PE Involvement in Physician Practice Transactions

Jarrod Barraza, Horne LLP, and Patrick Souter, Gray Reed, discuss private equity involvement in physician practice transactions, including concerns such as corporate practice of medicine rules, alignment of goals, and due diligence. The podcast also covers valuation issues. Sponsored by Horne.

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Transcript

Speaker 1: 0:14

Support for A H L A and the following message comes from Horn, what's changing in healthcare valuation? The buy-in podcast from Horn engages healthcare attorneys and in-house counsel and lively conversation about trends and best practices in physician comp, hospital mergers, value-based arrangements, telehealth, and more brought to you by Horn Buy-In is available on Apple, Google, Spotify, and wherever you get your podcasts.

Speaker 2: 0:41

Okay. Hi everyone. Uh, welcome to a h l a's speaking of Health Law podcast. My name is Jared Barraza. I'm a manager at Horn, l l p, where I serve in our focus area. Um, on the valuation team today we'll be discussing private equities, involvement in physician practice transactions or transitions, uh, as some people like to call it. And on a personal note, I'm thrilled to make my podcast debut and, uh, very fortunate to be joined by Pat Souder, who is better suited to introduce himself. Pat. Thank you.

Speaker 3: 1:18

Thank you, Jared. Um, and this is my first podcast as well. So, uh, um, th th this is a new adventure for, uh, for both of us. Um, again, as Jared said, my name's Pat Suder. I'm a, um, attorney with Gray Reed and McGraw in Dallas, Texas, and also the, uh, professor of healthcare studies at Baylor University School of Law. And, and so with that, I do wanna kind of get into the whole area, the, the general area of private equity, uh, and physician practices, because it is one that we've seen an evolution over time. Um, fortunately, or unfortunately, I'm old enough to remember when it was the, uh, projected, uh, darling of Wall Street back in the 1990s when you had private equity getting involved with physician practices, primarily through management service organizations or MSOs. And, and you still see that format now, but you know, back at the, in the time, people did not appreciate the difference. Um, and when I say people, it's not that I'm just saying the private equity group or the physician practice group, I think both sides did not appreciate the difference in how you operate a physician practice from another industry. So, with that, there were a lot of, uh, of projections made and, and, um, uh, the as underlying assumptions under those projections really weren't realistic because of the fact that they were treating, um, uh, these, these assumptions and, uh, um, like they were in other industries, you know, with this, you, you have seasonal activity as it relates to the delivery of healthcare. You have payer issues, you just, all of these evolutions. So they weren't as, as successful back in the nineties. Um, you had a lot of physicians who sold their practices, um, to, to these private equities. And I'm using that in a global term. I'll tell you a little bit, uh, how to differentiate what I'm talking about there in a second. But you sold a lot of them based on the idea that the management companies were gonna go public, because that was the exit strategy for the private equity. And unfortunately, a lot of physicians sold their practices for paper rather than for cash. And when the dust settled at the end of the day, when it did not go as everybody contemplated, then you had a lot of, uh, a physician sitting there with really no value. Now, I'm not to say that they all, uh, were, were, uh, terrible business ventures. There are a number of successful ones out there, and I think it was the ones that, that appreciated the marketplace and had the financial resources and included physicians in the governance that were more successful. So, um, we're seeing that, again, private equity is, is recognized that, um, healthcare is an area that they can take advantage of, uh, makes up about 18% of the gdp. Um, and, uh, but they've learned the lessons that they've had in the past. So, you know, with that, and looking at these types of deals, I mentioned the, the, the M MSO model. And, and traditionally what you will have will be, um, private equity funding, um, uh, an MSO so that the M MSO will purchase the assets, the operational assets of a physician practice, and then lease them back through a management services agreement, um, along with providing management services. And the actual revenue tied back to this arrangement is that, that, that, that payment for management and administrative services, office space, um, uh, furniture fixture and equipment, um, staffing, those types of things. So when, uh, um, when, when you get into the area, there's several different, uh, issues that come about. First off is, and, and I think the most important one is dealing with the corporate practice of medicine prohibition. Because when you have a private equity group and you have a physician practice, um, the physicians are those who are licensed to, to practice medicine in a given state. And there may be restrictions on the involvement of the private equity or the layperson in that process, uh, in that business arrangement. And you have some state such as Texas, which probably has the strongest prohibition against the corporate practice of medicine. This says that a, a a layperson can't own a physician practice in general terms, there's a couple of exceptions there, but layperson can't own it, can't control the delivery of services. You have fee splitting issues and the like. And so that can drive what the arrangement is in with the private equity group. Um, do, do you have to do the management services organization or is there another way to do it? So when you, when you look at these types of arrangements, the first thing to consider is what is p is permissible in the state where the practice is, is, uh, actually operating. Now with that, that can drive whether the, the, the transactional framework is gonna be an asset deal, a stock deal merger, uh, with another physician practice or, or with some other type of entity. But recognize that in these types of private equity plays with physician practices, you're generally going to have, uh, a, a a, uh, the, the private equity company funding a, an administrative and management services organization and a physician practice. Now, it's not to say that you only have one physician practice and you roll all the physicians into it, rather, I mean, which you can have what's called a friendly, uh, uh, practice arrangement, but you can also have it where it's just that the, the, the, uh, management company is doing management deals all over the place with a bunch of different practices. So there's no right or wrong reason. Again, it all comes about as to what state law will allow and, um, just what the, the, the preference is between the parties. Now, with this, when you're structuring this arrangement, you need to consider the long-term plans. What are we going to do with this arrangement? Do we envision that we're just getting into a single specialty arrangement? Is it a multi-specialty arrangement? Um, are we gonna allow physicians to have ownership in the management company? Um, uh, you, you know, there, there has to be long-term planning because that's, again, the, the, the failures back in the nineties, um, what there wasn't long-term planning. It was just believed that we can, uh, a private equity can do a financial, uh, transaction with a physician practice, and it just keeps going business as usual. But that is not the case in this because you're, the, the healthcare is such an ever-evolving world from payer and reimbursement issues, fraud and abuse concerns, um, um, advances in the delivery of care. And what the government wants to see in that is that you really have to be able to be looking forward with what are we going to do here? And, and with this, ultimately, what's the exit strategy? Is this going to be something a and the, the physicians are gonna wanna know this a as well, that, are we going to flip this management company in three or five years? Are we gonna take it public, or are we just going to keep operating it as usual? And instead of trying to hit a home run, we hit singles and doubles and, and make a lot of money. So in, in, in, in approaching these deals, I think it's incumbent upon both parties to have common aligned, uh, goals, incentives, and a vision. So with that, you know, the deal process itself, many times a deal like this will start off with a letter of intent. Um, I and myself always try to use an M O u a memorandum of understanding first, because there's been many times that you start negotiating this L loi and it turns out that you're not on the same page. So I tried to do a very short, uh, memorandum of understanding so that everybody knows once we start drafting that L loi, that we know what goes into it and recognize the l o I is still just developing the framework that M MOU is just think of if you're gonna build a house, the M MOU is, is, you know, here are the list of, of things that we're going to need to build a house. And then the l o i is where you're starting to actually do the, the, the framework or the outline of the transaction l o y is going to, many times when you get into it, a lot of them are, are, are pretty much the same, but you will have, uh, differences as it relates to the type of transaction that it is. But the most important part, and, and it's one where I have seen deals fall apart, is the element of due diligence. And due diligence is where, um, you know, that the, that the, the private equity group, before they're going to get in this transaction and commit their money, they need to see everything about this practice. And many times you'll have, uh, practices that'll say, well, I'll, uh, you know, I'll give them this, this is the good stuff. But you have to recognize that you have to give them everything, and Jared's gonna talk about it when he gets into valuations, how important this is to be able to, to provide this information and provide it in the, in the most, uh, complete fashion upfront. I will tell you that I've seen many deals where the, there, the private equity side starts getting apprehensive when the physician practice can either a, not respond timely or not respond at all to due diligence items. So, so you, you want to recognize that if, if somebody is asking for information and you can't provide it or it's incomplete, that there's going to be concern, which may change the transaction itself, may may change the, the, the price that's involved or the terms that have been negotiated. So, um, I would encourage the physician practice side to recognize that if you're going to look at doing something with private equity before you get into it, have your, your, your practice manager, your consultants and consultants, attorneys, accountants, business consultants, have a, a, a data room already set up that has everything that would be on a due diligence checklist and going back at least two, but maybe even three years and put everything in there that, that, that, that, that the, the consultants believe will be necessary. But because that way, and when you go to it, they start asking for information, it's already there. You're not scrambling around trying to do anything. But, so with that, that that's the reason why I, I, I can't, uh, uh, tell you how important it is that due diligence, um, I is something that is considered way before you start talking to private equity. Now, on the private equity side, you need to realize that, um, you have your due diligence checklist, and you're, many times you're dealing with somebody that may not have, uh, the sophistication that you have in a transaction. So I would encourage you not to assume the worst, try to have open dialogue between the parties and, and, uh, so, so with that, as part of building your transactional deadline, be realistic as to w you know, this is when we're going to have the L LOI done, this is when we're going to have the due diligence done. Um, those types of things. And so with that, as, as you're doing this, you're also negotiating the transaction, the, the, the, the underlying agreement. Um, I recognize that, uh, many times people will have a form agreement that they're, that, that they're a slave to. But I will tell you that, um, it, it is for the working relationship of the party moving forward. Um, and, and I've done this on the private equity side, I've done it on the physician side. Don't just discount what somebody says. Many times they don't understand, uh, what, where the other person's coming from. Um, and so you need to have an open dialogue and recognize, well, maybe we should, uh, add something to this purchase agreement, um, or maybe we should delete it, or we should recognize that there's an issue out there. And, and you're going to see this when we, when we, the last part of this, we're gonna talk about covid and the impact on, on transactions in this area. Um, you're going to see that there needs to be some flexibility there. Now, let's say that you get to the end, everybody's happy, the paperwork signed, um, but recognize that these are folks that have not worked together before. Um, there may be a need, depending upon the arrangement, to actually have, uh, a breakup provision contained within the documents that, that the physician with the physician group in the first two years may feel that they want to, this isn't what they bargain for. And so they want to be able to unwind the transaction or vice versa. Maybe it's the, the, the private equity group says, these are folks we can't work with. So I would encourage you to at least consider, uh, a breakup provision. Now, it's, it's, it may not be, uh, possible in every transaction, um, but in some, in those transactions where it is possible to have a breakup provision where you can unwind the deal, people get back into their place, but this should not be something that is a trigger that you're willing to pull immediately. I think that you need to have, um, dispute resolution provisions that must be, uh, carried out prior to exercising the breakup provision, or have an independent party that will come in and, and, uh, you know, provide their insight to the party. Their breakup provision is one that I've used before, sometimes has been successful, other times both parties get hurt with it, and you can't unwind time. So, but it, but it is something to consider if you want, when you're, when you're, uh, uh, negotiating a transaction, um, that part of that, you know, that forward thinking that I would mention earlier, that you would want to do. So, um, this is kind of the groundwork and, and the issues dealing with, uh, private equity and, uh, physician practices. And so for that, I'm

Speaker 2: 17:48

Gonna, gonna, with that, I'm gonna turn it over to Jared. Thanks, pat. Um, Suder. Yeah, I apologize. Um, there goes my podcast debut already. Well,<laugh>. All right, well, anyway, um, what does valuation have to do with it? You know, clearly private equity has its own lexicon, its own transaction framework, its own motivations to do deals that make it really distinct from, for example, a hospital deal. Um, as Pat mentioned earlier, an exit of any type is one of the, perhaps namely, differ differentiators between a hospital deal and pe. Um, so it makes comparisons very difficult. Um, and something that I'm cognizant of in my job when, you know, maybe most of my day is spent doing fair market value opinions for, for hospitals, um, I, I hear it from the subject practice all the time, you know, well, what's the EBITDA multiple on this, uh, on this valuation you have? And it, it's, it's a really difficult crosswalk to navigate, uh, for, for any number of reasons. But, um, you know, speaking of the, the private equities, uh, framework, you know, I wanted to discuss as a valuation guy, uh, talk a little bit about the EBITDA multiple, uh, EBITDA's par lands for earnings before interest taxes, depreciation, and amortization. It might be a rough proxy for operational cash flow, but the, there's a lot of discussion about EBITDA multiples. It, I think it becomes a real talking point, pat, I think you'd agree. Um, and, and I, I think what I'd like to dispel maybe some of the myths here, you know, first, uh, an EBITDA multiple is essentially a ratio of a full blown valuation in the numerator and, and some measure of EBITDA in the denominator. Um, the EBITDA in the denominator is usually some recent period, i e historical number. And so, in other words, an an EBITDA multiple is the result of first a robust fundamental cash flow analysis of the subject practice, likely from the private equities perspective, stress test under multiple scenarios, internal rate of return assumptions. Um, and, and it's just provided in relation to ebitda, maybe for context more than anything. So, although it's a simple number, uh, comparisons of EBITDA multiples across different transactions, uh, from my perspective is, is quite problematic. Um, you know, for example, a a high EBITDA multiple from my perspective, doesn't really tell you much other than that a practice is valued high relative to a historical EBITDA figure. It, it does not answer a type of question like, am I getting a good deal if you're selling, or am I paying a fair price if I'm buying? Uh, literally it can answer the question of relative to a historical EBITDA figure, you know, what is the valuation? You can't read into it much more than that. Um, and you definitely can't compare to quote the practice next door, so to speak, um, because there's no way your EBITDAs are the same. So, uh, the EBITDA multiple being different is, is not really an indication of much. Um, and, and probably the main weakness of an EBITDA multiple is that the, the proforma picture is completely left out of the ratio. Um, one of the biggest elements of, of any deal is post-transaction compensation for the physicians or providers. That's the single biggest line item. So a, a discussion about EBITDA multiples without talking about comp is, is fruitless and, and can really skew, um, intentions or expectations. You know, if, if, if you just discussed the EBITDA multiple without talking about comp, we hear this all the time. The hospital down the street got a huge EBITDA multiple, the first question out of my mouth is usually, okay, well, what, how do they treat your post-transaction comp? More often than not, there's a cap or a decrease there, and that causes the multiple to be higher. So really a high EBITDA multiple is more, from my perspective, an indication that the, the projections or what's expected going forward bears little resemblance to historical ebitda. Um, for example, a a 15 times ebitda, it, you know, that sounds really high, but what it doesn't mean ever is that a PE firm is completely satisfied to have the practice return that same level of EBITDA for 15 years. And then the private equity, uh, firm recruits their money. Um, PE still operates on a deal cycle that, um, generally is less than the EBITDA multiple. So you gotta think about their exit strategy there. Pat, did you have anything to add on pe uh, multiples?

Speaker 3: 23:12

No, I think you hit it the nail right on the head. I, I, I've heard when I'm on the, the, um, the physician side that the physician leadership will have heard or read that so-and-so got x and it doesn't take into account the specialty, the practice, uh, payer mix, the location of the practice, like you said, the, the trailing comp after the deal's done. And it's truly not a one size fits all. And, uh, you know, on the PE side, um, this goes back to what I mentioned earlier about the, the PE company, uh, or PE firm may be not having the sophistication in the healthcare world. Um, there will be confusion on their side. And, and, and, and, and I should have mentioned this in my first part, I think that it's imperative that the PE firm truly understand and have somebody on staff, um, or hire consultants like, like, uh, you and horn to, to explain these types of things to them because they can't go into it thinking that it's a one size fits all deal.

Speaker 2: 24:28

Yeah, the, the PE multiple, I think it, it, it gets thrown around so cavalier because it's, it's a really easy, it, it's deceptively simple, and I think it, it's so easily skewed once you know how it works, that it's, it's just something that I think creates in, uh, expectations that, that aren't easily lived up to in a lot of situations. And maybe now is a good time for a shameful or shameless plug. It's, it's helpful to have evaluation expert dissect your letter of intent that, um, if you're, if you're on a sell side, to tease out maybe the growth expectations themselves, I'm not saying that that's a fruitful negotiating tactic in the slightest, I'm just saying it really helps to be informed and just have an, an EBITDA multiple isn't really helpful. You need to have all the info available to you if you're the seller, to make possibly the biggest financial decision of your life. So the, but the analysis that, that someone like me would do from a valuation perspective would consider maybe a scenario where you don't sell versus selling. And I would for sure consider the differences in compensation because again, that gets so often overlooked. Um, I'll give an example. You know, recently I was reviewing some private equity offers for a concierge, uh, medical company. And, um, so I asked for some financials and, and cranked out, uh, a quick valuation and basically confirmed that the private equity upfront offer that that is the offer that's excluding the earnout basically valued the company as if there was very little growth. So what I was able to do is tell the client, look, you know, they're valuing you based on the business that you're bringing to the table today, and they're completely discounting any growth expectations by putting those into an earnout or contingent, uh, consideration type scenario. So it, I think, think that's a really meaningful insight for someone who's reviewing maybe multiple offers from private equity firms, um, just to put it in context and say, well, you know, it could be the case that you're better off under these different scenarios, or, Hey, this is a scream screaming deal, you should take this. But having the fundamentals run too is com is paramount, because just hearing an EBITDA multiple doesn't give you anything. Um, and maybe I'll conclude my rant here by just talking briefly about discount rates. You know, that that's another impact of valuations, but discount rates, they're subjective. I think there's, there's myths out there that there's sort of a reasonable range for discount rates. I think that's, um, also a problematic myth I'd like to bust today. Um, they're based on asset pricing models, which use historical returns to predict the future. Just meaning that, okay, here's how much different asset classes have returned historically. And that's what we think investors in today's market would require to attract their capital investment to your, uh, specific practice. But there's always a subjective factor in the building blocks. Um, yes, people come up with discount rates differently, and they're a means to an end to come up with your valuation. And look, varying discount rates can have huge impacts on your valuation and discount rate itself doesn't really give you enough descriptive measure. For example, as a valuation guy, I know that some people, when they talk about discount rates, they're really talking about the cost of equity capital, whereas other people are talking about a weighted average cost of capital, which would include debt and equity. Um, I've done engagements where I've, I've, there are ways to convert a weighted average cost of capital to an implied EBITDA multiple, which is kind of fun. And, and it gives people a, an indicated range based on all those historical returns. But again, it's just historical returns in algebra, um, and you really have to have the context there. Um, so maybe that's the end of the valuation rant. I want to talk about networking capital adjustments, um, because I think that's an element of valuations that I get the most questions on myself. Um, and I, I have, uh, a very different perspective than what happens in the real world from a valuation perspective. We treat networking capital as this static nice, clean number. We say we generally peg it to a percentage of revenue, right? Maybe it's 10% of revenue. We we're, we have the luxury of saying in the valuation, okay, well, we just assume that a normalized level is on the books. And you know, to the extent that's different, that's kind of your problem, um, at at least the way the opinions normally are written. Um, so the discounted cash flows always assume a normalized level of working capital is on the books. Look, if networking capital won't transfer, what I usually do is just subtract it out at the end. So my DCF doesn't change at all. It's just a simple calculation at the end, but I know that's not how these things work in the real world, pat, how do these work in the real world?

Speaker 3: 30:15

Well, I, I'd like to actually go back and, and, and get you to shed some light on, um, something as it relates to the valuation first. So, um, many people you had mentioned that, um, somebody says, well, you know, the, the, the practice next to me was valued at x, and I'll have clients, um, on the physician side asked me, where does the valuation company actually get their information from? Um, what are the resources? So if you could, could you give us just a, a, a couple of seconds about where you could have information compiled from the different resources? Um, because for those listening that may not, uh, know it, that there are, uh, you know, tried and true, uh, sources to get that information.

Speaker 2: 31:09

Yeah, yeah, you're, you're absolutely right. There are definitely transaction databases out there. Um, capital IQ is one that's way more comprehensive, that, that might be sort of the Cadillac. But, um, we, we use deal stats here at Horn. Um, I think those type of transaction databases for physician practices, from my perspective, are reasonableness checks, um, because there's so much that's left out of the transaction databases that warrant, uh, I think a really careful or close scrutiny if you're using them to, to solely rely on. Of course. Um, I know that's not what you're saying, but they're, they're totally different deal terms that would make transaction comparisons very difficult. Um, and, and I think it's funny, I I was on a webinar recently where, um, private equity came up and I think someone anonymously asked the question of, you know, where do you see EBITDA multiples for, for primary care, uh, practices? And the PE guy gave like the most non-answer possible because it was just so difficult to give it, it all depends on so many different scenarios. So in my practice, I look at those transaction databases, yes, there's a lot of them. Some, some of them slice and dice by specialty. Some of them give you proforma EBITDA or historical ebitda. Some of them give you deal terms about post-transaction comp, but without all those elements, it's a really difficult approach to rely upon.

Speaker 3: 32:57

And, and, and I think that's the, the reason why it's important, um, to, to have somebody, um, you know, to have professionals involved, whether it's valuation companies or, um, attorneys in the area or other financial people that recognize that and where the, where these things come from, especially when you're negotiating a deal. So, um, but I did want to bring that up cuz I do have clients ask me, well, how are they, how are they actually valuing? Where are they getting this from? Because my, uh, uh, med school roommate just got, you know, some astronomical number, uh, that was probably not correct in, uh, in the first place. But, uh, just wanted to bring that up now and I'm sorry, I, I, so I've already forgot the question that you asked me. What w um, what did you want me to, to, uh, bring up?

Speaker 2: 33:50

Well, uh, I wanted to talk about networking capital because that o other than your question of, well, why didn't I get as much as my friend's roommate? Um, the networking capital questions,

Speaker 3: 34:01

Right?

Speaker 2: 34:02

I often get the most of, again, valuations are so simple, but there's no way that's accurate

Speaker 3: 34:09

In Yeah. And, and it, it's a, it's a problem that, that we run into, uh, when you're trying to come up with networking capital, because many times, uh, uh, you know, as you talked about, it's a moving target. You're gonna have financials that that will not be up to date. And, and, and the really a nightmare is that you get is if you're doing a mid-month closing where you have some things that are paid, some things that aren't paid, we don't know what the collections are, it's a, and with that, then you're getting into trying to do a look back based upon, um, uh, uh, an incomplete data set. Um, I would always encourage people to try to use a natural month in quarterly annual, uh, clo uh, closing, but sometimes there may be reasons why somebody is, is is wanting to close, uh, mid-month. I'm dealing with two different transactions now where we close mid-month and we've been going back and forth for the past month, um, trying to get, one party says, okay, well it's this. And then the other party says, well, what about this? And we go back and forth and back and forth and back and forth. So, um, recognizing networking capital and, uh, determination of, of, of how that is, how that is de uh, created and, and, you know, settled on, um, is a key in this process. And, uh, don't take it lightly. Uh, don't, don't think that you can just say all liabilities, um, will be counted this, well, maybe there's been some things that are prepaid or, uh, maybe there's things that, that have, were, were a liability that did not get presented until after the closing. So recognize that it, it can be problematic, but, but the need to accurately determine, uh, networking capital, um, is an absolute

Speaker 2: 36:18

And it'll affect the valuation, right? I mean, I think if, if someone says, well, we got X times EBITDA or whatever, or we got x million, you know, there's automatically in my mind there are questions, Hey, is that an invested capital number or is that an equity number? You know, what, what does that include or exclude because there's, there's no consensus out there at all,

Speaker 3: 36:44

Right?

Speaker 2: 36:47

It's just a difficult, one of the more complex areas, I think evaluation and especially one of those areas where, um, I know in practice it's, it's treated quite differently than, than some of us valuators can often, uh, take it to be. Uh, with that, we'd be remiss if we didn't talk about covid and its impacts. I know there, there's, there's maybe not a whole lot we can say from a, from a broad perspective on how Covid has impacted healthcare deals. I, if I had to say something, I would probably say that it, it has accelerated the creation of winners and losers. Um, pat how do you feel about that as the, the broad statement?

Speaker 3: 37:29

No, I think that's true. Um, I have seen, so what, when people ask me has covid affected the, the, the deal flow? And, and I would say, at least from my experience and what I've been dealing with, um, it hasn't necessarily affected the deal flow, but what it's, it has affected are the way things are negotiated, um, what the term, what the terms are, um, you know, how are we gonna bridge the valuation gap, um, where one party is trying to say, well, I want to do a 12 month look back. And, uh, so there's, there's not so much of a, uh, uh, of an, uh, of an impact on, um, the valuation versus somebody saying, well, no, I wanna do a, you know, a shorter term and do a vi and then, um, you know, annualize that. So, um, but from a deal standpoint, there are folks out there that are, that are doing deals, um, um, based upon straight, straight valuation and, and, uh, and, and the opportunity in the marketplace. Um, and, and so, you know, how did they address these types of things with covid? Well, if they're gonna, if they're gonna do a pricing based upon a historical, well, maybe they're gonna use more earnouts or that there's gonna be a retention agreement that's a longer term period, um, uh, you know, maybe look at, um, pressure testing, certain assumptions. Um, and, and Jared, that goes into what you were talking about on valuations and the assumptions that underline it. Um, and, and, and so with that, I think that it has impacted it, it, but I don't think that we have seen enough to make a determination that what's gonna happen, um, you know, in, in first quarter of 2021, because honestly, with where we're at with covid and possible increase, you know, with the increases that we're seeing, again, it's just a fluctuate, it's fluctuating left and right. So I think that the folks that are doing these transactions are just going to have to build into the private equity model, um, uh, some, some, some, uh, safeguards that are there. And also with that, I've had a couple of deals recently that were under an loi, um, that they said, if you will hold off on, if you will agree to push out the date, we will actually give you, um, I don't wanna say a kicker on the deal, but there is some financial consideration almost like they're, they're, they're buying an option, but it's really not, it's really just tied into, um, the, the, the, uh, the ultimate amount that is paid, maybe that there's a less of a, uh, of a retention or, um, better terms on an earnout, those types of financial considerations I have seen in this, in, in, in the marketplace because of covid and becau because if you, if you're able to do that, it does protect both sides. Um, it protects the PE side that they're not overpaying. It also protects the, the physician practice side that they're not taking a deep discount. So, uh, just my 2 cents on the lay of the land, on the deal side from what I'm experiencing and what, um, others that I deal with in the area are experiencing,

Speaker 2: 41:16

Yeah, I, I think sometimes people ask the question of what covid is doing with the expectation that maybe someone like you or me is gonna say, oh, it's completely different now. Um, I usually have to respond by saying, I'm, I'm pretty busy pat, I I think you're pretty busy. Um, you know, deals are getting done. Um, the industries are still fragmented, PE still thinks they can achieve scale and improve operations, and the, the amount of dry powder that's out there hasn't gone down. So I think that also plays into private equity's role in healthcare in general and physician practices more specifically. Um, it, it doesn't mean that there aren't, uh, bottom feeders now that are scooping up bargain purchases, but not only that, there are also certain sub-sectors or industry verticals that are white hot, and PE is still doing what I would call a pricing exercise as opposed to valuing, uh, businesses because there's, there's certain environments where the laws of supply and demand might prevail over fundamentals. Um, maybe some of that gets tied more into earnouts, but I, I think the tailwinds that were there pre C O V D are still there, and I think people are still referencing the same tailwinds they always were, and they're still getting deals done.

Speaker 3: 42:39

Yeah, I agree a hundred percent. And, and, and recognize that. I think that, um, if you're, if, if you're looking at it, you know, we talk about doing a historical look, uh, uh, review as, as trying to determine, um, whether a, a transaction is, is good for parties or not, and what the pricing is on it, what the underlying terms are, recognize that those that are going into it with private equity are looking at not necessarily the next six months or the next year, they're looking at it long term depending upon what, what their vision is, whether, what their exit strategy is. Um, so, so you know, looking at what's, where is this, where is this investment going to be five years from now, um, is more likely our three to five years is more likely what people are looking at. So covid, you, you can get around it negotiating deal terms in this, in this area.

Speaker 2: 43:45

Yeah. Yeah, that's a great point. Yeah, I think, and, and, and maybe just a transition to, to value-based medicine, you know, in the mix as if COVID wasn't enough. You know, I I'm not sure that that's really affecting deals right now, but um, pat, I think if we asked you in 12 months, the answer might be yes.

Speaker 3: 44:06

Yes. I, I, I agree. So there's the, there is so much on the horizon with value-based medicine and, um, uh, you know, payers incentivizing, uh, the transition to that, the government and, um, demanding it in some regards. But with everything going on and, uh, I, I think that right now we're, we're, they're not, it's not affecting deals, but I think that it will affect deals once we get past this once, once everybody gets their legs back underneath them and a and we're back to business as usual, and you're not dealing with so many different waivers as to how you can deliver care or get paid, um, you're, you're going to see that pick back up and, and it will impact the, the deals that are out there and the, and the participants in those deals.

Speaker 2: 45:03

Definitely. Well, I think, you know, final thoughts from me, I, I think I'll speak from the valuation perspective. I, I, I've heard, uh, you know, us as a community, we've, we've circled the wagons and tried to figure out how we're gonna address covid and, and everything else. Um, I'm not sure a retreat to basics is, is the right term, cuz I think we've always been there and it, we're doing what we always have done, just like deal makers are doing what they're, they've always done. Um, we're always projecting future cash flows and we're discounting them to present value using a, a rate of return that we think, uh, reflects the risk in the investment or the cash flow stream itself. Um, yes, now it's, it's more difficult. I think, um, you know, wall Street has, has diverged from Main Street in meaningful ways that I think create some, some difficulties for us, but our job is still the same and it, that's not gonna change. Um, there's definitely a need to understand the specific value drivers of the practice you're valuing, you know, there's plenty of practices that weren't impacted very much by Covid and are not expected to be impacted that much going forward. That that's always the answer that I give a lot of people. I just reach for the ones that, that really haven't been impacted that much, you know, to a sur surprising degree. Um, you know, valuation is again, but one piece of the overall picture, especially if you're free standing right now, as Pat alluded to, the integration phase so to speak, is, is much longer and more impactful than, than the valuation itself. Um, maybe my last word of caution is, is never discussed EBITDA multiples without post transaction compensation in the same sentence. Uh, do that for me.

Speaker 3: 46:59

I'll wrap it up here. And, um, on behalf of Jared and myself, we do want to thank y'all for, for tuning in and listening to this. Um, if, if you have any questions, I'm sure, uh, Jared would be, uh, willing to, to address those along with myself. Um, you know, so feel free to do that if, if we've peaked your interest or you have something that, that, uh, you'd like a little bit further information on. Um, final thoughts on my end is that the, the private equity investment in physician practices, um, is something that despite covid, despite payer issues, things of that nature, they can be win-wins. Um, you just need to recognize that you need the right partner and negotiate the right terms. And again, uh, as Jared mentioned, it's not just from the valuation, but it's long term. What's that comp gonna look like? I've seen deals that, uh, that somebody bid at the, at the, at the first thing, the first deal that came by cuz it was the highest price that they were going to get. And then they turned around and realized that long term they were in an employment relation or employment agreement with a onerous, non-compete non-solicitation that allowed for that comp to get to, uh, be reduced. So be smart, um, uh, bring in everybody you feel that you need to help in the negotiation and with the transition on these things because, um, it it it's imperative to, once the transaction happens that there's not a hiccup in in the physician practice. Um, but also that there's not bad blood between the parties because now y'all are working together, y'all gone from dating to being married and you need to recognize that. Um, and, and, and then finally with that, recognize that you know, what we're talking about, especially on my end deals so much with what your, your state law allows and, and, and recognize that it is not a one size fits all transaction from the transaction terms or the valuation in the ul in the ult underlying financial considerations that you really need to look at each one of these. This, this is, um, this podcast is really just kind of to to, to bring that to the forefront. So with that, I don't have anything else to add. Again, appreciate y'all's time and with that, Jared, I think we are through. Appreciate it. Thank you.