Volume 8, Issue 16, October 19, 2021
Is it possible for the owner of a durable medical equipment (DME) company to time the market to maximize an exit? That depends. Successful transactions come together when the following three conditions are in sync:
The seller and a merger and acquisition (M&A) intermediary can influence control over the first two of these conditions. The third condition, on the other hand, requires a bit of luck. Let's take a closer look at these conditions and their importance in a successful transaction.
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 awry. The owners and management team must be proactive in finding what buyers are most likely to perceive as shortcomings. They need to either make logical changes or prepare to defend their systems and explain why they are viable and successful.
A challenge here is that shortcomings — real or perceived — can be magnified when the buyer does not have a DME/home medical equipment (HME) background. This is often the case, for example, with financial buyers. Our DME/HME industry nuances are difficult enough to digest (e.g., 36-month capped rental, January deductible holds, overbilling) for outsiders. These issues are best addressed on the front end where they can be easily managed as opposed to later in the sales process when they are often discovered in diligence. Buyers and owners alike need to approach certain topics with sensitivity. Sellers will often feel they are being attacked for their decisions while buyers are seeking to identify opportunities to improve the business post-transaction. Topics that are usually hot-button items include employees, patient care, and future company growth. DME owners with clinical backgrounds — present company included — tend to be hypersensitive when their programs are reviewed. Clinical-minded owners must keep in mind that buyers are weighing the cost-benefit analysis of these programs and that this exercise is not a personal attack on the validity of the owners or their programs.
Lack of adequate preparation by an owner for the exit of their business is much more common than one 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. Each owner must spend a good amount of time thinking about and ultimately determining what they would like to do post-acquisition before going to market or the owner risks derailing what could be a successful transaction.
An owner's preference of personal involvement will directly affect a potential buyer's interest. Financial buyers will often not be interested in acquiring a DME business 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 many kinds of exits, so there are plenty of options either way. The most important thing for owners: Be honest about your wishes and intentions.
Owners who are looking for a full exit often do not prepare for what is truly ahead of them once they no longer own and are working in their business. Owners must have a plan of what they will do with their life following the sale and integration period. For many owners, what scares them the most is having nothing to do or not having the ability to fill the numerous hours every day, week, month, and year that have long been dedicated to their business. It's one thing to take some time off work. It's another thing to no longer have that work at all.
Another critical factor when preparing for a sale: Will your financial needs be met once you no longer have a regular income? Most owners are used to a monthly paycheck or ongoing disbursements. The idea of having a single lump sum may sound great, but owners must think about how to budget for that payment. They need to plan not only for the payment itself but all the fees that will come out of it, including taxes, advisors' fees, attorney fees, accountants, any debt payoffs, employee obligations, and working capital. When all is said and done, that large payout can often 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 they know how long their money will last. Certain elements of an exit can be controlled and timed to a degree, such as company preparation and self-preparation. Allocating the time to these areas will make a significant difference in the transaction.
Now that we've covered what you can control, let's discuss the part that you cannot: capital markets and the DME market. The news here is generally positive. M&A market conditions at the macro level are currently strong and will likely remain strong for some time. There is evidence to support this. According to GF Data, transaction activity is essentially back to pre-pandemic levels, with "more favored sellers … capturing outsized results."
At the micro level, DME valuations are increasing, and for good reasons. Medicare competitive bidding, for the most part, has gone away with the pandemic. Competitive bidding greatly contributed to the consolidation of markets and players. There is a big emphasis on post-acute care practices. The Medicare Part A side of the business is so expensive, while the pandemic has further demonstrated that there are avenues to deliver high-quality cost-effective care and treatment in the home, both of which are increasing the desirability of DME, HME, home health, and other businesses.
While there remains some marketplace and payer source uncertainty, I believe that DME is currently a very good value. The risk with DMEs has largely subsided, making them even more attractive. Yes, there will still be audits and bundling, but most of the unknown is now known.
To further illustrate my point, private equity groups (PEGs) and other capital investors have been pouring unparalleled amounts of capital into our DME market. Why? PEGs are flush with "use-it-or-lose-it" cash. PEGs typically have five years to place the capital they raise. If it is not placed, the capital is returned to unhappy investors with a less-than-modest return rate. There is estimated to be about $2 trillion in private equity dry powder just waiting to be deployed.
PEGs need exits, and they are willing to go where deals are happening. Traditionally, PEGs have focused on the upper-middle market. However, these transactions are becoming scarce, with increased competition driving values even higher. PEGs are coming downstream and focusing their activity more on the lower middle market and the small business market for add-ons. Various reports indicate that a majority of 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. The S&P 500 is believed to have more than $5 trillion in liquid assets on their books. With innovation lacking and organic growth slow, it is no wonder that many chief financial officers have identified small strategic acquisitions as a significant means of growth.
Whether you intend to sell your DME business in the coming year or two or many years into the future, integral components of your business plan should revolve around determining the type of exit you prefer, increasing company value, addressing potential problems that could harm value and deter buyer interest, and taking careful consideration of your post-transaction plans. If this sounds like a lot of work, it is, but it's important work worthy of your time and energy. And it's the kind of work that is often best supported by an M&A expert who can help you make the decisions that are best for your company and yourself.
If you have questions about what activities make the most sense, we're here to help with more information on this and related topics. Contact us today!
For over 20 years, Brad has held a number of significant executive positions including founding Lone Star Scooters, which offered medical equipment and franchise opportunities across the country, Lone Star Bio Medical, a diversified DME, pharmacy, health IT, and home health care company, and BMS Consulting, where he has provided strategic analysis and M+A intermediary services to executives in the healthcare industry. In addition, he is a regular columnist for HomeCare magazine and HME News, where he focuses on healthcare marketplace trends and innovative business strategies for the principals of healthcare companies. At VERTESS, Brad is a Managing Director and Partner with considerable expertise in HME/DME, home health care, hospice, pharmacy, medical devices, health IT, and related healthcare verticals in the US and internationally.