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Four reasons to consider private equity

January 22, 2013
by Dennis Grantham, Editor-in-Chief
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Part 1: Why working with an equity investor could be your ticket to retirement

There are plenty of entrepreneurial spirits in behavioral healthcare, some of whom we recognize each year as Behavioral Healthcare Champions. But even the hardiest entrepreneurs get older, get a little tired, get short on liquidity, or simply want to get out—cash out, that is—of a successful mental health or addiction treatment business to which they’ve given their lives.

In this fast changing landscape, there are plenty of things to impede the growth of a behavioral health business:  fewer self-pay customers, deep-pocketed competition, demanding payers with long payment cycles, increasing administrative and systems requirements, and a price of adding new beds, amenities, or facilities which keeps going up—just out of reach of what you thought you’d have to pay.  All of this can lead you to the feeling that the work you love isn’t as easy, as fun, or as profitable as it once was.  Maybe it’s time to hand the reins to someone else—or to get out altogether.  But how?

For some, a sale of their business to equity investors might be the answer, says Hunter Peterson, a partner at Trinity Hunt (Dallas, Texas). He maintains that the right equity investor sees your business through fresh eyes and has the ability to offer not only capital, but the skills and knowledge needed to take on issues—of growth, improvements, or succession—that you and your current partners, management team, or clinical staff find difficult, bothersome, or just a bit too costly or risky for even your entrepreneurial tastes.

The problem

Peterson says that business owners who consider equity investors are often motivated by one of four key issues:

  • One is the need to fund growth. “If you’ve got a successful business and you’re making money, you might well have a waiting list and be thinking about expanding.” he says. “Maybe you’ve even got a property in mind, where you know you could move and double your patient census. But, you just never have the money to do it.”
  • Another is the perception that the business is becoming more demanding, and that perhaps your energy or passion is waning. “Often, you get the feeling that the business is getting more difficult—the feeling that you’re working harder, but not making money the way that you used to,” Peterson explains. “You know that the right owner could come in and build on what you’ve done, work with the staff that you’ve put in place, and take the business to the next level.”
  • Still another situation involves the need to attract new capital—to “recapitalize” the business. “Let’s say you’re a founder and CEO of the business and that you’ve always invested in the business—you’ve never taken money out of it. But as your retirement gets closer, you feel reluctant to risk it all again,” Peterson says. In this circumstance, an equity investor might allow a still-active executive to draw equity out of the business, yet lend expertise to the new investor, who takes a majority ownership through a “majority recapitalization.”  Hunter notes that while some would predict that executives “cashing out” of their businesses might be less effective as business partners, the opposite is generally true. He maintains that entrepreneurs who are freed from the stress of risking their own equity often work even harder, and are willing to make even bolder decisions in the interest of maintaining or growing the businesses that they’ve built.
  • Finally, he says, there’s the concern that industry changes are moving beyond your ability to keep up.  “There’s the situation where an owner recognizes that ‘We’re good, but we’re too small’” to deal with industry changes. One such change is the need to dramatically expand administrative staffing and systems to deal with the shift toward insurance-based coverage for addiction or mental health treatment.” In a situation like that, Peterson maintains that a wise owner is going to say, “Hey, please acquire my business and absorb it into your organization.”  In this case, an equity partner with expertise in the field—and the staff and systems expertise that you need—might be just the ticket either to continued success, or to eventual retirement.

Coming soon:  Part 2 of the story will explore the steps in a valuation process and surprising findings about what your business might be worth. 

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Comments

Hunter Peterson's key issues are very accurate in my experience as an M&A advisor. Private equity is an increasing force and opportunity for owners and nonprofit entities. There are at least a couple other issues that I think merit consideration.

The 5th key issue is the likelihood that a private equity investor will encourage the seller to keep all or most of senior management in place if it is operating effectively. This can be very attractive to a potential seller who wants to avoid the shake up of a good team that is sometimes mandated by a strategic buyer.

The 6th key issue is that it gives the buyer an opportunity to maximize a sales price by "keeping some skin in the game." This can be attractive to sellers in a variety of circumstances including undercapitalized but rapidly growing businesses.

Tom Schramski, PhD
VP/American HealthCare Capital
tom@americanhealthcarecapital.com

Tom:

I believe that Hunter Peterson would agree with your "5th issue" - the value of keeping all or most of senior management in place. He made a very similar comment to me about the potential danger of making big changes to a successful organization structure in a specialized and personalized business like addiction treatment.

As to keeping "skin in the game," another important insight. Thanks for your comments.

In part 2 of the piece, we'll be talking about valuation. Perhaps you'll have some comments there too?

Dennis Grantham, Editor-in Chief

Great insights. Angel investors and venture capitalists are also very focused on the management team as a key to future success in all markets, and it is an increasing emphasis in healthcare especially as we move from Baby Boomers all the way to Millenials. Looking forward to the second part on valuation!

Tom Schramski, PhD
VP/Ameican HealthCare Capital