Medical Physics M&A: 6 Questions to Answer Before Signing a Letter of Intent
May 9, 2019
Shareholders in medical physics practices are receiving unprecedented levels of inbound interest from potential buyers seeking to engage them in discussions about potential acquisitions. Assuming there is mutual interest, conversations often progress to providing certain financial and operational data to the potential buyer, before finally resulting in the potential buyer presenting the shareholders with a letter of intent (“LOI”).
Although LOIs are largely non-binding documents, they do commonly contain binding exclusivity provisions that prevent the selling shareholders from discussing a potential transaction with any other party for a period of time. Thus, it is important for sellers to be very comfortable with the transaction and counterparty before signing an LOI.
Before shareholders consider how to negotiate and/or whether to sign an LOI, they should be able to answer these 6 questions:
- What is my Adjusted EBITDA and Why Does It Matter? – Valuations for medical physics practices are largely based on multiples of EBITDA (Earnings Before Interest Tax Depreciation and Amortization). However, this is not a financial metric that should be calculated directly from the profit & loss statement. Often times in privately held companies, there are substantial adjustments that should be considered as addbacks to the reported EBITDA to determine a “normalized” EBITDA for the business. Common adjustments include owner’s compensation, discretionary expenses, and certain extraordinary and/or non-recurring expenses. A close inspection of the profit & loss statement of the business should be done to identify and addback any such expenses in arriving at the normalized EBITDA. This process nearly always results in increased levels of EBITDA and thus, higher valuations.
- Valuation: Is the EBITDA Multiple Fair and How Does it Compare to Recent Market Transactions? – Once the adjusted EBITDA is determined, buyers will then apply a multiple to that EBITDA in arriving at the total valuation for the business. Different buyers can have widely different opinions as to what is the appropriate EBITDA multiple to apply to a physics practice. It is a subjective judgement based on a number of factors including size, growth rates, earnings margins, revenue composition (diagnostic vs. therapy), quality of employee base, geographic footprint, and customer concentration. Certainly, not all physics practices are valued equally. However, given the recent M&A activity in the industry, there are a number of data points that can provide substantive guidance as to whether the offer being considered is a fair one.
- Proceeds Waterfall: What is it? – An LOI from a buyer will likely include an offer to acquire the business for a certain enterprise value. However, this enterprise value is not necessarily what the sellers will actually receive at closing. There are a number of obligations and expenses that will be paid out of, or deducted from, the stated enterprise value. For example, the interest bearing debt of the company will need to be repaid, certain transaction expenses paid, and escrow accounts funded. In addition, if the seller is rolling over equity or providing financing as a part of the transaction, these amounts would be deducted from closing proceeds. All of these items should be determined and a calculation of the estimated waterfall of proceeds calculated to illustrate what the shareholders will actually receive at closing.
- Deal Structure: What are the Implications? – Acquisitions can structured as asset or stock acquisitions and the choice can have significant tax and other transaction implications. Generally, buyers prefer to buy assets to obtain a step up in the tax basis of the acquired assets; on the other hand, sellers prefer to sell stock to maximize capital gain treatment and minimize post-transaction liabilities. Understanding the tax implications of either option is important to consider in connection with an analysis of the stated valuation. In the medical physics industry, deal structure can also impact customer contracts. In an asset deal, customer contracts will need to be assigned from the seller’s entity to the buyer, which may require customer consent. In a stock transaction, such assignment is not necessary as the entity being acquired is a party to the contract.
- Have All Potential Buyers Been Considered? – Buyers will often try to negotiate directly and quickly with selling shareholders in an effort to get a potential acquisition under letter of intent prior to sellers fully considering other options. Although the medical physics industry is a niche and fragmented industry, there are a number of well-funded buyers that are actively seeking acquisition opportunities. Shareholders should understand the current M&A landscape and consider whether approaching other potential buyers may maximize the probability of achieving the best possible outcome based upon their specific goals.
- Platform or Add-on Acquisition? – Private equity interest in the medical physics industry has never been higher. Several private equity firm have already made investments in the medical physics industry and are actively looking for add-ons, whereas other firms are seeking their initial platform acquisition in the industry. Being acquired as the platform acquisition versus an add-on can significantly impact the transaction terms, deal structure, and post-transaction roles for shareholders and management. A clear understanding these issues and their impact will provide for a better decision regarding which potential buyers would be best to achieve shareholder goals.
SC&H Capital has completed numerous transactions in the medical physics industry and continues to see an increase in prospective deals in this space. If you are considering a sale, or have been approached by a buyer, we encourage you to Contact Us in order to guide you through this process.
Greg Hogan is a Director with SC&H Capital and has more than 15 years of professional experience in M&A transaction, financial, and strategic advisory services. He has successfully advised buyers and sellers on a wide variety of corporate transactions valued at over a billion dollars.