transactions, I think, are cash components. It's just a much better situation for physicians than what we saw in the past.

 

And part of that is the hands-off attitude. It's not coming in and changing everything, not changing the administrator, not coming in and changing employees. If you have bad people, they're gonna have to do it. You should have done it probably already, but for people that have really good staff, good operations, the investors are not going to change that. They're not gonna change something that's working well. And that's the attitude they're coming in with, is that they're looking for a situation where they don't have to do that.

Eric:

Well they're investing in your brand, in the community as well.

Andy:

Oh, absolutely.

Eric:

And they wanna keep the brand intact. They're looking for physicians that have strong reputations. They will help them with future acquisitions in the area, all right? But also, they are not gonna do anything that would confuse the patient base.

Andy:

No-

Eric:

And just the local community. I can say with almost certainty, you're not gonna go in and find a practice that all of a sudden has a sign that says, XYZ Eye Practice, Owned by the Portfolio Company of Private Equity Company X. There's no need for it.

Andy:

Nobody cares.

Eric:

There's no need for that. Nobody cares.

Andy:

The patients don't wanna see that, and the investors know that. They don't need their name plastered everywhere. Some of the investors are extremely secretive about this.

Eric:

Right.

Andy:

And I'm fine with that. I think that's probably the right way to do things.

 

So, it's definitely very hands-off, relative to what I think a lot of people expect, and what they've seen in the past. And there is some variability among the investors. Some of them have more operational heft, I'd say. They probably have more to offer in terms of support of the HR functions, payroll, that kind of thing, sometimes financial.

 

But I think a lot of them are trying to stay very lean and to leave operations at the practice, because they realize it's often done best locally. It's done best where there's a local administrator and a local physician, and people that have been doing it, too, in most cases for a very long time. So, they do wanna keep that going.

Eric:

Right. Okay, well I think I'm gonna wrap it up there.

 

That's it for episode five, “How does life change after transaction for physician partners?” We talked about compensation after the sale, we talked about what it will be like for the staff and for you, and really, the hands-off approach that these investors are taking.

 

In our next episode, following these crucial questions, we're gonna get into what are the transaction structures going on, and get in-depth about cash versus equity and all sorts of other good things.

 

So, thank you for listening. Catch you next time. Shoutout to my dog Winston.

Andy:

Thanks.

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