In today’s healthcare landscape, transactions of private practices are increasingly common, whether for mergers and acquisitions, consolidation, or because a physician is retiring and selling their practice. While there are many things that go into how a practice is valued, one of the most universally used metrics in this space is that of the EBITDA, as it is an objective way of looking at the cash flow of the business. This is a very common term especially in the private equity and practice valuation space. Below, we’ll dive into what EBITDA is and what determines it, how investors use it to determine valuation, pros and cons of using EBITDA for valuation, and ultimately why it should be optimized and leveraged to get the highest price and best terms for your private practice in negotiations.
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What is EBITDA?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. This is a metric that many in the business valuation space, including private equity, use to assess the profitability and cash flow of a practice.
Recall that every business has two types of costs:
Operating expenses: For the physician practice, this includes things like employee salaries, supplies, marketing, and other expenses that contribute to overhead directly related to running the practice
Non-operating ‘costs’: This includes the taxes, interest, depreciation, and amortization. Depreciation is the loss of value of assets over time (at least on paper) that is written off on a tax return, and amortization is essentially an accounting technique that lowers the book value of a loan or debt (or intangible asset) by spreading out the payments over time.
The essence of using EBITDA instead of just looking at the net income on a tax return is that the tax return reflects decisions which may be different for the person looking to invest or acquire a business.
Using EBITDA to look at a practice’s cashflow takes out factors such as the financing methods and depreciation assumptions made by the current company, as well as any unique tax considerations in a given year. This can become important if a private practice holds a lot of hard assets that are being depreciated, or if a company has debt at different interest rates or chose to finance at a different percentage than the company looking at the asset would.
There are pros and cons of this metric, but it is widely cited in the private practice transaction world, so most physicians or physician groups looking to sell their practice must be aware of it and how to optimize it, as it will likely come up.
Most companies looking to acquire practices will actually base their valuation and initial offer based on this number. A strong EBITDA that demonstrates consistent growth will in general attract more buyers, and allow a practice to negotiate better terms.
How is EBITDA calculated?
It can be calculated in one of two ways, which essentially get to the same result:
EBITDA = Net Income + Taxes + Interest Expense + Depreciation & Amortization
or
EBITDA = Operating Income + Depreciation & Amortization
As you can see and as the name implies, the calculation of EBITDA essentially adds back interest, tax, depreciation, and amortization expenses to the net income.
Why is EBITDA not perfect?
While it may appear to be a straightforward calculation, there is some subjectivity, and the way that each party chooses to calculate EBITDA can be different. As you may expect, the company that is selling is going to calculate EBITDA in a way that favors them, and the company acquiring the asset is going to try and decrease the EBITDA to justify making a lower offer.
Fundamentally, by excluding the depreciation and amortization, EBITDA ignores the value of the assets and cost of financing decisions. It essentially makes it seem like financing and assets come for free, which of course is not the real world of a company’s profitability.
How is EBITDA used to determine a private practice’s valuation?
The EBITDA will essentially be multiplied against a valuation multiple to determine the valuation.
This valuation multiple is subjective, and practices will often shop around to find buyers who are willing to pay the highest multiple.
Additionally, note that there are other things that go into a practice’s ultimate valuation, and/or other methodologies of valuation. The goal of this article is to just focus on understanding those valuations based on EBITDA. However, while EBITDA is probably still the most common methodology for arriving at a practice valuation, other methodologies exist, such as using comparable practices, using a revenue multiplier for practices that are growing fast, or basing it on future projections for cash flow.
What goes into determining the EBITDA multiple that is offered to a private practice?
The exact multiple that will be assigned to your practice by a potential buyer is going to depend on how much they think that your practice can grow, and the amount of risk they feel they are undertaking.
Every private equity firm will benchmark these things differently, but usually will assign specific value to factors such as:
Practice size
Bigger practices get higher multiples, with bigger meaning more practitioners, locations, or revenue streams
Type of practice (solo practitioner, single specialty practice, multispecialty practice)
Multi-specialty will usually get the largest multiples
Specialty
Specialties with higher profit margins or cash pay components tend to get higher
Physician and clinician demographics and productivity
The more stable the income looks with clinicians that will stay and who are driven, the higher the multiple
Physicians who retiring soon or who may leave will decrease valuation
Location
Markets that are experiencing population growth or have high demand and needs for the specialty’s services will get higher valuations
Payor Mix
More commercial payors generally translate to higher multiples than government payors
Rate of Growth
Rapidly growing practices tend to get higher multiples
Synergy with other assets in their portfolio
If they already have other practices in this specialty or if the practice is synergistic which other holdings such that there is a nice symbiotic relationship that increases the value of both, this will increase the multiple they’re willing to offer
Amount of control/percentage of shares
Since in many cases, instead of a complete practice buyout, a private equity company is buying a percentage of the shares, they will generally assign higher multiples for increasing amounts of control
Strength of brand and referral network
If there is a strong brand awareness in the community, or a good reputation amongst clinicians in the community who prefer to send their patients to these clinicians, this will increase valuation
How modern the practice is
Practices that have invested in technology or infrastructure that results in the practice being more scalable are given higher multiples as the acquiring company will need to spend less on this
They will then look at the ways they think they can grow your practice for a return on investment. While this will depend on the nature of your practice, they’ll be looking for ways to decrease overhead and increase profits by doing things such as:
Improving overall efficiency of high level operations
Combining resources with other practices in their portfolio
Increasing productivity of the clinicians working at the practice and optimizing compensation models to incentivize clinicians to generate more revenue
Potentially decreasing clinician costs
Adding in technology or AI that could decrease operating expenses
Expanding the number of locations or clinicians
Optimizing revenue cycle management
Bringing outsourced services in house or standardizing them across their portfolio to negotiate down costs (supplies, labs, imaging, etc)
Implementing business best practices
Eliminating or decreasing sources of losses
Lastly, they will look at the relative risk of your practice. This includes:
Keyman risk: If a practice is very dependent on one person, which will increase the overall risk of acquisition.
Pending threats to compensation: Upcoming changes in compensation for certain procedures or commonly used codes
Risk of employees leaving: Will look at if a lot of the partners are older and may retire, or younger and not on board with the private equity acquisition
Major anticipated expenses: Necessary upfitting of the practice, renovations or repairs, replacement of equipment, etc.
What is a good EBITDA multiple?
The only thing we can say with certainty is that a higher EBITDA is better for the ultimate sales price you will get.
Because EBITDA is benchmarked differently based on the factors above, there is no set numerical value that we can say is a good EBITDA unless you are comparing apples to apples. This is why asking on our physician communities what multiple everyone got for their practice is futile - a multispecialty group with high earning specialties and hundreds of physicians is going to have a very different multiple assigned to it than a solo practitioner primary care practice. There are many companies in this space that can help you determine if the EBITDA you are being assigned is fair based on looking at comparable sales data (similar to when you buy a house), and what you can do to optimize yours.
Additionally, market forces and policy changes will determine how bullish buyers are on buying a practices and how much they’re willing to go out on a limb and offer a higher multiple. For example, if your specialty has pending reimbursement cuts in the pipeline on a popular code, that could potentially dramatically decrease how profitable your practice is, and buyers will want to hedge against that risk and offer you a lower multiple. Another common example in today’s market is that with current interest rates, the cost of debt is much higher, limiting how much buyers can pay for practices and still keep the return they want for their investors.
What can you do to increase your EBITDA or EBITDA multiple and practice valuation?
Hopefully, by understanding the information above about what goes into calculating the EBITDA and what factors buyers use to calculate the EBITDA multiple, you now have the knowledge to know where you should focus your strategy to increase yours.
Look at data from other private practices in your specialty or space and see how your EBITA compares to them. If it’s lower, what are they doing better than you, or how are they viewed as less risky than you? Things to consider:
Have they negotiated better payor contracts and are getting paid more for the same work?
Is their average clinician generating more revenue or more productive?
For cash pay practices, are they just charging more?
Do they have more clinicians? What’s your capacity to hire more?
Do they have more locations? What’s your capacity to expand?
Do they offer longer hours?
Do they have lower expenses? Who are their vendors? What technology are they using?
Are their collections rates and other aspects of their revenue cycle management better than yours?
Is their marketing strategy better than yours?
What’s the average age of their clinicians and how many are close to retirement?
What ancillary income streams do they have?
Do they appear more stable than you for some reason?
And so on and so forth. Essentially, you want to make sure that you’re not leaving low hanging fruit that can really improve your company’s bottom line revenue, and also minimizing things that could be perceived as threats or weaknesses.
On a high level, if you’re gearing up to sell your practice, you’ll want to maximize your EBITDA and multiples by negotiating your payor contracts well, optimizing revenue cycle management increasing efficiency and eliminating unnecessary expenses, adding revenue streams, adding locations or the number of physicians and clinicians, investing in marketing and brand-building amongst both patients and referring clinicians, expanding the scope of services offered by your practice, and implementing changes that allow scalability by building out infrastructure and investing in technology.
Of course, there are some things that are beyond your immediate control, like the economy, interest rates, and reimbursement cuts, so that just may be what it is. Focus on the things you can change!
Conclusion
In today’s healthcare environment, for better or worse, many practices are being sold or otherwise involved in transactions. EBITDA is a metric commonly referred to in the language that most buyers in the private practice transaction space speak. As a physician navigating this likely unfamiliar world, it’s important to understand what factors go into calculating EBITDA so that you know how to increase yours. The higher your EBITDA, the better the multiple you are likely to get, the more buyers are going to want you, and the more leverage that you will have when you are negotiating a deal. As deals are structured differently and with different terms, in addition to just the monetary value of a sale, having a higher EBITDA will also make you more likely to successfully ask for things that favor you in a deal.
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