It’s a common conversation we have when approaching prospective sellers, “How much more can you really improve my offer? Why would I pay someone to negotiate on my behalf if I already have a deal in front of me that I’m happy with?”
In truth, most of our job isn’t to ensure you get a valuation that you’re happy with. It’s to ensure the valuation you receive holds up, and that you’re protected from the other trapdoors built into LOI’s that will impact your value down the road. Unfortunately, you don’t fully understand what your offer really entails until it’s too late.
Here’s a pretty standard offer you might look at from a DSO:
- DSO Determined EBITDA = 850k on 3.5MM in Revenue
- Valuation is an 8X = 6.8MM Enterprise Value or 194% of collections
- Allocation = 65% Cash (4.42MM) // 25% Joint Venture Equity (1.7MM) // 10% Holding Company Equity (680k)
At face value, the outlined deal looks great. But buried deep into every LOI are deal terms, background information, and legal language that needs to be reviewed and negotiated for the deal to move forward. Deals often change dramatically from LOI to final documentation and doctors are left with the unenviable decision between agreeing to the changes or walking away from a process they’ve invested 6+ months into.
Here are just a couple of areas that are overlooked when perusing an LOI:
Problem Number 1: EBITDA
This baseline valuation metric is at the core of all PE/DSO/VC offers. As a measure of profitability, it informs the buyer of how long it will take to begin receiving a return on their investment. During the closing process you’ll go through a “Quality of Earnings” process which is a third-party analysis of your EBITDA. If it comes up negative, the value of the deal will generally be reduced. If it comes up positive, in a DIY deal, you’ll rarely receive feedback that it did. In a represented sale, we’ll help determine your EBITDA based upon the same accounting mechanisms that a QofE firm would, and then defend that number. We see numerous offers sent to sellers that have heavily inflated EBITDA projections from the buyers, dramatically inflating the offer, just to keep the seller engaged in the deal.
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Problem Number 2: Rollover Equity
It is highly likely that between 30-45% of your transaction will come in the form of rollover equity. In dental transactions, there are two specific types of rollover equity. JV Equity (localized to the practice you’re selling) or Holdco Equity (specific to the parent entity as a whole), both buckets can have all kinds of parameters that need to be sorted out for you to have a full picture of the offer you’re receiving.
Questions like:
- Exit Valuation
- Exit Timeline
- Who can you sell it to and at what price point?
- What is the historical track record of the equity?
- How realistic are the projections they’re putting forward?
- Can you sell it all at once or in chunks?
Problem Number 3: Management Fees and Distributions
This will impact the profitability of the practice and the distributions allocated to your JV Equity percentage. However, there are also various clawbacks that are often a part of the final APA, related directly to maintenance of EBITDA, growth clauses in earnout computations, and the value of the JV Equity. If you’re selling to a management entity, you need to understand how management fees will impact the numbers that you’re paid from.
Problem Number 4: Private Equity
This point is simple. It is critical you understand both the purchasing entity, and the organization writing checks to that entity. Where the funds come from matter and ensuring that you’re partnering with a group that has a track record of successful exits from their healthcare investments is critical for the future value of your investment in the organization.
These are just a FEW of the overlooked areas that make-or-break deals after signing an LOI. We often also see obstacles with legal language, buyer risk mitigation and a myriad of other topics. Suffice it to say, there are successful and disciplined buyers out there who understand exactly what they need out of a transaction to turn a hefty profit. They have a full team behind them helping them to bring on deals that check those boxes. You are at a disadvantage if you don’t have the same working behind you!
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About TUSK Partners: TUSK Partners (“TUSK”) provides M&A Advisory services in the dental industry. TUSK has completed over $1B of transactions across all specialties. With an in-depth understanding of the marketplace and access to 100’s of buyers nationwide, we help our clients confidently pursue M&A transactions that maximize their long-term value. With our significant collective experience of over 40+ years of dental practice transactions, we offer our clients solutions that help them achieve their strategic and financial objectives. For more information, visit https://tusk-partners.com
