My guest on this episode is Matt Hinson. Matt is a director of corporate development at Orthopedic Care Partners, a private equity group focused on acquiring orthopedic surgery practices. Matt and I talk about how he acquires these practices, some operational improvements they apply in new acquisitions, how their strategy unlocks value for physicians, and how to hold onto physicians after buying their practice.
One last note, Matt recently published two articles on Substack, one about calculating working capital in a deal process and another about how a seller might rake you over the coals in a deal. I’m adding links to these in the show notes and I highly recommend reading them if you’re involved in acquiring small companies in any way.
Live Oak Bank – Live Oak Bank is a seasoned SBA lender focused on search funds, independent sponsors, private equity firms, and individuals looking to acquire small companies. Live Oak has closed billions of dollars in SBA financing and is actively looking to help more small company investors across the country. If you are in the process of acquiring a company or thinking about starting a search, contact Lisa Forrest or Heather Endresen directly to start a conversation or go to www.liveoakbank.com/think.
Hood & Strong, LLP – Hood & Strong is a CPA firm with a long history of working with search funds and private equity firms on diligence, assurance, tax services, and more. Hood & Strong is highly skilled in working with search funds, providing quality of earnings and due diligence services during the search, along with assurance and tax services post-acquisition. They offer a unique way to approach acquisition diligence and manage costs effectively. To learn more about how Hood & Strong can help your search, acquisition, and beyond, please email one of their partners Jerry Zhou at [email protected].
Oberle Risk Strategies – Oberle is the leading specialty insurance brokerage catering to search funds and the broader ETA community, providing complimentary due diligence assessments of the target company’s commercial insurance and Employee benefits programs. Over the past decade, August Felker and his team have engaged with hundreds of searchers to provide due diligence and ultimately place the most competitive insurance program at closing. Given August’s experience as a searcher himself, he and his team understand all that goes into buying a business and pride themselves on making the insurance portion of closing seamless and hassle-free.
Well, thanks, Matt for joining us, we’ve been looking forward to having you here. It’s been a good while since we chatted last and then picked it up again here pretty soon. And I’ve enjoyed reading through your latest Substack with the working capital article. We can talk about that too, but I’d love to first hear about your background and how you got to do what you’re doing today.
Thank you very much for having me on here, I want to say thank you, first of all, for just creating this platform. There are two podcasts that listen to her on investing and finance and this is one of them. So thank you very much and I’m excited to see where this thing’s going for you. And thanks for having me on.
I grew up in a very rural town in North Carolina, and I went to school in-state there, at a second tier university. I did not have a lot of direction at the time that I went to college, and at my father’s suggestion, I decided to study accounting. And to him, I think that was just a career that offered a lot of safety. And I always loved business and just kind of enjoyed myself, thinking myself as a future business person so it just kind of made a lot of sense.
And somehow I lucked my way into a job with Deloitte & Touche in Charlotte, North Carolina. And so spent two years there, and anyone who listens to your podcast, who’s spent any time in audit knows that it doesn’t take you very long to figure out whether or not that’s a place you want to spend your career. And for me, I made that decision pretty quickly. And so after two years, I networked my way into an investment banking analyst role at a regional investment bank. And so I did my time there, and that’s really where I cut my teeth on deals learning about M&A, finance, et cetera.
And after about two years there I became a consultant specializing in financial due diligence and transaction advisory services. Most of that time was at a firm, a consulting firm called Alvarez and Marsal, and then for a while, I actually had a solo consulting shop for myself. About two years ago, I joined a private equity sponsored physician practice called Orthopedic Care Partners. And at Orthopedic Care Partners or OCP I’m in the corporate development group and my job is to find diligence and hopefully acquire orthopedic practices throughout the United States.
We’re very acquisitive, we did seven deals, should be six deals in 2019. This year was pretty impactful with COVID and we didn’t have a lot of activity, but we did do one deal. And most of our practices are in Florida and Colorado, but we travel and talk to orthopedic groups throughout the US. Really interested in deal flow anywhere. And that’s what I spend most of my time doing.
So what made you join this group and doing that orthopedic role up here?
It was really an opportunity that kind of fell in my lap. I was doing the solo consulting gig, I enjoyed having my own consulting business. It was a successful business but I was on the road a lot, I was having a kid, and my wife was kind of getting tired of me being on the road. And it just so happened that a former mentor of mine, still at Alvarez and Marsal had a client, Varsity Healthcare Partners, who was the sponsor of the orthopedic practice and the platform practice in Florida. And that just happened to be in Gainesville, Florida, where I was living or I’m living in now.
And he kind of put two and two together and they were looking for someone to kind of help out with corporate development. And a light went off in his head and he said, “Hey, my guy, Matt, lives in Gainesville, maybe you should give him a call.” And I met with the chief development officer, and two weeks later, I’m on the job doing orthopedic deals, and that was actually my first experience in healthcare. So jumped right in and since then, it’s been a wild ride and I’ve enjoyed it. As I said, we’ve done a lot of deals. It’s been kind of a blur of sometimes, but it’s been a great experience.
So you said you hadn’t done anything in healthcare before, did you have an interest in it prior?
The regional investment bank that I worked on, specialized in mostly kind of middle market, old economy type businesses, manufacturing, and then when I worked at Alvarez and Marsal, it was a lot of the same just kind of middle market private equity backed by side consulting. And so a lot of manufacturing, did some energy and infrastructure, and had just never had the opportunity to spend much time in the healthcare space. That’s a space that generally requires someone to be a specialist and have a body of knowledge around the specifics of the industry. And just by luck, I happened to go into something else and so I just had not happened to spend a lot of time there. And at the time, Orthopedic Care Partners was looking for someone with deal experience, not necessarily healthcare experience, per se, and that’s why it kind of worked in my favor to kind of make the jump and make the fit.
So how did you get yourself up to speed with the healthcare industry and orthopedic industry?
So I was very lucky in the fact that the person that I work for, the chief development officer was a healthcare specialist. And so we worked very closely together and anytime I had a question, I could immediately go to him. And he’s one of the smartest guys that I’ve ever worked with so he could explain it in a very clear way that even somebody like myself could understand it. And then I drank from the fire hose, and after long enough, you hear the buzz words, you’re explained something a couple times, the pieces just kind of meld together and soon enough, you just kind of have this latticework of experience. And it doesn’t take you that long to get there if you spend enough time and you’re kind of diving deep and hard. And when it’s kind of coming at you fast enough, you’re picking up the pieces together and eventually you kind of put them together in a way that makes sense.
So then what does your day-to-day actually look like? So on a normal week, what does your job entail in finding these practices and completing deals?
So it’s a decent amount of time on the phone talking to new practices who perhaps we’ve had an introduction to from one of our existing physicians. We have a group that helps us with kind of buy side outreach, maybe they’ve got a hit. It could be somebody that I’ve directly reached out to because I think it’s a group that would be a good fit. There’s a lot of different ways someone might come in or a group might come into our orbit, and so a lot of my job is just kind of shepherding that group through the process. And so it could be an intro call, where I’m kind of telling them about who’s Orthopedic Care Partners, telling them why they would be a good fit, here’s all the reasons why it would make sense for you to talk to us and for us to join forces.
And then there’s invariably some questions. And so I’m kind of doing analysis and writing down questions and kind of showing them where multiples might be and how we think about valuation. And a lot of times the private equity presence in the orthopedic space is so young that a lot of what we’re doing is educating a practice as opposed to convincing them to join us. It’s a lot of why would you want to do a deal with private equity to begin with? And then once you kind of get over that hurdle, then you’re explaining to them why it makes sense for them to join OCP as opposed to some other MSO. And so we’re kind of always having those conversations.
And then there are also other deals who may already be under NDA, and we’re in the process of obtaining information from them and doing analysis. There could be a deal under LOI that we’re working on. And in those cases, I might be doing analysis in Excel, or providing guidance and helping our associate in the kind of work that he’s doing. And you’re just kind of shepherding these deals through the funnel. And the last stop on the funnel is signing a purchase agreement. And there’s a lot of steps that it takes to get there but I’d say most of my time is 50% on the phone, 50% in Excel, and not much left other than that, that’s really about it, that’s it.
So what’s the pitch to these doctors in joining OCP?
The pitch to a physician is really it comes down to a couple of factors for them. The first is that a specialty physician practice, be it orthopedics or ophthalmology or any even any private physician practice, if you just go see your primary care physician that’s seen family for years and it’s a private practice, that’s a small business. And there are not a lot of ways for that small business to monetize any equity value that they have built in their business.
So if you’re a physician practice and you’ve been around for 20 years, you might have a good base of customers but when it comes to the end time and you’re at the end of your career, what are you going to do? Historically, you’ll just kind of either shut it down, you closed up shop, or you have convinced a fellow coming out of a university to buy you out. But then again, there’s not a lot of equity value there so you’re just trying to convince them to give you some money, and hopefully, you can make that work. And so we offer them a way to basically transact and monetize the value in the business that they’ve built.
And so that comes in liquidity, that liquidity comes in the form of cash, and also they become a partner in Orthopedic Care Partner, so that instead of being one partner in a two or three or five-person group, they’re now a partner in a 70-person physician practice. That’s one piece is the liquidity. I think the second piece is that unlike a lot of transactions that your listeners might participate in, the sellers, in our case, they stick around post transaction because they are essentially the economic entity that we’re buying into the stream of cash flows of the doctor generates the cash and we’re buying a piece of a stream of that cash flow.
And so they have to stay around post-deal to keep generating that, it’s not a business that’s a going concern that we can kind of keep operating. And so a lot of times we offer certain things that a small practice might not offer, that’s better purchasing, the big thing is payer rates and then we also just offer the security that a smaller practice would not be able to offer. Today’s healthcare environment is candidly very challenging for a small physician practice, the regulatory environment is very fierce, the compliance cost is very high, and a lot of times if you don’t have the resources to play offense in that type of environment, you’re really not looking at a good outcome over the next couple years. And so we are really kind of a safe harbor in an environment that otherwise would be very challenging for them.
Yeah, that makes sense. My mom is a family practice physician and so I totally understand the equity piece to that. She bought it from the previous doctor who had ran it for 20 years or so.
That’s the typical path.
Yeah, I think she effectively just bought the building, and then some of the accounts receivable and-
That was effectively all of the doctor got. If I remember, correct. I could be wrong, of course. But you’re right, there’s not a whole lot there, especially if the doctor leaves.
That’s right. Not a lot of options historically.
So how do you build that into a deal then, knowing that if any key person, if any of the doctors actually leave they take their business with them?
That’s a really good question. So in our deals, a physician effectively signs up for a decent amount of time after the deal and they commit to staying on, because the cash portion of the proceeds that we give them upfront at the time of closing is not insignificant, it’s a pretty substantial amount of wealth, it’s a lot of wealth for them created at that time of closing. And so we expect them to stick around post close and be a good partner with us so that we can kind of continue to grow the practice. And we hope that if they do have plans of retirement, say, three years down the road, we want to know about it and we just want them to be a good partner and kind of help us find their replacement.
In those instances where they’re, quote unquote, a good leaver, we’re happy for them. We want them to kind of go into retirement or into the next stage of their career, but we just want to know about it. And so we effectively plan on them being a good partner, and to the extent they are, we don’t have to build much into our deal from a valuation perspective, because if things go as planned, we’ve got somebody coming behind them who can replace them when the day comes that they decide to hang up their cleats.
So then do you look for practices with doctors who are right at retirement age or within two years or so? Or do you just kind of plan around that anyway, you don’t really worry about that?
We really just look for folks who are going to be good partners to us because after the deal, again, unlike a typical sale, they’re not leaving, they’re going to stay. And so we have to live together after the deal and just kind of live in the same tent, play by the same rules and just have to live in this environment together, and we want to be happy. And so we don’t pay a lot of attention to age and where they are in career, we just really try to make sure we’ve done enough diligence to know they’re going to be a good partner.
And so that’s how we kind of really just approach the folks that we talk to. And once we’ve checked the box there and we know that they’re a good partner, then we get into the more financial aspect of diligence of around valuation and things like that. And that’s really, we’re looking for like a robust practice, their referral base, where they’re getting their business from, where their patients are coming from. And what affects the multiple, per se, is not where they’re at in their career, but just kind of the robustness of the practice that they run.
Do you help them try to find a bench of doctors in case they eventually decide to retire in the middle of your ownership period, such that you could bump somebody up in that case?
So in most of the instances of retirement, the partner has known at the time of the deal when they’re going to retire and hopefully they tell us, they’ll usually say, “Hey, I’ve got three more years. I want to work for five more years, 10 more years,” whatever that may be. And a lot of times, they have a plan for where they want to steward their practice, because a lot of these physicians have close relationships with their patients, they’ve done both knees, or both hips, or they’ve done the son’s knee and the dad’s hip, and they really see their patient base as something they want to protect.
So a lot of times, they don’t want to just kind of flip those back into the group, they want to find somebody who they trust. And most of the time, they have actually found someone in fellowship who can kind of come behind them and they can kind of hand their practice off to.
So a lot of times, we’re happy to help them. And in the case they don’t have that, we’re happy to kind of step in because we have physician recruiting resources. And a lot of times one of the benefits of having a larger practice is you can more easily recruit folks out of fellowship as compared to a smaller practice. And so we can kind of help them find that funnel. But most of the time, they’re more than happy to do it themselves.
Obviously, one way that the strategy could go wrong is if you lose a doctor and you’re not able to effectively replace them. But what are some other ways the strategy might not go as planned?
So physicians leaving the practice is actually one of the biggest risks, because if you think about it, a practice that has more physicians on it is less risky. So think about a three-physician practice, if one of those guys were hit by a bus, that would be detrimental to the overall practice. But if you have a 70 physician practice, it’s just much more resilient to things like that. So, pandemic, COVID, here in Florida, we had a two-month mandatory surgical ban that effectively put all orthopedic practices on hold.
The smaller groups, because they were not as resilient, they were not able to kind of weather that storm. We were talking about physicians leaving the practice. So a practice is inherently more valuable the more physicians there are on the platform because it is less risky as compared to a smaller practice. And so the larger you get, the more valuable it is. And so as physicians start leaving the practice, it starts to become this negative feedback loop where the other partners who are on the platform look at the platform and they say, “Oh, look, well, Dr. Smith is leaving. He thinks something’s wrong, he doesn’t want to be here. Maybe I should leave too.” So then that physician leaves. And so you’ve become a little bit less valuable.
And then now the next physician says, “Well, I just saw Dr. Smith and Dr. Jones leave. Everybody’s leaving. I need to get off the platform.” And so they leave too. So as long as everyone is happy, things are going well, it’s a positive feedback loop. But if someone leaves the practice, it can potentially start this negative feedback loop where folks look around and they think they might want to get out too. And once that kind of starts, it’s a slippery slope and things can kind of unwind. But that’s inherent really in any kind of platform or network.
Has that happened in your experience so far, or at least began to happen and you had to stop it somehow?
No, it has not happened. Thankfully, our practice has been very successful. Our physicians are happy and making money, so that usually helps. And we have not had anything close to that happening. And we’re one of the few kind of fully baked MSOs in the orthopedic space, there are some others that had been established. And so there have not been enough others kind of in the space that I have been around long enough for me to see that happen to. But thankfully, it hasn’t happened to us and we haven’t seen that.
You mentioned keeping physicians happy, and obviously pay is part of that. But what are some other elements that you can improve or keep stable within their jobs that keep them happy and excited to be there?
I would say compensation is number one. A physician that’s making a good chunk of change is usually a happy physician. But physicians by and large, they love practicing their craft, and if you’re an orthopedic surgeon, you love performing surgery on folks because that’s what you’re good at. And you don’t want to spend a lot of time in the headaches of billing and collections, running a practice, thinking about overhead. One of the best ways to kind of make a physician angry is kind of get them bogged down in stuff like that.
So to the extent we can kind of keep them focused on doing what they do best, and that’s performing surgeries on folks and keeping the outcomes good, we’re going to have a good investment. And that’s why we have a back office, it’s fully baked, we have a CFO, controller, compliance, billing and collections, we kind of do all that in-house just so they don’t have to worry about that, they can focus on performing surgery.
Yeah, and obviously, they don’t want to do a lot of the back office stuff and a lot of them aren’t business people, so what is two to three things that they usually struggle at that you can come in and within a few weeks or a few months you can immediately start to improve?
With the smaller practices, operations is generally the first thing we can help them with. Small businesses generally are a mess. Small physician practices are really a mess, because the doctors, they want to provide good patient care and that’s their focus. And so they should be focused on that and oftentimes, that comes at the expense of business operations. And the most successful practices that you see are when those physicians have hired someone to kind of do that for them, and they have a very effective practice administrator. But those are kind of few and far between.
And the good ones get kind of snatched up and the folks that employ them don’t want them to go elsewhere, so they don’t move around a lot. And so the first thing we can do is just help them there. We can just take a lot of headaches out of their life. And then the second big thing is I noted the pay rates. Obviously, as a larger practice, we have negotiated better rates with insurance companies than the smaller orthopedic practices and generally smaller physician practices can negotiate. And so we’re able to pay them better fees for essentially doing the same amount of work.
So we hope that they’re… Provide a day’s work and their productivity metrics increase, because we want them to work hard. But oftentimes, we can show a practice that you can make more money doing the same amount of work just by coming under our tax ID number. Those are really good situations, and those are kind of, I don’t like to use the word, but those are synergistic.
Yeah, absolutely. And through my mom, I’ve gotten familiar with pay rates and dealing with insurance companies.
It’s a mess.
It’s definitely a mess. So what causes a physician, an individual practice to be getting lower rates with an insurance company? Are they just not as good of a negotiator, they don’t draw a harder line, or what is it about that relationship that they’re not as good at as larger ones?
That’s part of it. Part of it is that it’s a situation where the information is very asymmetric. And so an insurance company negotiates directly with the physician practice, and they know exactly what they’re paying to every physician practice providing that same specialty of care in a particular locality. But it’s actually against the law for the physician practices to know what the other ones are receiving from the payers. So the insurance company has all the information and then normally, they have a full bench of lawyers, attorneys, they can write the contracts in a complicated manner. If you’ve ever read an insurance payer contract, it’s a nightmare.
And candidly, they just kind of come in with shock and awe and it’s just hard to go to bat as a small physician practice who doesn’t have the money to throw at a specialty attorney who knows about healthcare regulatory compliance and things like that. But we can do that for them because we have folks like that that work for us, and so oftentimes, they’re happy to kind of outsource that to us, or just kind of come under the umbrella that we’ve already set up that allows them to kind of take advantage of those good rates.
So with your lawyer or helpers who can find those better rates or negotiate those better rates with your insurance companies, are they just finding better information around other practices without just going directly to the insurance company or how do they counter them?
The big counter is that you have to have an attorney to kind of jump through the hoops and do it in the right way and communicate things appropriately. But the leverage with the payer is actually on the business side, because if you have, in Florida we have 50 or so orthopedic physicians, and in certain markets we have a high percentage of the volume, and that’s leverage. And leverage is, is that when you’re talking to an insurance company, and they threaten you with a rate cut, you can say, “Okay, well, I’m going to go out of network, and then all of these patients who love Dr. Smith, all of a sudden, they’re not going to be in your network anymore. They want to come to me anyway, they’re going to pay out in network rates to do that.” And that’s more expensive for the insurance company.
And so by and large, those smaller practices, the twosies and threesies, they just don’t have any negotiating leverage. If they were to threaten to go out of network with a certain insurance company, the insurance company will just tell them to go pound sand because they would just send the volume elsewhere. When you’re a large physician practice and you’re established and you’re kind of entrenched in an area, and you’ve got marketing resources that can go out and kind of grab patients and make sure that they’re sticky and they want to come to you, the insurance company knows that they just kind of don’t have the leverage to come and push you around.
Yeah, so this seems like a truly synergistic element where as you scale and add more practices, you do in fact, gain some synergistic value. And you talked about handling the back office as well. I’m curious, is there anything then as you add more practices it actually gets more challenging and more difficult?
The thing that gets more difficult is just from a management perspective, it’s just harder to manage more people without creating an overly burdensome administrative structure. By and large, we are a very flat and fast moving, I don’t want to use the word hierarchy, but if you think of our corporate structure, it’s pretty flat and we kind of like the fact that we can kind of get things done quickly and we don’t have a lot of administrative overhead and bureaucracy. And physicians largely don’t like that.
And so as you grow, orthopedic practices and physician practices generally are just a kind of hands on business. So there’s got to be a practice administrator there, there’s always got to be someone there in addition to the physicians kind of doing the back office and the billing and collections. And as you grow, it’s hard to do that in a way that doesn’t kind of become overly bureaucratic. And so that’s kind of the main challenge for us as we grow. And that’s kind of something we’re constantly fighting.
Yeah. And you mentioned having a administrator at each practice. For folks like my mom who have their independent practice and want to create a more valuable practice for when they leave and pass it on to somebody else or sell it. What sort of best practices do you recommend having to run a clinic a little better?
So the thing I’ll note is for practices like your mom’s where you already have a practice administrator and things like that, we don’t come in and take a lot of costs out of a practice. We don’t do turnarounds of orthopedic groups, we only partner with folks who already are high performing and have a good practice administrator. And really we’re kind of resources behind them, as opposed to coming in and saying, “Here’s your new practice administrator. The old person’s out of there.” We largely don’t take any cost out of the practice. And so we really try to create value through the things like the pay rates, and purchasing economies and things like that.
It’s hard to just get bogged down in a physician practice generally in the kind of daily puts and takes of the billing and collections that have historically been done on paper. And when a patient comes in, in the past, imagine going to the doctor when you were a kid, and they give you the form and your mom fills out the things that are wrong with you. And then the assistant takes you back there, and she puts that paper on top of your old audit. And by and large, that type of level of operations still occur, and so we have a practice management system that kind of automates a lot of that. But a lot of these physician practices, they just, they still run on paper and pencil and fax machine.
And so, one thing that a lot of these places could do, even if you didn’t want to join private equity, if you just wanted to have a more efficient physician practice, just try your best to get off a pen and paper. Invest in something like a good practice management system or an electronic health record system. There’s a lot of those out there now, they’re fairly cheap. But by and large, physicians, again, are focused on providing good patient care, they don’t think about kind of how things go in the back office all the time. And so once they get kind of set in their ways and they like their system and they like seeing their piece of paper, it’s hard to get them off of that.
So you’ve obviously had lots of deal experience thence and your Substack article about working capital is it sounds like that’s part of your documentation process for sharing some of that experience that you’ve gained. Are there a few lessons that you’ve learned over time about giving deals that you’re looking forward to sharing more on Substack or in other outlets or Twitter and whatnot?
What I would like to share are experiences that can help inform folks like a lot of your listeners who are searching for a business or perhaps buying a business and going through it for the first time, or they might have done it before maybe once or twice. A lot of times if you’ve done one or two deals before, you’re pretty experienced. But a lot of the folks that are probably listening to this have read about “I need to do networking capital settlement, I need to think about getting debt-like items, I need to do quality of earnings.” But without ever having actually done that before, you’re not really left with a lot of resources other than just kind of finding another book that kind of tells you generally that you need to do it.
So the purpose of that article was really just to kind of put exhibits and hard numbers and hard examples on paper so if someone could see exactly when I get a set of financials from a target, here are the steps that I go through to actually calculate a working capital target. And hopefully, that’ll kind of help them get through that process and they can kind of line things up. Things don’t always clean in the SAS businesses we look at, but to the best that they can, I hope I can provide some examples as well as that one in the future that can kind of help them go through step by step and really kind of put some hard examples to things that are generally kind of talked and spoken to at a very high level.
Is there a story or a deal in the past that you remember that you felt had a really steep learning curve or among the steepest you’ve had?
Well, I would say that when I first got to Alvarez and Marsal I spent a decent amount of time in energy and infrastructure. And that ended up being kind of a significant piece of where I kind of allocated my deal time. And from a technical perspective that was a steep learning curve to get up because a lot of the accounting for utilities businesses and construction businesses are percentage of completion. Or they’re things like asset retirement obligations, and a lot of those, they’re very impactful for a deal and you have to think of those on a standalone basis as you’re looking at a target and on a pro forma basis if you’re thinking about how this fits into a larger business.
And so I would say that has been one of the steepest learning curves that I had to get up at one time, which is generally kind of things like energy, infrastructure, and just kind of putting all the regulatory pieces there together as well. Seems like anywhere that there’s a regulatory presence, there’s often some steep learning curve around the specialized accounting and things like that. That’s probably been one from a technical kind of blocking and tackling perspective that was pretty tough to get up.
Healthcare, obviously, was a steep learning curve. The good thing I noted that I had a good mentor there, have a good mentor there. And thankfully, it was tough at first, but kind of jumping in the deep end of the pool really helped me figure things out quickly and that’s usually kind of the best way to do it. As I noted in that write up about working capital, the best way to get good at something is just kind of do it as quickly as you can as many times as you can, and get as many reps. And so in all these instances, I think that’s the best way to kind of get over the hump or get up the curve.
In your experience doing deals, is the working capital discussion among the top three reasons a deal might go sideways or fall apart? Or what are some other reasons that you’ve encountered so far?
I would say that working capital was probably a big pitfall and a place that can significantly slow down a deal. In a middle market private equity deal, where it’s kind of two shops are trading the company between themselves and everybody kind of know how the adjustment works, that’s pretty easy, because folks know what to expect and a lot of times, there’s some sort of side help.
But when you’re dealing in our business now, where you’re talking to kind of first time sellers, or perhaps your listeners are talking to first time sellers, that’s an area where things tend to kind of slow down just because there’s the component of actually calculating the adjustment, you yourself may have trouble getting there. And then on the other side of that, you’re actually educating the seller on why they may owe you some additional purchase price 90 or 120 days after the deal’s closed. They’re probably going to think you’re trying to rip them off and that’s usually kind of where things go.
That’s probably what slows deals down the most. I think valuation is probably the biggest reason why deals die. And so it’s a kind of, I would say, valuation expectations from the seller’s side, and then inexperience on the buyer’s side and knowing how to bridge that valuation gap, if that makes sense. That’s usually the number one reason that the deal actually dies.
So how do you bridge that gap?
I think the first way you bridge the gap is you kind of sit down with the seller and you figure out exactly why there is some difference in expectations. And so you may… I’m just kind of making these numbers up. You may put an offer on the table that is six times EBITDA, if you’re using that as your profitability metric. And the seller might come back and say, “I got to have seven times to trade,” and you don’t want to pay more than six times. And at its face, it may look like, “Hey, we just aren’t going to get there because I’m not going to pay up.”
Well, if you sit down and you actually spend some time talking to the seller, you might find out, and just making this up, perhaps they need some extra liquidity because they’ve got a child that’s kind of going off to college next semester, and they need more money up front. Well, in that case, they think they need another turn but what they really need is you to kind of think about structuring the deal where maybe they get more proceeds up front. Or maybe you help them find someone that can give them reps and warranties insurance, instead of locking up a lot of their purchase price in an escrow account for 120 days, and a year and a half. And so they get more of that up front.
And so there are a lot of tools out there that a buyer can use to kind of bridge that, but if you don’t know them, you may just kind of walk in here thinking that there’s a valuation gap. And a lot of times they don’t really know the tools either, they think that the solution is just for you to kind of pay them more. And that’s usually probably the last thing on the list that it’s going to take to get a deal done if you can kind of sit down and help them think through what they really need and kind of dig underneath what is the perceived valuation issue. And you’ll likely find out there’s just something emotional or there’s something else there.
How often is it typically emotional versus they just need more cash upfront, or they need more money in their deal?
I wouldn’t say that it’s often, it’s usually not strictly one of those, it’s kind of a blend. And so what might be presented from the seller’s side is strictly I just think the business was worth more money. It may just be that it’s some perceived value, and you need to kind of help educate them on where market multiples are. And that might do it. It might not because they just think their business is special and you need to kind of pay up to have it. But even in instances like that, there may be an emotional reason that’s kind of underlying their view on that, that you just need to kind of dig in a little bit. And I would say it’s usually kind of a blend of the three. It’s not always kind of one or the other.
So how do you structure a deal like this where a lot of the value might be in just AR or maybe a little bit of goodwill, but it’s not in normal business services where you can give a normal multiple and just go from there, but these are very obviously people-centric and key-person-centric? So what does a typical structure look like for these deals?
So the way our deals work are, I’m sure a lot of your listeners have heard of this concept of the management services organization. And so what we have in Florida is an MSO, and that’s an entity with a tax ID number and that’s what holds the payer contracts. And then when a physician joins our practice, they effectively trade the equity in their old physician practice for ownership in the MSO. And they’re trading equity for equity so that makes it kind of a tax advantaged transaction, and they get some proceeds up front.
But essentially, what we’re buying on paper, what the transaction documents say we’re buying are the clinical assets of the business because they likely have X-ray machines and a C-arm. And then there’s always some inventory and some supplies and a little bit of accounts receivable, because a lot of these guys have been in business for a long time. It’s kind of what we’re buying. And that’s what’s kind of in the transaction documents. But when we’re valuing the business, and we’re kind of thinking about what we’re paying for, we are paying for a percentage of that physician’s take home compensation post-deal. And so the term we use a lot is forgone compensation.
And so if you have a physician… I’m just kind of using around numbers here for the sake of example. Let’s say you have an orthopedic surgeon who makes a million dollars a year, are highly compensated, make a million dollars a year and you want to do a deal with us, what we’re going to do is we’re going to sit down together, we are going to determine some amount of compensation post-transaction to be foregone to the management company, to Orthopedic Care Partners. And so it’s not going into executive bonuses in Gainesville, it’s going into a pot that all of our partners contribute to, and that’s the money that we go out to do other deals with and that’s our growth capital.
And so that forgone compensation that I was referring to, it’s usually calculated on a percentage basis. So the physician might say, “I’m going to give up 30% of my compensation going forward.” And so the next year, if that physician is at the same level of productivity, let’s just assume they would have otherwise taken home a million dollars. Now, they take home $700,000 and $300,000 goes to Orthopedic Care Partners, the entity that they’re a partner in. And that is what we pay them a multiple of, because the compensation that they are essentially giving to us is our EBITDA to the management company.
And so that’s kind of how our deals work. We’re buying assets, but when we’re thinking about proceeds to the physician, it’s based off how much money they’re giving us post-deal. And that’s how we’re effectively kind of buying into the stream of cash flows, because we want them to kind of continue to be productive. We want them to continue generating earnings for the practice and earnings for themselves.
And that’s how we align interest because if we did it as a percentage of collections, they would not be interested in the operations of the practice. Obviously, we want them to want to run an efficient practice. And so just like if you’re thinking about setting up an executive bonus, you’ve probably heard people say, “You should set it as close to the bottom as you can,” because that incentivizes them to kind of make the right decisions. And that’s why we set our forgone compensation and the number that we pay them off of at the bottom.
So how do you set forgone compensation? So using your example of a million dollars, how do you determine that you’re going to let them have the $700,000 as their normal income, is that just, is that a market rate or there’s some decision making and negotiating that goes on there?
There’s a couple guideposts. So one is the ability for them to give up compensation. So the physician who’s making a million dollars of compensation pre-transaction has not done anything in order to give, but they have the ability to give up more compensation than someone who’s only making five or $600,000 in compensation pre-transaction. And so they can just give up more, and they might be willing to give up more. So we sit down with them and all of this is done very transparently.
We show them all the numbers. We show them how everything’s going to work. And together with them, we essentially come up with a number that they are willing to live with post-deal. And most of them, they want to keep a certain level of compensation. They still have a family. They have a certain lifestyle that they’re used to, usually. And so together with them, we kind of triangulate some amount of compensation they’re happy landing at post-deal.
And then another guide post that we have is that healthcare generally just has a ton of data on anything that you want to kind of know about, because you’re giving data to the government, you’re giving data to the payers, you got to track a ton of data in order to get paid for the work that you do. And so, one of the good data sets that we have is on physician compensation. There are companies that just specialize in doing surveys among physicians of all sub-specialties and they can show us on a bell curve exactly what physicians are making.
And we try not to take them below a certain percentile of that compensation level, because they like to say when they’re kind of at the country club, “Oh, I did, I took home X number of dollars last year.” And so we want them to be able to say that, we want them to feel comfortable about being a partner in Orthopedic Care Partners, and part of that is them making a good wage post transaction. And then we also want them to make enough money, that they’re just a good partner. And we know that if we take them down too low, they’re just not going to be happy. So we want them to be happy post-deal, so we don’t want to take them down too low. So we kind of use those different guideposts to triangulate what we think foregone compensation should be.
That sounds like it would be a pretty delicate conversation when you start talking about compensation and removing part of it from them, and that sounds challenging.
It is a very delicate conversation because one thing I’ve learned that physicians… Well, a lot of professionals, this is not just physicians, a lot of professionals, M&A guys are the same way. A lot of lawyers, attorneys, they derive their self-worth from their take home W-2 every month and what their tax return says every year. And so it’s delicate because we do not want to insult them. There’s a lot of competition. A lot of practices candidly don’t share among partners how much each of them are making, because they know that it could cause an issue.
And so a lot of times we just have to be a good party, play by the rules. Sometimes that means we’ve had to present deals to partners individually, even though they’re kind of getting the same deal, because they don’t want each other to kind of know what they’re making. But you’re absolutely right it’s a very delicate conversation only because a lot of emotion with surgeons is and again, professionals in general is just kind of wrapped up in the emotional connection between their worth and their take home pay.
What class would you teach in college, if you could teach about any subject you wanted?
If I could teach any class, I think the most important thing I could teach students is if this were my class, it would just be down and dirty, cold calling, belly to belly, walk in door to door just sales, just good old fashioned sales. Not marketing. I’m not talking about building a funnel and pay per click and all that stuff. I’m talking about good old fashioned just face to face, voice to voice over the phone, just salesmanship. And the reason I would teach that class is I believe that business is largely just the combination of a bunch of sales interactions.
So your listeners they’re looking at a business, they have to sell a target on why they should sell their business to them, then they’ve got to sell a lender on why you should give me the money to do it. And then you’ve got to sell the target on why this structure and why the way I want to kind of set things up make sense. And then once the deal closes, you got to sell the current employees on why they want to stay with the business. And then if you’re growing, you got to sell new employees on why they want to join. And then you got to sell new customers, and it kind of goes on and on.
And where I’m going is again, I think business is just an amalgamation of just a bunch of kind of one-on-one sales. And the better you are at face to face sales and convincing people kind of face to face, I think the better you are at all of those. And I think as they add up over time, they just kind of compound into success. And so what the class would be is just get out a phone book, get out your iPhone, we’re going to go on Amazon and bought something maybe in… Or Alibaba, like a lot of 5,000 stuffed animals or something, and just get on the phone and start selling them.
Because I think the key to sales is that a lot of folks, they read selling books, and they kind of overthink it, when in reality, what it takes to get good at sales is really just kind of getting beat up and getting through the process of having people slam doors in their face and hang up on you. And eventually you get better talking to people, and you get better at presenting your product. And after a while you kind of glaze over and you realize it’s something you can actually do and you realize that you’re actually pretty good at it. And so that would be the class, it would just be good old-fashioned sales.
What was your evolution as a sales person over time and what kinds of things did you do at first that you’ve learned to kind of outgrow or you’ve shifted your wording and whatnot?
I think that what I’ve learned is I’ve gotten better at it in the past couple years as I’ve spent more time one-on-one with groups and I’ve been the one kind of making the pitch and making the sale, and not just kind of the guy in the background with the model. One, you get better at it, and I think the thing that I’ve learned is that the way you get better at it is actually just confidence.
And what I’ve learned is before I was worried about saying the wrong thing or maybe describing something incorrectly, and I would always worry about what the receiver would hear and I just kind of worried about saying it and doing it the right way, when in reality, it’s best to just kind of get up and do it. And if you know the details, you know the product, you can anticipate what they’re going to ask because I guess it won’t really matter what they ask because you largely know all the answers. You will have the confidence just to get up and do it.
And then the audience that’s kind of listening to you and kind of getting the pitch, they’ll feel that, and they’ll buy into it and they’ll know you’re confident in what you’re selling them. And eventually, you just get better at it. And again, you just get better at it by doing it. I would say that I spent a lot of time overthinking it and trying to say the right words and put the right slides out, when in reality, the best sales are the ones where you just kind of get up and talk.
Yeah, definitely. And along the same lines, what’s the belief you used to hold strongly that you’ve changed your mind on?
I think it’s connected to what we were just talking about. I think that for a long time in my career if there was a contentious deal issue or a question or something that needed to be worked through, I thought that the way that we resolve that was by me going away and putting together some whiz bang pro forma financial analysis. And if I could kind of package that in the right way and put the slides together in the right way, then I could come to you and present it to you, and the light bulbs will go off in your head, and you would get it and you’d see it my way, and then it’d be done and it would be resolved.
And where I have evolved to and what I’ve changed my mind about is that I’ve realized that, that largely does not matter. And I think specifically what I’ve changed my mind on is the idea of financial analysis, or detailed financial analysis and pro formas and things like that in resolving issues. And where I’ve evolved to is a lot of times as we were talking about emotional issues before, just picking up the phone, or sitting down with the seller and understanding what it is that their concern is, what their question is about.
And instead of trying to, again, anticipate and overthink, and kind of beat somebody over the head with a model, someone who may or may not be a numbers person like me, because that’s the way I think about it, that’s what you’re probably going to think about it too, when in reality, that’s not even close. The best thing to do is just kind of sit down and talk. And a lot of times, kind of bringing those things into the equation, they aren’t helpful, and they’re sometimes detrimental.
Yeah, that’s understandable. That makes a lot of sense. What’s the best business you’ve ever seen?
So the best business that I’ve ever seen, or at least it was the best business I’ve ever seen at the time that I saw it, was a multi-level marketing business in Utah called Jamberry Nails. And so Jamberry manufactured nail wraps. And a nail wrap is essentially a fancy sticker that a lady puts on their fingernails in lieu of getting a manicure. And it was founded by a husband and wife team and the wife’s two sisters, after the three of the sisters had been at a beauty convention and someone there was selling these nail wraps.
And so they brought them home. And they were raving about how cool they were. And the husband saw them and it just so happened that he had been in a ski manufacturing business and he had this machine that could essentially kind of lay down pictures, and laminate and things like that on wood. And he saw these things and he said, “I think I can make those.” And so they started a business.
And it found product market fit immediately. And they’d only been around for four or five years or so by the time I had seen them. And the way that I had come in contact with the business is that our consulting firm was doing some sale side work. They were going up for sale to private equity. And what made them such a great business and made private equity kind of trip over these guys was kind of a few things. The first of which is that the margin on a nail wrap is or was incredible. I mean, they manufactured these things, which were essentially stickers for like 50 cents apiece. And they turned around, and they sold them for like 20 or 30 or $40 apiece, depending on what level of those that you got. So the margin was just insane.
And then the overhead was pretty low, because if you can imagine a nail wrap is like, it’s basically like the size of an index card. So the entire inventory of the company could fit on a bookcase. And they had some spend for like marketing and logistics and things like that and commissions, but by and large, the overhead was pretty low. And so they had no debt. The really interesting part of the business is that it generated negative net working capital.
And so in a traditional business, think about a manufacturing business, you buy inventory, you make a product, then you turn around and try to sell it. So you’re essentially kind of you spend 50 cents, and you hope you can get it to come back to you as $1 after you sell it. Well, the way Jamberry sold their product was that they had salesmen that would have… Usually sales ladies that would have these nail parties and it would basically be a bunch of girls kind of drinking wine and trying on nails and stuff. And at the end of the party, the customer would decide what they wanted to buy. They’d give the sales lady their 30 bucks. They’d check the box on what they wanted. The sales lady would turn around and send it in to Jamberry and then Jamberry would turn around and just print off your nail wrap of whatever type you wanted and then send it to you.
They got the money up front for what they then had to turn around and kind of manufacture. So again, negative networking capital. And so all of those things together essentially made the business a cash printing machine. And private equity again, were just kind of tripping over themselves to get this business. And the founders had a good exit. But unfortunately, since then, and since it was owned by private equity, it’s gone out of business, it’s no more. I think it was probably kind of rolled up into something else, but they eventually kind of went out of business. But at the time, that was the best business I’d ever seen.
Why did they go out of business?
I don’t know why it went out of business. I mean, it’s one of those things where I remember seeing an article about them going out of business, and it was a surprise, and I think all the employees were surprised. So I don’t have any information on what happened within the company, but at the time, it was really something special.
How long after you saw it did it go out of business?
Had to be within five years. I mean, they weren’t owned by a private equity for that long. I don’t know what the story was or if it was on the first buyer or perhaps it had been flipped to another private equity firm, not entirely sure. I just kind of happened to be there at a special kind of point in time in the company’s history where they were just rocking and rolling.
Well, thanks, Matt, for sharing your time. It’s been great to hear a little about your deal experience and then the healthcare industry roll out. This is something I haven’t had the pleasure to talk to or talk about on the podcast. So it’s been exciting to approach that angle, especially with my family background of having a doctor in the family. So thank you so much for sharing your time.
Alex, thank you for having me. I’ve enjoyed this. Again, thank you for having me on here and excited to watch this thing grow for you. Thank you.
Matt is a director of corporate development at Orthopedic Care Partners, a private equity group focused on acquiring orthopedic surgery practices.