How to Time the Market for an Exit
How can providers looking to leave the market, properly time their exit?
- By Bradley Smith
- Apr 16, 2015
Is it possible to time the market to maximize an exit? Well, that depends. Successful transactions come together when three conditions are in sync.
- The business is ready for external scrutiny.
- The owner is personally ready for a transition.
- The timing of the capital market (macro) and the DME market (micro) are favorable.
The first two of these the seller and the M&A intermediary can influence control over, while the latter is more difficult and requires a bit of luck. Most importantly, all three conditions must come together for a successful transition to happen.
M&A market conditions at the macro level are currently strong and will likely remain strong through the remainder of this decade. There is strong evidence to support this. According to GF Data, quality and size premiums (multiples) are at their highest level since 2003. This has caused the median EBITDA-to-valuation multiples for buyout deals to rise to the highest level on record.
At the micro level, DME valuations have started to rebound but are still low, due to marketplace or payer source uncertainty. I believe that DME is a very good value at this time. The risk with DMEs has largely subsided making them more attractive. Yes, there will still be competitive bidding, audits and bundling but the majority of the unknown is now known making DMEs attractive again. To further illustrate my point PEGs and other capital investors have been pouring unparalleled amounts of capital into our DME market as never before.
Private Equity Groups (PEGs) are flush with use it or lose it cash. Typically PEGs have 5 years to place the capital they raise; if it is not, the capital is returned to their unhappy investors with a less than modest return rate. According to Pitchbook, at the end of last year PEGs had accumulated $486 billion worth of dry powder, they need to spend it or risk returning it to investors
PEGs need exits and are willing to go where the deals are. Traditionally they have focused on the upper middle market, but these transactions are becoming scarce and increased competition has driven values even higher. PEGs are coming downstream and focusing their activity in the lower middle market and the small business market for add-ons. Pitchbook reports that 62% of all middle market deals last year were at the low end of the market. I fully expect the PEGs to continue to seek smaller and smaller platform acquisition targets over the next five years.
On the Corporate side, companies have cash to invest. According to the Fed’s latest Flow of Fund’s report the S&P 500 has over $5 trillion in liquid assets on their books. With innovation lacking and organic growth slow, it is no wonder that a majority of CFOs have listed small strategic acquisitions as their primary means of growth.
Is the Business Ready for External Scrutiny?
One of the most difficult factors for a business to overcome is external scrutiny. Management teams and business systems become accustomed or adapt to how to best operate cohesively. Some of these are thought out while others happen naturally. Regardless of how they are currently functioning when scrutiny and /or stress is applied, things can go offline. The owners and management team need to be proactive by finding what buyers will perceive as shortcomings. They need to either make logical changes or prepare to defend why their systems are the best solution.
These issues are easily exacerbated when the buyer does not have an HME/DME background such as a financial buyer. Our DME/HME industry nuances are difficult enough to digest (36 month capped rental, January deductible holds, over billing, etc.) for outsiders. These issues are best addressed on the front end where they can be easily managed, as opposed to later on when they are often found in diligence.
Buyers and owners alike need to approach certain topics with sensitivity. Sellers will often feel that they are being attacked for their decisions while buyers are just seeking ways for further improvement. The topics that are usually hot button items are employees, patient care and future growth of the company. Often DME owners with clinical backgrounds (present company included) have a tendency to by hyper sensitive when their programs are reviewed. These clinical minded owners need to keep in mind that buyers are weighing the cost benefit analysis of these programs and that it is not a personal attack on the validly of them or their programs.
Is the Owner Personally Ready for a Transition?
Surprisingly this is much more common than we would think. Everyone gets cold feet from time to time, but a fair number of owners do not think all the way through an exit. There are many different kinds of exits and each person needs to spend a good amount of time really thinking about what they would like to do post acquisition before going to market.
An owner’s preference of personal involvement will directly affect potential buyers’ interest. Often financial buyers will not be interested without ongoing owner involvement in the day to day operations, but strategic buyers may prefer the owner to step down after a brief transition period. There are plenty of options either way, and the most important thing is to be honest with your intentions.
Owners who are looking for a full exit often do not prepare for what is ahead. Owners need to have a plan of what to do with their life post sale and integration period. For many owners this is what scares them the most: having nothing to do. The other consideration is, will your financials needs be met? Most owners are used to a monthly paycheck or regular disbursements. The idea of having one lump sum may sound great, but owners really need to think about how to budget for that payment. They need to budget not only for that payment but also all of the fees that will come out of it, including taxes, advisors fees, attorney fees, accountants, any debt payoffs, employee obligations, working capital, etc. Often times that large payout can become less than half of when it started. It is a good idea for owners to create a personal monthly budget prior to an exit so that they know how long their money will last.
Certain elements of an exit can be controlled and timed to a degree. Obviously, one cannot control the capital markets or the DME market, but one can control self-preparation and company preparation and will make a significant difference on a transaction.
This article originally appeared in the May 2015 issue of HME Business.
Bradley Smith, ATP, CMAA is a former DME owner, a certified mergers abd acquisitions advisor and is a Managing Director at Vertess Advisors, LLC, a national mergers and acquisitions advisory firm focused exclusively on the healthcare marketplace. He can be reached at (817) 793-3773 or firstname.lastname@example.org.