ASC lifecycle
The lifecycle of an ASC includes periods of initial growth (start-up phase), sustained growth, slowing growth and a plateau to decline phase. The various stages of growth during the lifecycle generate differing amounts of profitability defined as earnings before interest, taxes, depreciation and amortization (EBITDA). Your ASC's stage of growth will have a major impact on the price a buyer is willing to pay to invest in your center.
Initial growth. The initial growth phase is normally short in duration but critical, as this phase lays the foundation for the business's future growth. The physician-partners' first impressions of operations will determine how aggressively they begin to shift cases to the ASC.
Planning must be thorough during this phase as it determines important aspects about the future of the ASC. Here are critical things to consider when developing your business:
- Accurately assess the surgical cases and case mix
- Recruit strong physician partners
- Don't overbuild the physical plant
- Raise enough working capital
- Determine what, how and when you get paid
- Don't overstaff
EBITDA growth will lag volume growth due to fixed operating costs that must be covered during this time. The initial goal should be to break even as quickly as possible. The ASC should focus on receiving the surgical cases identified in the business plan and efficient operations and cost containment to achieve this goal. During this phase it will take between 6-12 months for the business to become cash flow positive. At 12-24 months, your center should begin to build cash flow.
Sustained growth. During the sustained growth phase, case volume and solid operations yield positive results. Operating performance is deemed effective, and physicians have gained confidence in the clinical and business staff. Cases continue to shift to the ASC as a result of their confidence.
Fixed costs are now covered and profitability is increasing during this phase. Returns are being realized through distributions and EBITDA margins are expanding with incremental volume increases. Growth is driven by the core partners. This is an ideal time to sell an interest in your ASC to a corporate partner as the business exhibits an upward EBITDA growth trend, which may yield a higher valuation.
Slowing growth. A period of slowing growth is possible at any time during the lifecycle of your ASC, but it is likely to happen as the business captures the bulk of the initial physician partners' surgical cases. Once this volume is captured, it is important to recruit new partners. The recruiting process is fraught with challenges including valuation of share price, partnership dynamics, dilution and personality considerations.
During this phase, some business aspects may be overlooked. For example, payor contracts may be out of date and in need of renegotiation; staffing levels have crept up and so have supply costs. Efforts to control costs may have been neglected. As a result, cash flow levels off and profit margins begin to suffer. Partner distribution versus partner contribution may also become an issue.
Although growth has slowed, this may be a good time to bring a corporate partner aboard — if cash flow is still relatively stable, recruiting prospects are good and out-of-network revenue is low.
Plateau to decline. At this point in the life of your ASC, growth has stalled. Business fundamentals begin to break down. The partnership begins to fracture. Older partners start to retire, and the partnership may be unable to repurchase shares without adequate protections in the operating agreement/governance structure. Ownership no longer reflects contribution, and apathy begins to set in.
Efforts to control costs in this stage may be ineffective because it is difficult to change the established operating cost levels experienced during its growth periods. The center often becomes overstaffed and capital expenditures increase. Unfortunately, the opportunity to capture the best value of the center has likely been missed. Your center may now be recognized as a turnaround opportunity for corporate partners or management companies.
Factors affecting valuation
So, what are the factors that most significantly affect the value of your ASC to an outside investor like a corporate partner or management company?
First, EBITDA represents the cash flow that a business generates and is an important factor when figuring out the price of your ASC. The main concern of a potential buyer is the stability of that cash flow. The value of an ASC with a positive EBITDA can be determined using a formula. The time period used to determine the EBITDA is typically the trailing 12 months of financial data. The formula takes into account the EBITDA for the trailing 12 months times a multiple (current range is 5-7 times for a majority interest purchase) less partnership debt plus some level of working capital times the percentage a buyer is purchasing.
An example of the formula and resulting purchase price: $2.0 million in EBITDA (trailing 12 months) times a 5 multiple equals $10 million enterprise value minus debt of $500,000 plus $100,000 cash/working capital equals a $9.6 million dollar equity value times a purchase of 55 percent equals a purchase price of $5.28 million dollars.
The 2009 ASC Valuation Survey, conducted by HealthCare Appraisers, representing 18 buyers and 500 surgery centers, showed that 50 percent of buyers who purchased a controlling interest in an ASC reported multiples of 6.0-6.9 times EBITDA. An additional 38 percent reported multiples of 7.0 or higher. Forty-five percent of respondents perceived that valuation multiples stayed consistent with 2008, while 38 percent perceived that multiples decreased.
4 main pricing criteria
A buyer must be critical of the stability of the center's cash flow, the growth prospects of the center and its underlying operations. Valuation multiples are determined by the outlook for future performance and, therefore, are extremely sensitive to growth prospects and risk factors. There are four main pricing criteria that have either a negative or positive impact on price.
1. Competition/barriers to entry. The multiple will decrease if there are few barriers to entry for other ASCs in the area, if there are several competing partnerships within your center or if physicians have ownership in multiple facilities. If it's unlikely that you'll experience success recruiting new partners or users, the growth prospects are diminished, driving a discount in valuation of the business.
The multiple will increase if there are significant barriers to entry for other ASCs (such as requiring a certificate of need), if there are few competing partnerships or if physicians do not have investment interests outside of your ASC. These factors create multiple recruiting/growth opportunities for the partnership and receive credit in valuation.
2. Reimbursement risk. The multiple will decrease if your center has high out-of-network revenue, if it has a specialty concentration facing significant Medicare changes or if there is other exposure (such as workers' compensation reform). Out-of-network payments can boost net collections, but centers with high levels of out-of-network payments are generating a level of cash that's not sustainable in the future. The historical trends of the business are important, but what you are really buying into is the future cash flow. If you expect that to decline, you're going to discount its value.
The multiple will increase if your center has contracted with major payors, if your center's specialty is in a "positive" Medicare concentration (such as ENT or orthopedics) or if there are no other exposures.
3. Partnership profile. The multiple will decrease if a significant number of your physician partners are nearing retirement and your center has no contingency plan to replace them. Another factor is partner concentration. Having too few partners sharing sale proceeds may create incentive for them to slow down or eliminate their surgical case production. Also, having a dominant partner creates risk that there is too much reliance on a single individual.
4. Growth prospects. The multiple will decrease if there is limited growth opportunity from existing partners, if there are few recruiting prospects or if there are capacity concerns.
The multiple will increase if your center consists of partners with growing practices, if there are excellent recruiting prospects, capacity to grow and a diverse case mix.
Buyers consider two types of growth when making these determinations — organic and external. Organic growth depends upon the maturity of the individual partner's practices. Each partner is interviewed individually to determine their objectives and ability to bring additional surgical cases to the ASC. External growth is analyzed based on the probability of recruiting new physicians to the partnership.
Determining when to sell your ASC
So, when should you sell your ASC? The answer is simple: sell when an outside investor can add the most value to your partnership.
This can occur at different stages for different partnerships, and buyers exist at all stages. It is important to asses the current and future needs of the partnership and to create realistic valuation expectations. It is difficult to anticipate a future decline in business, so it is necessary to determine where the partnership is and where it is headed. Always remember that valuation is not solely determined by past results but by the expectations of future performances.
Once an assessment is made, finding a corporate partner that can best meet your needs is critical. You should research companies to understand their track record in the industry, as well as get references to determine if they will be a good fit for your partnership. There should be chemistry between you and the potential corporate partner to ensure your goals are met. Price is likely the number one consideration when picking a corporate partner, but you should consider that it may be better to accept a slightly lower offer from a company that can create future value than a higher bid from one that cannot.
Valuations should fall in range, and you should be careful of wide variations in price. If it comes down to two possible partners and the money is equal or close, pick the best partner for your ASC. Remember not to burn bridges with those corporate partners you choose not to pick — you may not close the transaction the first time you are engaged in this process.
Consider that incremental value can be generated from a corporate partner focused upon growing and extending the life cycle of your business. The future value perspective of the buyer is focused upon maximizing existing partner volume, recruiting new partners in order to extend the growth of your business, renegotiating payor contracts and expense management in order to expand EBITDA margins.
In the end, choose the right corporate partner based upon what the needs of your business are and the benefits that the partner can offer to you.
Finally, it is wise to retain a single lawyer to represent the partnership, ideally a healthcare lawyer who understands how to structure these transactions and will ensure that the process goes smoothly.
Mr. Hancock (khancock@meridiansurg.com) is the president and chief development officer of Meridian Surgical Partners, a company that aligns with physicians in the acquisition, development and management of multi-specialty ambulatory surgery centers and surgical facilities. Learn more about Meridian at www.meridiansurg.com.