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Private Equity Update for Retinal Physicians

Take careful consideration before deciding to move forward.

 Having spent several decades advising ophthalmologists on how to be better and smarter in growing their practices, it came as no surprise that many doctors were both amazed and confused as private equity firms (PE) began buying ophthalmic practices and paying large sums in the process, far outstripping any valuation offered upon retirement by a younger associate or another practice in the community. 

In the past year alone, the number of practice platforms established by private equity firms grew from fewer than 5 to more than 20. The exact number, as well as the purchase terms of the various deals, are difficult to attain as these are private transactions. My colleague Bruce Maller estimates that 800 MDs are now part of these platforms, and analysis done by my firm SM2 Strategic indicates that this trend will only continue over the coming years.

Private Equity in Retina

Retina specialists are participating, with acquisitions taking place of retina-only practices as well as multispecialty practices. The goal of this article is to help shed some light on both what’s behind this surge in merger and acquisition activity for practices and what physicians need to consider moving forward.

While PE activity is surging, it is not an appropriate strategy for most practices, at least at this stage. Practices being acquired tend to be larger as measured by revenue and the earnings before interest, tax, depreciation, and amortization (EBITDA) or free cash flow generated each year. Private equity is willing to pay a large multiple, ranging from 4 to 10 times the annualized cash flow. While this is indeed attractive, it comes at the end of a long and grinding process where bankers, lawyers, and the buyer all do extreme due diligence to evaluate the quality of these earnings. A PE firm will invest a lot of time and money before finalizing a deal that can be a mid-eight-figure transaction, including deep analysis of financials as well as compliance. The data need to be correct in both content and format. This is one reason the services of an investment banking firm can be invaluable in guiding physicians, who have little time to spare and even less knowledge of how to negotiate and complete a transaction of this magnitude. 

The Investment in a Retina Practice

For most physicians, this is the largest financial transaction of their lives. But the buyer is not another ophthalmologist who understands and speaks the same language. The buyer is a savvy healthcare investor looking to deploy capital and viewing ophthalmology as attractive relative to other investments. That attractiveness will change over time based on other opportunities as well as the performance achieved by early entrants into the profession. 

Even before discussion of money, it’s important to understand one’s motivation. If it’s mainly about money, it’s likely the physician will be miserable after the deal is done. What PE firms are interested in is partnering to help grow practices. Their willingness to pay a high multiple now is because they believe that by working together, they can create even more value for a future sale that generates a return to their investors as well as to the physicians who remain employed with a stake that is often referred to as the “second bite at the apple.” 

There are multitude of issues to consider, and every transaction is different. Thus, I advise physicians against comparing their practice to others in trying to precisely determine its worth. All practices will trade in a range, and the final value is determined by both internal (“How attractive is this practice to the PE firm’s goals?”) and external (“How is the stock market and economy doing and how much liquidity is looking for a place to invest?”) considerations. Other common and important issues include how to deal with the inherent loss-of-control that takes place after the deal (you no longer call all the shots), how to retain younger partners and associates (without whom the future of the practice is at risk), and whether the practice is in a good position to sell or would be better off trying to improve EBITDA now to increase its value later. 

Retina specialists face a similar predicament to the cataract surgeon: dependence on referrals. For the retina practice, if traditional referral sources are swept up by a PE platform practice, the practice can suffer, especially if the practice plans on bringing in its own retina specialists. As a result, we’ve observed competing retina groups combining to create strength in number and strive to maintain market dominance. We’ve seen other large retina practices serve as the platform acquisition and then evolve into a multispecialty enterprise. 

For now, the retina subspecialty enjoys a market benchmark that is approximately twice in annual compensation that of a general ophthalmologist that does some anterior-segment surgery. That’s good when it comes to determining the value of the practice and what it will cost to replace a retiring physician. But in the long term, risk relating to both reimbursements as well as access to patients can flip this into an unfavorable scenario. This does not imply that a practice should sell now, as we are still early in what will be a process that unfolds over many years.  But retinal physicians need to pay special attention as a tertiary specialist in the overall eyecare treatment system.  

While most physicians we speak with are advised against considering PE for the time being, most often due to the size of the practice, we do believe it makes sense to work proactively to boost and grow EBITDA. Often, with a little bit of work, the practice can uncover opportunities to save money or attract patients in new ways (disclosure: Our firm specializes in helping practices unlock value in this manner). When it comes to being attractive to a likely future buyer, it makes sense to seek ways to increase value. The math is straightforward: Every $10,000 you are able to increase EBITDA is worth somewhere between $40,000 to $100,000 in a transaction. That should serve as sufficient motivation in this regard. 
 
Other Specialties as an Example

As you consider your future, remember that ophthalmology is not the first medical specialty to be attractive to a financial buyer. Dermatology, for example, is about 5-7 years ahead and shares many of the same characteristics that PE finds attractive, making it a good example for ophthalmology. Dermatologists who sold to PE in that early phase were typically required to take part of their proceeds (eg, 20% to 30%) in the form of equity in the new platform company. This maintains alignment of interests among all owners (doctors and their new equity partners) to keep growing. 

Those initial platforms spent years doing both acquisitions as well as consolidation of functions (eg, purchasing, billing, human resources), with doctors focusing on clinical and surgical patient care while professional management handles administration and all aspects of acquiring additional practices to continue to build their platform. Their goal is to achieve scale and efficiency as well as increased profitability.

Having performed that aggregation work, their platform is now of sufficient size to be attractive to PE firms that only consider acquisitions once they are of sufficient size and profitability, in this case much larger than the original practice when it was first acquired. Just in 2018 within dermatology there were 36 acquisitions, providing evidence that the “second bite at the apple” does indeed exist for those doctors who sell and remain involved as owners in a PE-backed platform.

In the PE world, this is known as climbing the ladder and is a process that can repeat every 7-10 years depending on market conditions. For younger physicians, participating in 2, 3, or even 4 of these cycles can generate similar or greater income over their career, depending on how well each of the platforms performs. It’s a different economic model than what traditionally was available where ownership, risk, and reward are shared rather than shouldered by the individual.

Summary

As stated earlier, exploring a sale requires much thought and effort and, if successful, will be the largest financial transaction in most physicians’ lives. It requires a great team of both internal stakeholders and external advisors to make it happen. I would list the key considerations that need to be analyzed in this order:
  1. Motivation: What’s the goal in selling?
  2. Control: Can you handle emotionally having less control?
  3. Expertise: Are you willing to recognize and hire resources to help?
  4. Younger physicians: Can you achieve alignment across generations?
  5. Practice health: Is your practice ready financially and culturally?
  6. Market dynamics: Will your practice be attractive to buyers?
  7. Tax efficiency: Have you fully explored how to optimize and reduce tax exposure?
As you can see, this is not a process for the faint of heart. There are numerous issues that are both complex and intertwined with one another. Like anything else in life, it is important to measure risk vs reward. At the end of the day, there is no single “right answer” that can apply. I look forward to continuing to observe the market as it develops over the coming months and years and providing perspective and knowledge to the ophthalmic community. 

Shareef Mahdavi has been advising ophthalmic practices and companies for many years and is focused on helping physicians achieve greater value in their practices and in their lives. He can be reached at (925) 425-9963 or via email at shareef@sm2strategic.com.