Private Equity Sales

There is, perhaps, no transaction an optometrist will engage in that is more legally complex than selling his or her practice to a private equity buyer. Nonetheless, in the right circumstances, selling to private equity can be a perfect exit strategy. 

Pros and Cons of Selling to Private Equity

Private equity offers a few clear benefits to many sellers. These include: 

• Because private equity generally requires that the Selling-doctor stay on for about 3 years after closing, sales to private equity are ideal for a doctor not quite ready to stop seeing patients, but definitely ready to let go of the administrative burdens of owning and operating a practice. It makes for an easy, natural, transition to retirement. Moreover, in most cases if, after three years, you still want to continue to work, most private equity owners are happy to have you stay on. 
• Private equity generally pays more to a seller than an OD buyer would pay. This is not always an easy analysis, but when the total compensation is added up, assuming the Selling doctor meets the required post-close benchmarks (if there are any), the sale will both NET the seller more money and will do it in a tax-advantaged way compared with selling to an OD buyer. 
• Private equity generally offers your staff and you excellent benefits post-close. A fair amount of paid time off, health care benefits, and other employee benefits that many ODs could not offer to their staff. 

But there are also some disadvantages, or "cons" to selling to private equity. These include: 

• The sale process is burdensome and often annoying and frustrating. Private equity engages in very thorough "due diligence," far more than any OD buyer would typically engage in, and the process typically takes at least 60-90 days, sometimes more. 
• The personality of your practice is likely to change after a private equity owners takes over. Private equity often does things differently than the Selling-doctor did, and the Selling doctor must be prepared to "let go." 
• Though the total compensation for the sale is typically higher than when selling to an OD buyer, that compensation is not all paid at closing as is usually the case with an OD buyer. Typically about 60% is paid at closing, about 30% is paid over the following three years and may be contingent, and about 10% may be invested in the private equity company itself. That 10% may or may not become liquid in the future, it's a risk. 
• Generally the sale includes the right to accounts receivable at the time of closing (not cash on hand or in the bank). Selling doctors struggle with this concept because in sales to an OD buyer the Seller usually pays the liabilities and keeps the receivables as of closing. That is usually not the case with private equity. 

Complexities of Private Equity Sales

Selling to private equity is more complicated for two reasons. First, private equity cannot actually OWN your practice. That would violate the laws against the corporate practice of medicine. So private equity sales involve multiple transactions with the equity company acquiring your non-regulated assets and either your corporation keeping, or a "friendly PC" acquiring, the regulated assets of your business. The private equity then enters into a management agreement through which it operates and manages the practice. This means there are additional documents related that management. In addition, if some of your compensation is in the form of equity in the private equity company, that too adds additional complication. Second, in most cases private equity is not buying your practice to run it, they are buying your practice to flip it. The private equity buyer has to account to both the SEC and its investors (hence the detailed due diligence). 

Valuation of Your Practice

Private equity takes a very different path to valuation of your practice. Whereas an OD buyer is looking to buy all the net revenue of your office, grow the practice, and some day sell it and retire, that's not private equity's path at all. The only thing they are buying is your "free cash flow" after all bills, including the costs of doctors, are paid. So, whereas most OD buyers pay based on a percentage of your gross revenue, private equity pays based on a multiple of your "adjusted EBITDA." 

EBITDA means "earnings before insurance, taxes, depreciation, and amortization." For our purposes, it means your profit after doctors are paid. Your "adjusted EBITDA" is the expected cash or profit of the practice after all the bills are paid based on your historical EBITDA after being "adjusted" to account for non-recurring expenses and other changes that can be expected. For instance, if your rent will be increased after the sale the private equity will lower your historical EBITDA to account for that higher rent. If you painted the office your EBITDA will be increased to account for that one-time expense. If you were paying your spouse or children a salary, but they didn't actually work for the office, that will be added back into the EBITDA. In the end the private equity will determine your adjusted EBITDA (typically about 15-17% of your gross) then multiple it by anywhere from 4.5 to 7.0 and that will be your practice's valuation. 

Much of the due diligence by the private equity is in validating the financials to confirm the adjusted EBITDA valuation. This is typically called the Quality of Earnings and is often performed by an outside 3rd party agency, again, because private equity must satisfy investors and the SEC that the valuations are correct. 

Transactional Documents

Whereas the sale to an OD buyer typically involves one Asset Purchase Agreement, the transactional documents when selling to private equity are many and complicated. Experienced counsel will always be needed to review these agreements and (a) be sure you are getting what you expected to get and (b) that there are no unfair provisions buried in the pages and pages of legalese. Do not expect your friend, the estate attorney or family law attorney, to be able to work his or her way through these documents. 

Typically you will see, in some form, at least the following:

• Asset Sale Agreement for non-regulated assets
• Sale or transfer agreement for regulated assets
• Management agreement
• Continuity agreement
• Subscription agreement
• Employment agreement
• Bills of Sale (2)
• Disclosure Schedules
• Buyer and Seller Corporate Resolutions and Certifications
• Officer Certification
• Lease Assignment
• Non-Foreign Status Certification

This is not necessarily a complete list, but it gives you a sense of why sales to private equity are more complicated and require experienced legal counsel. 

Typical Process 

Here is how the process typically plays out. Most private equity sales begin with the PE buyer obtaining from you some basic financial information. From that the PE will generate a non-binding letter of intent (an LOI) which is, basically, their offer. In most cases this is the point where you will want to contact and engage experience legal counsel. While the LOI is typically not binding, it IS what the private equity buyer expects the deal to be, so negotiations should occur before the LOI is signed or there is a good chance the deal will fall through. 

Once the LOI is executed the private equity buyer will begin its due diligence process. This is cumbersome and takes 30-60 days during which you will need to provide the PE buyer will a lot of documents (many of which you won't have and will have to obtain) and a lot of information, and the PE buyer will be obtaining lien searches and examining your history. 

As the due diligence proceeds the private equity legal team will generate the draft transactional documents. As the quality of earnings is being evaluated the lawyers -- theirs and yours -- will be working through the transactional documents and negotiating any changes that your attorney requests be made. Later in that process a series of "signature pages" will be generated which will be signed, but held in escrow. 

Shortly before Closing there may be some final inventory, lien releases, and dealings with your landlord so that the lease can be assigned to the PE buyer. If you own your building, there will be negotiations concerning the lease between you and the Private Equity company. A few weeks before Closing the Private Equity will meet with your staff to prepare them for the changeover, going over the new employment terms, benefits, etc. 

In the days before Closing you'll provide bank wire information for your payment and for any liens that must be paid off. The actual closing is typically just a couple of emails confirming that everything is done, the signature pages can be aligned with the contracts, and the funds can be wired.