This week, I talked to Larry Elisco, CPA liquidity events around the sale of a medical practice, specifically selling to private equity vs. a hospital vs. an internal succession plan to your partners as a pain practice owner. Nothing that you hear in this episode should be construed as legal or tax advice.
This week, I had an amazing conversation with Larry Elisco. I don’t generally say 106 episodes in that this was one of my favorites yet, but this is absolutely true of this conversation. We talk about the real nuts and bolts of liquidity events around the sale of a medical practice, specifically selling to private equity versus a hospital versus an internal succession plan to your partners as a pain practice owner. So if you’re either considering a sale right now, or you think that one day you will, today’s episode is absolutely recommended listening as always make sure you’re consulting your own personal CPA or attorney in conjunction with this type of deal. Nothing that you hear today should be construed as legal or tax advice. Hello, and welcome to episode 106 of APM success. I’m really pleased to be joined today by our special guest. Larry Elisco. Larry is a partner at Wipfli, which is a national accounting tax and consulting firm. He has specific expertise in valuation for physician practices, compensation arrangements, unique, unique tax considerations, and much more. He brings decades of experience to this conversation. Larry, thank you for being here.
Larry Elisco, CPA (01:36):
Well, thank you, Justin. I appreciate you having me. Yeah.
Dear colleague Jim GC, a couple of weeks ago, we’re talking about tax considerations for ASC owners today. We’re going to talk about another phase in the life cycle of practice ownership, which is the exit from practice ownership or beginning to land the plane on a potential exit. Right. So there’s obviously a number of ways that that exit can happen. So maybe put yourself in the shoes of one of your clients who’s later in their career and beginning to think about what does it look like to start to take a step back from medicine as a practice owner? And in this case, we’re talking specifically about pain management because it has its own flavor. What types of questions should a physician begin to ask in those circumstances?
Larry Elisco, CPA (02:24):
Well, I think one of the first things would be why, why would I want to go with private equity as opposed to trying to go another route in order to create a liquidity event for my practice quite often physicians have, you know, at least historically have relied on bringing partners in or, or selling to a hospital. You know, those are, are certainly still possibilities, but selling to a hospital generally can be limited. As far as the value you’re going to receive for your practice. It’s very, you driven towards compensation as a way of creating a liquidity event and hospitals are limited in their ability to value a practice and include Goodwill which we can certainly talk about when, when they are able to purchase a practice, if you’re, you know, fortunate enough to have a partner or a, an associate that you would make a partner or a number of associates that are interested in buying in that’s also a very good option.
Larry Elisco, CPA (03:35):
Again, your valuation is gonna kind of be a little lower you’re, you’re not going to be able to get the type of valuation you get from a private equity firm when you bring partners in. And quite often, partners are really not that interested in being entrepreneurs and owning a practice and, and certainly not interested in paying for it. They’re a, in many cases, very happy to be earning what they’re earning and they don’t want the headaches and they don’t want to have to buy in and then have to worry about who they’re ultimately going to sell to. So it’s become less and less prevalent. I think in the marketplace in general with physicians, you know, bringing, bringing partners in that are going to buy you out as an exit. So that kind of leaves private equity, which in the last 10 or 15 years has become much more prevalent.
Larry Elisco, CPA (04:26):
And it, it really provides an exit that will provide an immediate liquidity events when, when that, when that takes place. So that really, you know, is quite often the best solution in, in, you know, the physician’s mind, you know, going private equity. I want to work for the next three to five years. And then I want to retire and I want to get a big check upfront. I also may want to get some stock in the PE firm you know, in, in order to really kind of capitalize on their initiatives.
That’s really helpful context, Larry. So just as briefly sort of describe the three different options as you just laid them out. We have a private equity exit. We have a hospital acquisition exit, and we have what I’ll call like an internal succession plan to other physician partners exit. And I think as I just described them, we can sort of, would you put them in descending order as I just described them in terms of like the amount of money you can get for your, obviously there’s a lot of complexity around, like, what does it mean for your job? What does it mean for the future of your practice? But if we just look at the numbers for a moment and say, how am I going to get the most bang for my buck with the asset that I’ve built? That is my practice. You’re saying the private equity exit makes that makes the most economic sense, is that accurate?
Larry Elisco, CPA (05:47):
I would say that’s accurate the, the private equity firm, number one, aside from the hospital, or, you know, as opposed to the hospital can really pay for Goodwill. They, they do that and the way that they structure their deals however, you know, hospitals have to pay for Goodwill. That’s specifically identified like a workforce in place or, or you know, what the costs would be to bring up that the, the same you know, starting a practice, buying a lease, doing all those things. The hospital can assign Goodwill for that, but it’s gotta be very specific. And it’s very limited, kind of the same with, with a physician that partner that you’re bringing in, they need to be there, they need to pay some Goodwill, but they look at a lot of their Goodwill is their own Goodwill. They’re buying their own Goodwill because they’re the ones that are providing the services. They’ve provided the services, they built up the value of the grant. There’s so many cases they don’t want to buy their own Goodwill. So private equity is clearly the best option from an economic perspective. And to
Be clear at Goodwill for our listeners who are uninitiated into the realm of finance is, you know, I would describe it as like the Delta between the book value that the value of all the assets that your practice has and what you can sort of get for your practice on the open market. How, how do you define it
Larry Elisco, CPA (07:14):
As an evaluation? That’s a great way to, to look at it. The, the, the economics of Goodwill, it is the difference between not necessarily the book value, but the fair market value of your assets, and really what would you really have when you have you know, the assets of physician practice, it’s typically a, you know, some equipment you know, you, you, you may have you know, some software, but generally the fair market value is pretty limited. And then anything over and above that is really considered Goodwill difference between the purchase price and the fair market value of those assets Goodwill, I would look at and say, it’s there’s kind of two components to that Goodwill. There’s what I would consider personal Goodwill, which is the value and the reputation of the physician themselves. So if you go somewhere and somebody is a world famous transplant surgeon, for example, they have Goodwill would go with him or her, you know, he or she, as opposed to the practice itself.
Larry Elisco, CPA (08:20):
Whereas if you look at McDonald’s, for example, wherever you go to McDonald’s, you’re going to pretty much get the same product, whether you like it or not. And, you know, that is all, that is what I would consider enterprise Goodwill. So there’s two components to it in the case of physician practices and, and, and with, in regards to the, the difference between the purchase price and the fair market value of the assets, which we’re considering Goodwill, there really isn’t that much of a distinction with that. There’s some tax considerations to it, but rather than the getting into the weeds on there, we could just say that that’s how Goodwill will be viewed.
So as a physician, as a practice owning physician, essentially what you’re doing, that the specific asset that you’re selling that is the most valuable component of this exchange is the Goodwill that you’ve built through your practice over the years. Is that fair to say, that’s,
Larry Elisco, CPA (09:14):
That’s, that’s fair to say, and it’s also, you know, how it’s viewed by the buyer. You know, so the buyer looks at you and as a physician practice and says, you know, I’m going to Vail, you, you, but I know that I, in, in, in four or five years, I can sell, this is the PE buyer. I can sell your practice for a much greater value in four or five years. And after I build up your practice and aggregate other practices with you and generate economies of scale, better billing and reimbursement and basically managing the practice in a more effective way, and then packaging that those, those groups are created and ultimately selling in, in, in four to five years. So that’s where kind of the economics are in, in, in the private equity side. And that’s where all the Goodwill kind of comes from.
That’s a great point. So let’s talk about this for a second. The, the intent of the buyer, what they’re going to do with the practice influences how much they’re willing to pay for it, because it also influences how much money they’re gonna be able to make with the thing that they buy. So I think the way you just described this, it explains the difference. Well, it explains the hierarchy, right? The hierarchy of PE and then hospital, and then internal succession, if we assume for a moment that that is the proper configuration the private equity strategy associated with the acquisition of a practice, the, you know, I would say probably what they’re going to do is gradually transfer that personal Goodwill, turn it into enterprise Goodwill, take it from like Dr. Smith MD and how much he’s allowing the community to take it to, you know, Dr. Smith and associates. And then we really over time transfer that Goodwill to the associates. And then there’s another opportunity to you know, monetize that enterprise Goodwill at a, at a greater multiple perhaps. So that strategy that a private equity firm would use is different perhaps than the way a hospital would monetize that same practice,
Larry Elisco, CPA (11:18):
A hundred percent agree. That’s a great way of putting it because you really have a practice that is generally personal Goodwill with the physicians. You know, there may be a name if you have like a large organization that owns a lot of practices, maybe their name means something, but in general, it’s the physician that has the personal Goodwill. You’re really kind of converting that from personal Goodwill, the enterprise Goodwill and the, and the PE firm is basically creating a market for your practice. You know, they have the market for your practice is limited. Unless you go with a PE firm that has a strategy will create value for you, and then also create value for them down the road. And, you know, I’m simplifying it because the processes a little more involved than you know, who I’m describing, but that is the essence of the economics. Yeah. So
Maybe for just a moment, describe the, how this would work in a hospital-based setting. And like, why is that? Why is the hospital handcuffed a little bit in terms of how they value? Good? Well,
Larry Elisco, CPA (12:20):
Sure. So hospitals are not allowed to buy referrals under the, the, the federal stark and anti-kickback rules. You know, they are not allowed to say, okay you know, I’m going to buy Goodwill. That is undefined. So if it’s again, kind of the workforce, the value of your charts, you know, these are things that can be quantified and it enables the hospital to buy Goodwill in addition to the fair market value of your assets. But that’s very limiting considering that, you know, if you’re a PE firm you’re looking at, you know, w we would call earnings or EBITDA and applying a multiple to that, that’s going to be significantly more than what a hospital can pay, but because the hospital cannot by referrals and it’s viewed by, by paying for Goodwill, that’s undefined, it’s viewed as buying referrals. So that’s why they’re handcuffed. Now. They could, again, make up for it from a compensation perspective down the road, pay a signing bonus or retention bonus.
Larry Elisco, CPA (13:21):
And, you know, again, the, of course, it’s taxed as ordinary income as opposed to Goodwill, which is taxed at capital gains rates. So, you know, there’s, there’s clearly disadvantages economically to selling to a hospital and the, unless there’s a true opportunity for you to be compensated as a physician significantly more because of their contracts and because of their leverage and, and because of what they can provide to you and referrals. But you know, it’s still difficult. You’re, you’re, you’re still working. You’re, you’re getting paid for your services. And there’s only so many, so many hours in the day. So, you know, being paid handsomely isn’t necessarily going to substitute for the ability to sell the practice. Right.
And if we take that same question, understanding from the buyer standpoint, how they’re going to monetize their purchase, and we apply it then to the internal partnerships succession, like I, I’ve got two associates and I’m going to sell my practice to them. Similarly, they’re going to be pricing. Their, their offer is going to be discounted because they’re, they don’t ha they don’t have the same plans that the PE firm does of like scale infrastructure, being able to take that personal Goodwill, transfer it to enterprise Goodwill and experience the same pop. They’re basically just trying to keep their jobs. So the way that they’re bringing their offer to the table is going to be constrained. Would
Larry Elisco, CPA (14:43):
You say, right. Right. And Justin, it’s also you know, there are economics involved. And when you look at it, it, you know, like, like an associate that’s worked for you for, you know, three to four years and is, has created their level of collections. They’ve created their reputation. They’ve created their personal Goodwill. You, you are then asking them to buy your personal Goodwill in the form of a buyout. And it could, there’s a valuation formula in that. And it doesn’t have the same constraints that a hospital would have. You can pay Goodwill when you’re buying in, but quite often, that’s going to be significantly less than what you’d be able to generate from a private equity firm. Plus, the other component to this is that when somebody buys in, even though they may not be buying a hundred percent of the practice, you then have governance issues and you have control issues.
Larry Elisco, CPA (15:39):
And those really are not always thought of by the physician. That’s the a hundred percent owner of the practice. Wow. I’m going to have to give up some control here. And they, they will, you know, that is often the point of, of contention when, when these deals take place. And it, it’s very expensive to you’re, you’re dealing with, you know, paying your accountants, your lawyers, their accountants, their lawyers, it, it gets to be pretty costly. And if you don’t have an existing platform for, for partners buying in, then it, there can also be, you know, costly. So these are things that you have to think about when you want to admit partners, assuming that the partners want to be admitted and they want to pay for that interest. Right?
Another challenge of selling to a partner is they either need to cut a check from their own independent wealth, or they need to get a loan from a bank, or they’re going to do some sort of a seller finance deal where they’re taking a loan from the practice and using the profits of the practice to continue to pay the seller a which has its own its own
Larry Elisco, CPA (16:48):
Complexities. Right? If the new,
If the new physician runs the practice into the ground, after they buy it, then the seller, they don’t get the money that they are due.
Larry Elisco, CPA (16:57):
Exactly. The, the profits, the profits of the practice are generally used to buy in, at least the part of the profits of the practice are generally used to buy in. And quite often, physicians will say, why am I doing this? I’m just giving you, I’m giving you this partnership interest by saying, okay, you were paid X number of dollars before. Now that you’re a partner, you’re going to get money from our ancillary business. And you’re going to use that to pay me. So what am I really doing other than just kind of shifting money around in the practice that I would normally be entitled to. I’m effectively giving you at least partially giving you this partnership interest. So where are the economics, was he kind of a benefit for me in that
Setting aside for a moment, sort of the a desire that a physician might have to sort of it in the family, so to speak and to give your partners an opportunity to continue to maintain autonomy. Let’s assume for a moment that a physician who says, you know, what, I’m ready to hang up the cleats in a few years, I don’t want to deal with the drama of the internal succession. The hospital route has its own challenges. And so private equity is the way that I want to go. Describe, you know, if somebody comes in and sits down in your office and says, Larry, I’m, you know, I’m five years out, I want to start, you know, doing the window dressing, so to speak. I want to start putting the pieces in place, doing the due diligence to make my practice grow in the right ways so that I can have a smooth landing for an optimal valuation in a PE deal. What types of questions are you starting to ask them?
Larry Elisco, CPA (18:34):
Well, number one, what is your ultimate exit? And are you willing? Number one, if your ultimate exit is three to five years, that’s great. If you want to retire in a year, and for whatever reason, you know, hopefully not health reasons, but just in general had enough and you want to retire in a year. That’s, that’s most likely not going to be a good fit. If it’s the PE firm that’s going to acquire, you would want you to continue. They’re going to have you sign an employment agreement that will require to meet a minimum of three most likely five years so that you can transition your patient base to either another physician they bring in, or a you know, a mid level or whatever their plan is. They need you there to make sure that their patients are comfortable with the new environment, so to speak.
Larry Elisco, CPA (19:27):
So that’s one of the first points. One of the other, the second point would be you know, are you willing to forgo compensation in order to make this happen? So, as an example I had a practice that I worked with where the physician was getting paid a million, eight a year out of their practice, very successful practice, obviously. And they sold to a PE firm that said, we’re going to guarantee you $800,000 a year plus some incentives and plus some ways to make some of that million-eight back, but you’re not going to hit a million a however, the difference between the million eight and that 800,000 creates earnings and the earnings are used to value the practice and that those earnings are then applied to a multiple that the physician or that the PE firm is willing to pay for that practice.
Larry Elisco, CPA (20:29):
Typically they have multiple, it would be anywhere from five to six, and then they had multiple creates a $6 million purchase price. However, for the next three to five years, the physician is losing a million dollars of compensation effectively, but they don’t care necessarily because they want an exit. It’s more tax advantageous to do it this way. So you, as a physician have to be willing to understand number one, you’re going to take a big reduction in compensation in order to create value for the practice. Number two, you’re going to have to answer to these to the PE firm and practice the way that they want you to practice. And not that they necessarily tell you how to break this medicine, but they certainly put things in your mind or let you know that it’s not the same as when you call up the shots before.
Larry Elisco, CPA (21:20):
So you’re going to have to follow suit with the way they want you to do things. You know, you may have issues because you don’t, you know, it, it constrains you from practicing the way that you want. You know, you’re suddenly introduced to mid-levels and you may not have had before you’re introduced to a new system. It’s not an easy process. You, you pay the price in, in, you know, compensation and as well as, you know, perhaps your mindset and, you know, some of the things that you have to go through in order to be part of a PE firm. Yeah.
You bring up some great points in the one I want to point out first is I basically described an optimal scenario, which is, ah, five years from now. I want to be done in reality. That’s a really nice, you know, long timeline. And it’s impossible to start planning too early for this. I would say the shorter, the timeframe, the less options you have, and the less flexibility you have in terms of this deal. So a private equity firm, if you come to them and say, Hey, 12 months, I want to be out the transference of that personal Goodwill to the enterprise Goodwill. Many times, it takes a lot longer than a year and the private equity firm wants to protect their investment. So they’re not going to give you top dollar. They may, they might give you a big haircut on that five to six multiple you described in order to give you the timeline you’re looking for, and there’s going to be trade offs. So that’s an important dynamic to be, right?
Larry Elisco, CPA (22:36):
Yeah, I think they would probably in most cases, they won’t agree to that. You know, they’re just, you know, private equity firms have people that go out and, you know, our, our, the business development folks, they, they kind of find opportunities. They try to close the deals, but typically they have a, another, they have a board that they have to answer to. That really is their investor board. That’s where the money comes from. And if they present a one-year exit, my guess is that most boards wouldn’t agree to that.
The thing that I’ve found really fascinating about my vocation is understanding how incentive drives outcomes. So obviously the more you can align your incentives with that of the PE firm or whoever you’re selling to the more you can create a win-win all the way around. So talk for a minute about the way these deals are structured in terms of, you know, if I’m a hundred percent owner, or maybe I’m a 75% owner, and I’ve got a couple of junior partners who are willing to go along w how much of my 75% am I going to sell? And are there, is it usually like a full sale that happens over time? Or is it like a partial where maybe we give another, that PE firm, we give them a controlling interest, but we S we maintain a portion and maybe they want us actually to make, they’re not, they’re not willing to buy a hundred percent. They only want to buy 51%, and then they want to keep us wanting to grow the value that we continue to hold to keep us engaged in working. So what can you describe a couple of different ways you’ve seen this structure?
Larry Elisco, CPA (24:10):
That’s a great question. So typically the PE firm wants to own a hundred percent and they’re, they’re not going to be willing to put themselves in a position where they have to deal with a minority shareholder. Now, you know, in some cases, you know, there may be, you know, options where you’re, you’re so valuable and you have such a large organization that a PE firm would be willing to come in and take a minority interest. But I think for most practices, they want to own a hundred percent because that don’t forget in four to five years, they want to sell to a bigger PE firm. And they don’t want to have you know, partial interest in these great cases. They want to have complete control, and they want to own a hundred percent of them. So typically what ends up happening is that the firm will come in, they’ll value your practice.
Larry Elisco, CPA (25:07):
You’ll provide them with a lot of information, even before what we call due diligence. They’ll give you a letter of intent that says, here’s what we think. Here’s the way this is going to work. Here’s the purchase price. And here are the terms you’re going to have an employment agreement, and it’s not a binding document, but it pretty much says, Hey, if you agree to this, then the next step is that we’re going to have you know, the actual documents prepared that will, will be binding you know, typically an operating agreement and an employment agreement. The structure of these because of the corporate practice of medicine becomes complex. So typically a physician that owns maybe a a C Corp or an S-corps, or maybe a single member, LLC, you know, it’s pretty simple structure in order for the PE firm to own and generate economics from their practice.
Larry Elisco, CPA (26:04):
That’s where the complexities arise. There’s something called a management service organization that is generally owned by a PE firm. It’s typically an LLC, and it basically will generate management fees from the entity that the physician owned previously. And that entity will bill the way it is always built because it’s fin is what drives the billing. So that that entity stays intact for the most part still owned by the physician. But the physician then agrees to, for lack of a better term shift, any excess profits. In other words, any collections minus the physician’s salary creates excess profits that gets shifted to the management services organization in the form of a management fee. That is really where the value of the, of the, this, this PE group is established in this EMESCO. They can own the MSL, even though they’re not physicians. And typically when the deal is structured, the physician will be paid based on the valuation of their practice, you know, around 75 or 80% cash, 20 to 25% will be stack in the MSO.
Larry Elisco, CPA (27:38):
And it gives the physician the ability to continue to capitalize the, the initiatives of the PE firm and the success of their practice. In other words, if the, if the PE firm comes in and says, Hey, we’re going to do this, this and this. We’re going to really increase your, your, your collections. We’re, we’re going to run your practice much more efficiently. You know, you now have created this value after you’ve sold, and this is a way that you can stay on and still make money from the sale of your practice. Ultimately, when that MSL is sold, or, you know, in some cases with really big PE firms, they, they hold and they have a sponsor that will will buy the stock by, by, by the, the, the, the ownership and the MSO by the physician down the line. They’ll give them an opportunity for a liquidity event. Should they want that before the MSO is ultimately sold to another party? So I know that’s a lot of information, but hopefully that was somewhat understandable,
Very helpful background. I actually, I recently saw there’s a really great video. So Dr. Eric Bricker is a guy. He has this organization called a healthcare Z, which is educational intended to help people understand the, all the mechanics of how the healthcare ecosystem functions. And he just did a great video the other day about corporate ownership of medicine, and basically how it works and how is this, what are the legal infrastructure in place in order to make this function properly? And he did a great explanatory video we’ll link to it in the show notes. So if you go to APM success slash 1 0 6, you can check out that video, if you want to have more information. In addition to that great explanation from Larry understanding that MSO dynamic, I think is really important. And even having an ownership stake in that MSO is an important economic piece of this puzzle that you’re going to want to get your brain wrapped around.
Larry Elisco, CPA (29:28):
It’s interesting. Yeah, it’s interesting, because quite often I’ll be dealing with clients that are selling and their point is, Hey, I just want the cash. I just want a hundred percent cash. And most PE firms are not willing to do that. And it’s also not necessarily the most effective way of selling your practice, because you really can be giving up a significant amount of upside by owning that MSO. But the other side of it is that the PE firm wants you to take this stock. That’s the deal because you know, they, they are looking to have you continue with some skin in the game. They want you to have a commitment to this practice. They don’t want to just write you check. And, and then, you know, you start taking all your deferred vacation and all of a sudden things, you know, even though you’re not getting paid, what you were being paid before, you’re good. Cause you’re set. And that’s one of the things that they’re trying to avoid. But yeah, it’s one of the other things to consider too, is that when you’re, when you’re creating this type of structure, your your, your cash obviously is taxable to you when you receive it, but the stack or the, the ownership and that MSO, I should say, should be able, you should be able to roll that over on a tax deferred basis, if it’s structured properly. That’s
A great segue. Let’s, let’s pause there. Cause I want to zoom in on the taxation of this transaction. So we’ll just to keep things simple. I’m a hundred percent equity owner in my entity, Dr. Smith practice, LLC. And I’m selling this entity to a private equity group who wants to buy me out and in the structure that we just described. So talk about the tax treatment and the different ways to structure this deal and what it means for me in terms of the tax bill.
Larry Elisco, CPA (31:15):
So, so let’s, let’s just use some, some hypothetical numbers. Let’s say the practice is worth $5 million to the PE firm and they’ve done their evaluation. And this is the number that they’ve arrived at. And they’re going to give you 80% cash and 20% stock in the area. And when I say stack, I mean, ownership in the MSL. So the cash is paid to you perhaps there’s, there’s a, of that 4 million that’s being paid to you, maybe 3 million is, is a check at closing. And a million is based on some hold backs. And some contingencies, you know, particularly with COVID, these deals are still taking place, but, you know, the PE firm wants to make sure that you’re going to get back to where you were pre COVID. So they have certain hold backs and contingencies where you have to kind of reach certain levels in order to get that extra million dollars for the difference between the form, the 3 million.
Larry Elisco, CPA (32:14):
But as you receive it, it becomes taxable. So when you get the cash, it’s danceable, it’s typically taxed for the most part of capital gains, but they’re because they’re buying your assets. Some of that will be subject to ordinary income, depending on how much depreciation you’ve taken on your assets. So for the most part it’s capital gain, some of it’s going to be ordinary. So plan at least under current tax of paying anywhere from you know, 25, maybe 28% tax for federal purposes, state, it’s up to your individual state on that money. Then you have the stock or the, the MSO LLC interest that you receiving. And if it’s done properly that, that those interests can be rolled over. And, and you don’t pay tax on those until you sell the VMs, your MSO interests either selling it to, to the existing owner or selling it more likely in a, in a, in a subsequent transaction. So that million dollars also will be taxed at capital gains rates for the value and whatever the difference is between when you ultimately receive for those MSO shares. And you know, what your you know, w that, that also all becomes capital gain because typically they have million dollars of value that you’re receiving will have no basis to you. In other words, the million dollars that you’re getting is deferred, but you’re not going to pay tax on that million dollars. Plus the additional proceeds until the, the MSO shares are sold.
Got it. Now this million dollar piece, the MSO piece if that is for like a new MSO that we’re creating for the purpose of buying Dr. Smith practice, LLC I’m curious how, you know, how do I know that these shares of this entity that we just made is worth a million bucks
Larry Elisco, CPA (34:19):
You don’t, and if you are doing this, there’s, there’s some advantages to getting out on the ground floor, so to speak, but there’s also disadvantages because of the risk. So there is risk that they have million dollars is is, is going to be worthless at some point, if the PE firm doesn’t succeed. So you have to do your due diligence, you have to know what their plan is. You have to know why you know, kind of where they see your practice fitting in with all the other practices that they’re requiring. And you, you need to have a full understanding of their background and what their ultimate plan is and what they’ve done in the past. Typically, the folks that you’re talking to have had a success story in the past, at least one or two, and they’re, they’re doing something now that is similar to what they’ve done in the past.
Larry Elisco, CPA (35:10):
So they, you can look to their track record for that. In many cases though you know, you’re also getting in on the ground floor, and if you have someone that has done this before, and you’re the first you’re, you’re, you’re the first one, you know, one that they’re acquiring, then you have the benefit of hopefully getting a lot of accretion, a lot of appreciation on those MSO interests, because you’re, you should be getting kind of the biggest bang for your buck by, by agreeing to accept the shares. So maybe, you know, you’re getting, you know, 10% of the MSO and the next person that, that buys in gets, you know, 5%, if you’re, you know, against, you know, looking at the values as being the same, because you’re the first one in, and they should be willing to pay you more in the form of, of appreciate, you know, of, of, of MSO interests.
Larry Elisco, CPA (36:10):
As far as, you know, they’re you know, again, they may be an established MSO as well, which, which makes things a little different, but, you know, generally I think that, you know, you have to kind of weigh the, you know, the benefits with it. And, and many, many physicians say, look, I’m, I’m okay with getting the $4 million. You know, I, if I could just get the $4 million and I get this stack and nothing ever happens with it, I’m good. I’m set, I I’ve got the money I wanted and this other million dollars is somewhat, you know, I’m a come and it may not happen. So that’s the way many physicians look at, and it’s not a bad way of looking at it, particularly if you’re not paying tax on that additional million dollars until it’s sold, you know, you don’t want to be in a position where, you know, you’re on the ground floor and you’re paying tax on those MSO shares based on some valuation that has been arrived at. And that’s where you can kind of have issues.
Speaker 3 (37:07):
That makes a lot of sense. How long does this take from the time that I walk into your office and say, you know, I, I want to be out in five years at the time that I’ve got my ink on the contract with a group that wants to acquire my practice.
Larry Elisco, CPA (37:23):
Well, I think that the PE you’ll find that the PE firms want to act very quickly. There, they have resources. They want to know if you’re serious and it doesn’t really take them that long to go through your initial information in order to come up with an offer. So you could be looking at maybe from the time that they approach you to the time that they asked for your information. You send that to them. Once they have your information, they should be able to come up with a letter of intent within two to three weeks after that, because they want to move quickly. They’re teed up and ready to go. They know what their, their L excuse me, their LOI looks like, and there isn’t much to it. They know their deal. You know, you, on the other hand are looking at this and saying, oh, I got to show this to my lawyer.
Larry Elisco, CPA (38:18):
I got to show it to my accountant. I got to make sure I want to do this. I got to talk to my wife. I gotta talk to my colleagues, but, you know, and, and that’s where even though the letter of intent is not binding. Once you sign that letter of intent, it is, you know, a flurry of activity. You then go into actual due diligence where they come in and, and really turn your place upside down, looking at everything possible. They have, what’s called the quality of earnings report quite often, which we, we do those types of things. And it really goes in and, and truly analyzes your, your revenue cycle and your contracts and your expenses. And it’s, you can look at it as an audit, but it’s way more detailed than an audit, because really when we’re doing a quality of earnings report, we’re telling the acquirer, Hey, this is these, these numbers are good.
Larry Elisco, CPA (39:11):
Or these numbers have these issues. And that then becomes, you know, a further discussion before the actual documents are drafted. If, if everything goes okay with the due diligence and the quality of earnings, then you’re probably talking about another two months in that process. From the time you signed the LOI until the time that documents are actually being signed. So if, you know, under an optimum level, this could be, you know, three months, four months from start to finish until you get your check. And you know, it, it happens quickly. So be prepared.
Yeah. And, you know, furthermore, you know, just working through, in addition to the things that you mentioned, working through the potential identity crisis of working for 14 years on this thing that you built, that you bled sweat for, that you’re now trading in for a W2 wage, working for someone else, that’s a process that you should give some consideration to as taking some time and giving yourself time to process that, because that could be the biggest part of this whole thing.
Larry Elisco, CPA (40:14):
Yeah. And bear in mind too, you know, the PE firm wants to do these deals that they are selling you to do this because this is they, they have to deploy the money that’s been invested and they want to do the deals. And that’s why you see these larger and larger multiples and valuations arising, because they are, they’re under a lot of pressure to find opportunities and they want to do the deal. This isn’t something where they’re just kind of feeling you out. You know, once they look at your numbers, they know where they’re going to do this or not. And once they decide they want to do it, they are going to be putting a lot of pressure to get this stuff.
Are there any common pitfalls that you see in terms of doing the quality of earnings analysis, where a practice might get zapped more frequently than not on some sort of shortcoming or oversight in terms of their you know, their books where the there’s a big gap then in the LOI, like the PE said, PE firms said, they’re going to give you this multiple. But we came in and we looked around and we don’t really like what we see. So now we’re going to dock that multiple
Larry Elisco, CPA (41:19):
Well, absolutely there’s there’s situations where if they, if, if, if the quality of earnings is done and it’s determined that you’re not billing properly, if you’re over billing, if you’re billing, you know, fives, not fours or threes, then that creates an issue. And then the PE firm looks at it and says, you know, we, you know, we still want to buy you, although there could create questions in their mind, but, you know, we know we’re not going to get the money that you’re presenting or that you, that that’s on your tax return or in your books. So we, we know that, that you know, we’re going to have to take a haircut on what revaluing you add in the steel may not work. You know, in many cases when they’re going, when you’re going through the quality of earnings, and you’re looking at expenses, there may be expenses that are, are, have, have been non-recurring or that you’re presenting to be non-recurring and effectively increasing your valuation, because we call those normalization adjustments.
Larry Elisco, CPA (42:26):
You know, you may say, Hey, those are non-recurring expenses. W the PE firm says, oh, no, they’re recurring. In other words, you say, I don’t need a practice manager anymore. And the PE firm says, oh, no, you do. And your initial valuation assume that you wouldn’t need a practice manager. So all of a sudden that reduces the valuation, you know, but I tend to put it in extreme, and I know nobody on this call does this, but there are practices that when they get cash payments they don’t always report them on their income taxes. And they still expect to have them included in their valuation. And that’s very difficult to do that. So again, not to cast any aspersions at people, but that does happen. And it does create problems in the valuation side. So those are all considerations that could take place that could create problems for the, for the the ultimate deal taking place. You find
That as long as the quality of earnings is reasonable or within kind of the expected boundaries, that there’s not much gap between the LOI and the final deal in
Larry Elisco, CPA (43:31):
Terms of yes. Yeah, absolutely. I find that when they do an LOI, they know what they’re expecting. And when you sign that LOI, even though it’s not binding the PE for wants those to be the terms, they don’t want to change anything. They want the deal to go through. So they know what, you know, they know how to, how to make these things happen. And there generally should not be a lot of gaps in what they’re telling you. Cause you know, they have a reputation as well. Think about it, that, you know, you go through this process, you pay your account and you pay your lawyer. You know, you go through the LOI, you give them all this information. Your staff is up in arms. You may not even want to be telling your staff you’re selling. So it creates all this, these issues while you’re going through this process. And then if they come back and say, we’re changing the deal, then that’s a bad reputation for them. And your colleagues that they’re talking to as well are going to hear this. So they don’t want their name on the street to, to have that associated with them. So they want the deal to be done on in accordance with the LOI.
Whenever you’ve seen deals fall apart. If you have with clients of yours, are there any, you know, can you give us any sort of anecdotes of kind of what happened and things to look out for in that way?
Larry Elisco, CPA (44:49):
Well, some of the things with the quality of earnings that take place are you know, could, could create a deal fall apart between the LOI and documentation the, the LOI you know, make certain assumptions, obviously. So, you know, if somebody is over-billing then they’re there creates issues, you know, bear in mind the buyer, the seller never sees the, the quality of earnings report it’s done for both the buyer. And so there may be things, you know, actually in, in the, in the quality of earnings that tells the buyer, I can actually build more, I can make more money. So, you know, if, if they, if, if, if the, if the seller learns that and says, oh, okay, I’ve been under billing. I should get more money for this practice. So they go back to the, to the buyer and say, well, you know, we you know, we want more money and this and that.
Larry Elisco, CPA (45:41):
So if there can create issues, you know, after the fact, once you’re part of the PE firm, I’ve seen things happen there as well, where, you know, the physician isn’t performing, they’ve gotten their money and they’ve decided again, to take on their, you know, take other deferred vacation. And their mindset is different. And even though they’re trying to, you know, provide shares in the MSO is somewhat of a carrot and motivation. The, the physician, all of a sudden says, okay, I’m done. I sold my practice. Well, no, you, you’re still on the hook for three to five years and an employment agreement, but the mindset is I’ve sold my practice and there creates a lot of problems, you know, with, with the PE firm itself. And I’ve seen physicians, you know, have you know, w w you know, exit from the PE firm and, and find other opportunities, particularly if they’re younger and they’ve sold they’ll exit, because it just hasn’t worked out. And then, you know, that becomes obviously huge legal battle.
Yeah. So I think one thing I’m getting here is it might also make sense to do your own quality of earnings report belongs to the buyer. You’re going to want to do your own due diligence and probably have some sort of billing audit done to verify it for yourself and see if you are living a bunch of money on the table, because you’re under billing and that’s being excluded from your valuation, and it should be accounted for, you want to know that before you go ahead and sell that future income stream. Right.
Larry Elisco, CPA (47:06):
Right. It’s, it’d be, you know, in preparation for all this, it may make sense to have someone come in and really look at your revenue cycle, because that’s really where you’re going to find, you know, differences. And you want to know going in whether your revenue cycle is, is appropriate, meaning are you billing and collecting, you know, effectively the terms of your contracts, and are there ways that you could be either capturing more money in the way that you’re billing, because that will obviously lead into a greater valuation or if you’re over-billing, then you don’t want to run into those pitfalls either. So that’s what I would recommend the rest of the you know, on the expense side, pretty pretty, fairly straightforward. You know, your, your accountant should be able to come up with expenses that are both recurring. And non-recurring when they’re looking at your results of operations, those recurring and non-recurring expenses are very important, because those that you say are non-recurring, as I mentioned before, theoretically increase your valuation. And the PE for may, may contend that those aren’t really recurring, that non-recurring expenses causes an issue with the valuation. So those are all things to think about when you’re kind of going into this.
Awesome. Let’s wrap it up there. Larry. This has been immensely helpful. I have learned a ton. I really appreciate your time today. If anybody out there wants to reach out to Larry, we’re going to put his contact information in the show notes, APM success.com/ 1 0 6. If you don’t already subscribe to the YouTube channel, do that. You can watch Larry and I’s talking heads bobbing back and forth instead of just listening on audio. Larry Lesco, thank you very much for joining us today on APM six.
Larry Elisco, CPA (48:52):
Thank you, Justin. It was really enjoyable as well. I I thought your questions were great and I’m always happy to you know, discuss these things. And if anybody wants to call up and check, I made
Me to do so. If you liked what you heard this week, head on over to APM success.com, where you can find more content and free resources to help you build a successful career in anesthesia and pain management. If you want it to leave a review in iTunes, that also really appreciate it. Thanks for using some of your valuable time to join me today on APM success.
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