Crucial Questions

Podcast 18.6: What Are The Typical Acquisition Structures In Private Equity Investments?

podcast_GEORGIA ARIAL 18.6This is an area of major interest because it is totally new territory for our clients and it can be both overwhelming and intimidating. New terminology, a multitude of cash and equity structures, private equity companies and global ophthalmology platform operating companies.

We bring experience and understanding to this complex issue so our clients can evaluate their options and find the best solution for their situation and goals.

  • What are the typical cash/equity structures in a private equity transaction?  0:50 - 9:20
  • A review of: 1) 100% cash purchase, 2) Cash plus minority retained equity in the practice, 3) Cash plus global platform operating company equity.
  • What is the difference between the private equity company and the global ophthalmology platform operating company?  I get confused by multiple names.  9:21 - 11:44
  • Should I seek more cash or more equity in the deal structure?  11:45 - 15:47
  • Understanding global ophthalmology platform company recapitalization risk and reward
  • What other types of investors may be interested in investing in my practice?  15:48 - 18:53


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Transcript

Speaker 1:

All the private equity firms who are in this space generally are looking to acquire, build these things and then sell them to another investor after a finite period of time. Some of these alternative investors are looking to hold forever. For a lot of physicians, that's attractive.

Speaker 2:

Welcome to PF Insights, hosted by the leadership of PhysiciansFirst Healthcare Partners. If you're a physician 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.

Andy Snyder:

Welcome to PF Insights episode six, brought to you by the leadership of PhysiciansFirst Healthcare Partners. This is your host, Andy Snyder, partner at PhysiciansFirst. With me, as always, is our managing partner, Eric Yetta. Welcome, Eric.

Eric Yetter:

Morning.

Andy Snyder:

Okay. Well, so if this is the first episode, you're listening to episode six. We are still focused on ophthalmology practice investments in acquisitions going on across the United States right now. We're answering a series of crucial questions that are posed to us from our prospective physician clients. Today's question is, “What are the typical acquisition structures in these investments?”

 

I think the first subquestion into that greater question is, “What percentage of my practice are investors looking to buy?

Eric Yetter:

Yeah, it was a good question. First, the caveat, and that is that we use the term acquisition pretty loosely. It's kind of the best term for this, but I do want people to keep in mind that there are sophisticated legal structures behind this. Sometimes the practice in a legal sense is not technically being acquired. It's the assets of the practice that are being acquired, usually non-clinical assets of the practice. So, there's some sophistication behind that that a lot of attorneys have been paid a lot of money to create. So, we're using that term in a loose sense.

Andy Snyder:

And we are investment bankers, not your attorney.

Eric Yetter:

Yes, exactly. But acquisition is the best term for what's going on here. We kind of use it to describe these types of transactions generally, that happened between physician practices and private equity-backed ophthalmology investment companies.

 

When we're talking about the different structures, there's really, I would say scenario A and B, and sometimes there's scenario C. Let's start with scenario C, sometimes. Sometimes, a physician will have an opportunity to sell 100% of the practice for all cash. That's not as common. The reason is that the investors want the decision to continue to be motivated in some way through some type of stake, some equity component, some skin in the game after the transaction. But sometimes, usually for a smaller practice or maybe a physician that's later in their career is more looking for an exit solution, there may be an opportunity to acquire or to sell 100% of the practice for cash. That's scenario C, sometimes.

Andy Snyder:

Those look a lot like when there's a large practice in a region that a physician who's on the way out and acquires a smaller practice and kind of leads into his retirement. They're a little bit similar to those situations about the 100%, but keep going.

Eric Yetter:

Yes, I agree. That's probably where you're going to see that the most. I think we're going to see more of that too, by the way. I think that as there are more practices being acquired in different areas of the country, they're going to be looking to grow. They already are, but that's going to accelerate. Looking to grow through acquisition of smaller practices is add-ons. It could be smaller ophthalmology practices, could be OD practices, but some of those are going to be hundred-percent cash acquisitions. Because stocks are going to become more valuable.

 

Right now, physicians are getting stock in a big way because it's early-stage. There's a lot of upside on it. As these companies mature, the investors will likely stop giving stock the same way, because it's going to become too valuable. They're going to want to hold it themselves.

Andy Snyder:

But with option C, those are smaller practices. So, if you're from a sizable practice, I'll keep that loosely defined, and you're going into this thinking, "I'm going to test this market and see who's going to give me 100% cash up front," then you might be disappointed with the results.

Eric Yetter:

Yeah, I wouldn’t count on it. It's possible, but I wouldn't count on it. Again, scenario C, sometimes. The scenario of A and B are the ones we see more often. So, scenario A is what I would describe as a retained equity scenario. The key here is “retained.” That means that you are keeping ownership in the practice that you have now, similar to what a lot of ophthalmologists have seen with surgery centers. If you have a surgery center and you sell 51% of it to one of the surgery center management companies, you're retaining 49% ownership in that surgery center. Even if maybe the legal structure changes, maybe the surgery center moves into a new tax ID, it moves into a new legal entity, you still have ownership in that specific entity that's related to your surgery center in your practice. So, you have local retained ownership. That scenario A.

Andy Snyder:

True partnership.

Eric Yetter:

It's a true partnership. Yeah. That's what I think has been going on longer. That's what's been going on with ASC management companies for 40 years. What happens in those situations is that anywhere from 51% and up of the practice is changing hands, is being acquired by the investor and there's a lot of variability there. Some investors ... actually this is more common for surgery centers, but sometimes it happens in practices too. As we're seeing some of the more legacy investors come into the practice space, companies that have historically been acquiring surgery centers and are not necessarily private equity are starting to invest in practices more.

 

At first, it was “I would only invest in a practice if it had a surgery center with it.” Now, some of them are interested in just investing in practices by themselves, which is pretty exciting. They're coming around to this too. But it’s common in those to acquire something more in this type of scenario where there's retained equity kept by the physicians. Sometimes it goes below 51, but generally we're talking about 51% to 100% of that is changing hands to the investor. I think that's relatively easy to understand is that you're keeping some of it. You're selling some of it, and you're keeping the rest.

Andy Snyder:

You're losing majority control. You're diversifying, obviously, but you have the same incentivization as your new partner as far as the distributions are coming from the same bottom line, right?

Eric Yetter:

You're probably going to continue to get distributions, but just pro rata, right? So, you gave us 100% and distributions. Now you get 49% of them. So, more apples to apples in terms of post- versus pre-transaction. That's scenario A.

 

Scenario B is the one that we see the most. It's probably really the one we see almost all the time now. That is, it's an equity component. You get some cash and you get some equity, but the equity is not necessarily in your local practice. In this scenario, it's not. It's in the global company. It's in the ophthalmology company that the investor is creating. The reason people like that is that there's a lot of upside. If the investor is successful, they go out and do what they're trying to do, which is acquire a number of ophthalmology practices and then grow them both organically, by driving more referrals, by driving higher reimbursement rates, et cetera, or inorganically, by acquiring other practices. We talked about small practices being added on to existing ones for 100% cash, et cetera. They're growing that way.

 

The value of the equity that the physicians get in that global company can be worth a lot if there is success. There are a lot of things that physicians need to be careful about with that, including what kind of equity is it. Equity is not all the same. Some of it is better than others, for lack of a better word. Some of it participates in the same way with the investor, some of it is subordinate to the investor, which means that the physician only gets money if the investor gets money first. I think that physicians need to be careful about that. But if this is done in the right way, in the way that physicians can benefit from and that's something that physicians work on with their attorney, that's something that we advise them on. But if they do that, and things are successful, things work out, there are never guarantees, but if things work out, that equity can be worth a lot of money.

Andy Snyder:

Right. I think a couple things I want to clarify. One, the global equity that we're calling in this situation, it is a minority percentage of the entire transaction, which we're still talking about cash usually making up at a minimum 60% of the transaction value. 60 to 80, I think, is probably the range we see the most. Really that remainder of 20 to 40%, that's what we're talking about it being rolled to the global equity.

Eric Yetter:

Yeah.

Andy Snyder:

I think the second thing is all the articles out there, say, “Oh, private equity entering the ophthalmology space and that that practice was bought by PE or a private equity firm.” And then all of a sudden, we talked about the platform companies, the global platform company versus the private equity firms, and they have different names. And so, that can be somewhat confusing to people looking into it for the first time. So, can you go through the difference there?

Eric Yetter:

Yeah. Private equity companies typically are not trading under their own names. They're not doing business under their own names. They have a lot of different companies that they own and they don't usually bear the name of the private equity firm. For example, KKR is one of the biggest private equity firms. It has a ton of companies in its portfolio, and they don't say KKR on them.

 

A good example was ... Let's use an example. In Atlanta, based in Atlanta and this is kind of Southeast-focused investor in ophthalmology called [EyeSouth 00:10:24]. Good company … W work with them a lot, very professional people there and we hope we continue working with them.

Andy Snyder:

Yeah. Shoutout to those guys.

Eric Yetter:

Yeah, we hope they're very successful. I think they will be. That company, EyeSouth, is owned by Shore Capital Partners. It's not 100% owned. Some of it is owned by physicians, et cetera. But the major investor in it is Shore Capital Partners, which is the private equity firm and you don't hear that name as much. But that is the private equity firm that is behind EyeSouth, and pretty much all of them are structured in that way, in that there's a private equity firm backing an ophthalmology operating company, which is the entity that's actually going out and developing business and making those acquisitions.

 

Now, some private equity firms are looking for their first investment, and we work with a lot like that. They haven't come up with a name yet. When they make that first investment, they'll probably come up with a name that has Eye or ophthalmology or something and probably with partners.

Andy Snyder:

Something very witty around the use of an eyeball or the letter I.

Eric Yetter:

Yeah.

Andy Snyder:

But yeah. So, if you are one of the initial platform investments for a private equity firm, then yeah, part of the gravy I guess is you probably could participate in naming what the below global platform is going to be called.

Eric Yetter:

Huge plus.

Andy Snyder:

Yeah. I guess then we talked about the global equity that you can ... By the way, when you went through your three options, you went C, A, B. That's kind of confusing. But anyway.

Eric Yetter:

Yeah. I did that on purpose.

Andy Snyder:

We're still talking about B, the global equity percentage. Sometimes that could be 20% or less, sometimes it could be up, 30%-plus. I don't know if that's a lever, but for physicians, they might say, "Well, okay, as my advisor, what do you recommend? Am I going for more equity in the global company or should I have more cash? How does my situation-?" Go ahead.

Eric Yetter:

It's kind of up to them. It's up to them and their personal situation and their appetite for risk. It's up to them in terms of the confidence that they have in the growth of the global ophthalmology company post-transaction, or in some cases, and probably always too, in the growth of their own practice post-transaction. I think if you're optimistic, you may want more equity. If you're pessimistic and you're seeking security, you may want more cash, and neither is wrong. I think there can be a lot of value in this equity. I also think there can be a lot of value to getting cash up front and maximizing that.

Andy Snyder:

If there's going to be a lot of value in the equity portion of the deal, when are the physicians going to see the results of that?

Eric Yetter:

It varies case by case, but typically, there will be some opportunity to do that during the recapitalization. The word recapitalization means that the initial investor, the private equity firm, sells its ophthalmology investment to another investor. Could be another private equity firm, probably will be, or it could be another type of investor. It could be a larger healthcare company or it could be an insurance company or it could go public. There are a lot of things that can happen. But there's some kind of financial event where the initial major investor, the private equity firm, sells its interest and realizes its success, realizes a successful investment hopefully.

 

As part of that transaction, there will typically be an opportunity for the physicians to sell their equity as well. The reason it's attractive is that often the value that's received by the private equity firm could also be received by the physician. So, they're selling for a lot more then than they would have been able to at the outset.

Andy Snyder:

Yeah. I've seen several presentations where the private equity firm is showing results from past portfolio companies, and they're saying, "Look, we more than quadrupled the value of your stock in a five- to seven-year period. So, if we're doing an 80-20 split here, if we do what we want to, that 20% is going to be a larger value than that 80% was. So, you should want the equity portion.

Eric Yetta:

Exactly, yeah. If we repeat some of the success we've had before, it'll be really good. Now, look-

Andy Snyder:

You have to trust that though.

Eric Yetter:

... it could be worth absolutely nothing, and everybody who does one of these needs to be comfortable with that. It's just like any other investment that when you invest money, at least in something like this, maybe if you're buying an extremely secure investment like treasuries or something, it's different. But with an investment like this, an equity investment, particularly a private equity investment, which is really what this is, you need to be able to lose that money.

 

I think most of our clients are wealthy enough and successful enough and sophisticated enough that they can, but it can go to zero. We never want to be the people that didn't tell you that. We don't take responsibility for what happens to the equity, of course, but I want to be upfront with people and say, "Look, you need to know that this could go either way, and we've seen it go either way." But I think that it's up to the physician, it's up to their attorney to look very closely at their own situation and decide what's best for them.

Andy Snyder:

Yeah, now is a pretty deep dive into a private equity transaction scenario. But not all of these investments into ophthalmology practices are necessarily private equity. There are a few other companies out there that are not private equity-backed. Could you talk a little bit about how that's different?

Eric Yetter:

Yeah, there's some really interesting things going on. We talked before about how some of the traditional investors in surgery centers are now starting to be more interested in acquiring practices. Those are the big names that our old company, Covenant Surgical Partners, is now more interested in acquiring practices, not necessarily even with a surgery center. We're seeing that more and more now, which I think is really good.

 

In addition to those companies, there are also just other private investment companies. We've worked with a couple of them, and they typically have a lot of investment from a single individual or a family. That's where a lot of the money comes from, but then they also supplement that with other third-party investors. A common one would be life insurance. Life insurance companies need to invest their money relatively safely, but for your return. That's an asset that those companies can use. They can also use the same type of investors as other PE firms, but the difference is that they're not necessarily operating with the same type of timeline.

 

One of the things that's unique to private equity, or relatively new to private equity, is that their goal is to grow for a period of time and then exit. Exit just means sell. So, they're looking to build this company and sell it. They're looking at that under a finite timeline; they have to. The reason is that their money comes in funds. So, they go out, they raised what's called a fund, which is basically a pool of money. Part of that fundraising, part of the agreement with their investors, is that it will be invested and returned in a certain way under a certain timeline. There's probably some flexibility in that. In most cases there is, but they can't hold it forever. Their goal is not to hold it forever; they have to return it to their investors.

 

All the private equity firms who are in this space generally are looking to acquire, build these things and then sell them to another investor after a finite period of time, probably seven years, five years, something like that. Some of these alternative investors are looking to hold forever. They're looking for a cash flow investment that they can buy and hold, and they're looking for stability and conservative growth in those cases. For a lot of physicians, that’s attractive. Typically, a little bit different structures, because the equity component is different. You don't have equity that you can sell later in the same way as part of a recapitalization when the investor sells, because the investor’s not going to sell. So, they have alternative equity structures that accomplish some of the same things. They accomplish upside for growth, and they allow the physicians to participate in growth, but the timeline on that is different. It's often exercised at the physician's discretion within certain parameters.

Andy Snyder:

That will wrap it up for episode six. We covered what are the typical acquisition structures in these ophthalmology practice investments, covered what percentage of the practice is being acquired, the difference between retained equity and equity in the global company, and really the difference between private equity firms and these other alternate investors.

 

We thank you for your time today. I'm Andy Snyder. He's Eric Yetter. Thank you for listening to PF Insights. We will see you next time.

 

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