Volume 9, Issue 4, February 22, 2022
If you are looking to acquire or sell a healthcare business, something you will quickly find is that there is a lot of terminology and lingo specific to mergers and acquisitions (M+A). M+A has its own diverse vocabulary. The more you understand these terms, the easier it will be to engage in the transaction process. Even a surface-level understanding of key concepts will at least provide a foundation to better participate in conversations and ask more in-depth questions.
Below is a list of some of the most common terms and acronyms you are likely to encounter in your discussions and review of documentation. If you come across an unfamiliar concept, do not hesitate to ask one of your M+A partners, such as an advisor like VERTESS or your healthcare attorney, to explain it to you. During the M+A process, ignorance is definitely not bliss.
M+A — Mergers and acquisitions (M+A) is the broad term used to describe what a company like VERTESS helps facilitate. The term is used to describe the consolidation of companies or assets through different transactions, including mergers, acquisitions, consolidations, recapitalization, and purchase of assets. VERTESS will sometimes represent a buyer that has hired us to find acquisition opportunities specific to their industry, but most often we represent a seller. We may also work with two companies of similar size to help them merge into a single organization.
NDA — Signing a non-disclosure agreement (NDA) is the first step in engaging with an M+A advisor. An NDA is an agreement that certain information shared between parties will remain confidential. An NDA binds an individual who has signed it and prevents them from discussing information with any non-authorized party. NDAs are commonly used to protect trade secrets, client information, and other sensitive or valuable information.
At VERTESS, both the client and advisor sign an NDA to ensure confidentiality of shared information even before a formal agreement has been reached. Note: The term "confidentiality agreement" can be used interchangeably with NDA.
BOTE — To inform owners of the estimated transaction value of their company, we provide them with a free, detailed, back-of-the-envelope (BOTE) market valuation. The BOTE approach establishes the estimated transaction value of a company by comparing its financial performance to similar companies that have recently sold.
EBITDA — Earnings before interest, taxes, depreciation, and amortization (EBITDA) is a measure of profitability. This is the ultimate measure of a company's success in the eyes of a bank or investor. A business is much more than its profitability, but when it comes to purchase price, that price is primarily based on profitability — or at least the potential for the company's profitability.
Adjusted EBITDA — This is an area where an experienced advisor can be particularly valuable in helping a seller. In preparation for the sale, the seller will want to identify all one-time expenses or those that the buyer would not incur to run the business successfully following the transaction. Business owners often run personal or extraneous expenses through their companies that may not be necessary. Another example is investments in more personal protective equipment or excessive overtime expenses brought on by COVID-19 that are not likely to be necessary in the months or years ahead. These expenses are added back to EBITDA to create a more realistic adjusted EBITDA on which to base the purchase price.
Fee agreement — Once a client has decided to engage VERTESS for our services, a fee agreement is circulated and signed by both parties. This agreement specifies the relationship between parties, the agreed upon fee structure, and the exclusivity with tail (i.e., how long the commitment remains if the agreement is terminated). These facets of the fee agreement can vary greatly between different advisors. It's important to find an advisor and agreement that best suits you and your transaction goals.
CIM — When a seller client of ours is ready to hit the market, we email a blind executive summary teaser to our extensive mailing list to notify buyers of the opportunity. This summary has no identifying information about the company. It includes general geography, the nature of business, high-level numbers, and some other non-identifying details. When a buyer is interested, they respond with a request for further information.
After signing a confidentiality agreement, we grant them access to our data room. This contains the seller's confidential information memorandum (CIM). It's a robust marketing packet containing a full description of the seller's organization, what makes the business unique and special, the seller's intentions, the current market for the type of business, and opportunities for growth. We pair this VERTESS marketing book with a robust financial analysis to answer questions that we know from experience will likely be asked by prospective buyers.
IOI — The indication of interest (IOI) is the document provided to a seller by the interested buyer to indicate their genuine interest in purchasing the business. The IOI is the first formal document exchanged during an M+A transaction. This document provided by the buyer suggests a valuation range they are willing to pay for a company.
Typically, a seller receives IOIs from numerous buyers. If a buyer's indication is acceptable, the next step is for them to attend a management meeting, which usually includes the seller and interested buyer, and submit a "letter of intent" (defined next). Not all sellers will include the IOI in their process. For those that do not, they go straight to a letter of intent.
LOI — A letter of intent (LOI) is essentially an M+A form of a marriage proposal from the buyer. As the name implies, the LOI lays out the intent of both parties: The seller states they are willing to sell for the proposed terms, and the buyer states what they are willing to pay.
The LOI is an important step because it lays out the basics of the final deal: the purchase price and terms, anticipated leverage closing date, length of exclusivity, required approvals, and more. However, the LOI doesn't necessarily reflect the final deal. Rather, it's the framework or roadmap for that final deal. Based on what each side discovers during "due diligence" (defined below) and/or whether the profits of the company decline, the structure of the deal may change. The LOI is not legally binding, and either party can walk away from the deal, but it often contains an exclusivity clause that can restrict a seller's next steps if the agreement is terminated.
Exclusivity clause — An exclusivity clause in an LOI prevents a seller from engaging in M+A talks with other buyers. When an LOI is signed, it almost always includes an exclusivity clause that not only restricts a seller and their representation from shopping for alternative buyers but may also determine how long this restriction is in effect.
Multiples — To determine valuation, we use a common industry standard of taking a multiple of the adjusted EBIDTA. Textbooks will tell you that the average market multiple is between 4-6x, which means that if your adjusted EBITDA is $2 million, then we would expect offers to come in between $8 million and $12 million.
The key word here is "average." Some multiples will go higher depending on the industry, size of company, and demand. We have recently seen multiples exceeding 17x for larger, established companies in durable medical equipment, staffing, and applied behavioral analysis services while some very small provider agencies have received offers as low as 2x. Such a substantial range of multiples shows the importance of having a knowledgeable advisor who can help determine a strong adjusted EBITDA (knowing the appropriate add-back expenses), understands the industry and its multiples, and can sell the value of the organization beyond its profitability.
Due diligence — Once an LOI is signed, the due diligence process begins. This is when the buyer conducts its complete investigation of a prospective acquisition, including gathering more intimate details of the company such as full financials, employee breakdowns, customer concentration, contracts, and any skeletons like lawsuits and potential liabilities. Most of this information is provided by the seller via the uploading of supporting documentation as requested by the buyer into a secure data room. The buyer will often submit several different lists of requests covering everything from finances to regulation and compliance reports. The due diligence period is when the buyer discovers if it is buying what was represented through the CIM and management calls.
QofE — Quality of earnings (QofE) is the process through which a buyer verifies that the financials represented in the financial analysis matches tax returns, billing reports, payroll reports, and other documents. QofE is part of the due diligence process and usually completed before other members of the buyer's team perform their review.
QofE is often performed by a third-party accounting firm or agency. The buyer will want a level of assurance that the financials determining the price are accurate and acceptable. Some buyers need to present this report to a bank or investor to receive approval for the funds to complete the acquisition.
SPA/APA — What exactly is a seller selling? It's not simply "ABC Company." Rather, it's either the stock that controls the company or the assets of the company. Simply put, selling the stock or equity of a company means one is selling their role as the owner and the buyer will step into the owner's shoes and continue running the company. On the other hand, an asset sale means the buyer is buying everything the company owns or controls, from the furniture and tangible items to the contracts and delivery of services.
A final contract for an acquisition will either be in the form of a stock purchase agreement (SPA) or an asset purchase agreement (APA). The nuances of the contracts will be similar, but the stock versus asset will affect the level of liability the buyer assumes and the tax burden to each party.
Buyers tend to prefer asset deals because it is easier to clarify what pieces of the company the buyer wants to assume, and they do not assume the potential liabilities from years past. If the buyer acquires the stock, any past misdeeds of the company are a liability for the new owner. In some cases, an asset deal may help shield a buyer from the past misdeeds of the seller, but that's not always the case. Stringent representations and warranties and an escrow account help mitigate this concern, but the risk never completely goes away. The biggest benefit to a stock deal, specifically in healthcare, is that many licenses are easier to transfer while the organization remains intact.
CMAA/CM&AA — Most VERTESS staff, including those working in our back office and our development team, have earned the certified mergers and acquisitions advisor (CMAA or CM&AA) certification. Our advisors also have operations experience. Many of us have exited a company through the acquisition process, so we understand not only the M+A process but the emotions, investment, and culture of owning and operating a healthcare business.
Lawyer with M+A expertise — For the same reason you wouldn't use your corporate lawyer for a car accident, you will need a lawyer with M+A experience when you sell your company — and one specifically with experience in your healthcare vertical. This will not only save you money but will save you from a lot of headaches. A lawyer can make or break a deal, so finding someone who understands the process and your space is essential. Not all M+A lawyers will have the regulatory expertise of your state, but they should have access to someone who does.
Accountant — Some sellers will lean on their chief financial officer during the sale, but there are many financial questions about past reporting and decisions that will affect your tax basis post close for which you may need further guidance. It's important to have a financial advisor who can help you make the best-informed decisions based on your numbers and performance.
PEG — Private equity groups (PEG) (i.e., private equity firms) are investment management companies that raise money from investors and purchase companies with the intention of generating a financial return. Many of the PEGs VERTESS works with are looking at acquiring smaller to middle-sized healthcare services and then adding them together to create economies of scale. Some PEGs also own parts of large organizations to further help them grow. Some of these buyers have a clear intention of growing a company and then selling it after 3-5 years while others are more committed to a longer-term engagement.
Family office — Family offices are private wealth management advisory firms that serve ultra-high-net-worth individuals (HNWI). They are different from traditional wealth management shops in that they use the funds collected from a small number of people to directly invest in companies.
Search fund — A search fund is a specialized private equity fund formed by an individual or multiple individuals. The fund is used as an investment vehicle through which an entrepreneur raises funds from investors. This money is then used to acquire a company in which the search fund's principals wish to take a day-to-day leadership role. Once the acquisition is completed, the search fund's principals step in and operate the company.
Search funds are distinct from traditional private equity funds in that the search fund's principals take active operating roles following the acquisition, and the search fund only acquires one target company and not a portfolio of companies.
Strategic buyer — Strategic buyers are those companies that operate in the same field as the seller and provide a similar service. This might be a large hospital, clinical practice, or direct service organization looking to grow its company through acquisitions. We will often see a private equity-backed strategic buyer as this enables the strategic provider the ability to compete with private equity buyers. It is also commonplace for an existing organization to acquire a provider of complementary or additional services to help expand service offerings (e.g., a home health agency buying a hospice provider).
When I get to know a new business owner, I often face a learning curve as I work to get caught up on the company's lingo. Participating in M+A is no different. A good advisor will understand that this is most likely the only opportunity to sell your company and that it's probably unfamiliar territory for you. A trusted advisor will help you navigate unfamiliar terms, translate your lingo to an unknowing buyer, find synergies between parties, and ultimately negotiate the best purchase terms.
As Co-Founder of LifeShare, a multi-state human services and healthcare organization, Rachel has a unique background of over 20 years of successful operational and executive experience, in addition to an MBA in Healthcare Management. She began her professional life as a home care provider, an experience that created the foundation for the innovative quality and success of LifeShare, while also changing her life. At LifeShare, she managed their Operations (Adult Day/Residential; Child Therapeutic Foster Care; HCBS; Child Therapeutic Day/Diversion Services, and Educational Programming), Finance, HR and Quality Assurance (facilitating COA accreditation and policy/procedure implementation). After selling LifeShare to Centene, Rachel remained during the transition of management and helped to provide outcome measurements and COA compliance reporting. At VERTESS she is a Managing Director providing M+A advisor and consultant services, specifically in the I/DD, behavioral health and related healthcare markets, where systems are rapidly evolving, and providers are striving to adapt strategically to diverse challenges.