January 26, 2016
Marta Alfonso, CPA*/CFF, CIRA, JD, principal at MBAF, was quoted in the article Tips When Contemplating Recapitalization for Expansion.
When looking to expand one’s healthcare business, one way to raise funds that also helps spread business responsibilities among parties is a recapitalization. Recapitalization for expansion can be a way for a company to work with a third party to grow their business using various methods of the process. The Ambulatory M&A Advisor reviews the reasons to recapitalize, risks that come with the process, when to make the move, and more.
Roger Strode, partner in National Healthcare Practice with Foley Lardner says that recapitalizations are transactions that are very common these days and they are very common in the private equity industry.
Strode says the definition of a recapitalization is, the re-financing of a business oftentimes by non-physician investors.
“With a recap, what usually happens is a fairly well funded strategic or financial investor will come in, will buy anywhere from 60 to 90 percent of the business and will cash out the owners anywhere from the extent of 60 to 90 percent of their equity and pay them cash for the business. The owners will roll over a portion of their equity into the new company that will be the growth vehicle,” Strode says.
Marta Alfonso, principal with MBAF says although a recapitalization is typically performed through additional equity capital, it can be used to take out, restructure debt, or can even be debt. Alfonso says that instead of it being capital contributed as equity to the business a business owner could ask for a loan to recapitalize the company because they are looking for additional cash to grow.
Strode says that often the target company for a recapitalization is a company that has grown very quickly or has grown to the point where it has quite a bit of value to it.
In these situations Strode says the owners are sitting on a lot of built in equity, but they don’t really have the ability to monetize the equity.
“They want to grow bigger, they want to grow more, but they really don’t have the necessary cash to fund the growth on their own,” Strode says.
“Another option is to partner with a hospital. The hospital would essentially lease the practice through what is called a professional services agreement and pay the practice an amount that is higher than what the practice would otherwise be able to make if it billed directly for its own professional fees,” Daniel Frier, founding partner of the Healthcare Law Firm of Frier-Levitt says.
“It injects funding into the practice, and helps the practice expand. It also benefits the hospital because it helps to expand the hospital’s reach within the community. Essentially what is happening is that the practice is utilizing the hospital’s resources to grow and this is capital which the business would not otherwise have access to.”
Frier advises that when a recapitalization involves a medical practice the situation is different from a lot of businesses in the regard that business owners can’t have private equity investing in the medical practice. It has to be a licensed physician. The ability to expand and to get capital is limited by the fact that one can only have doctors own the medical practice, Frier says.
“The way that I have seen practices get around that problem is for them to form what is called a Management Services Organization, which manages and runs the practice. That can be a regular business entity, which does not need to be owned by physicians. Then the management fee pulls some of the profitability out of the practice, and that profitability can then be used to enhance the earnings of the management company. This way, outside investors don’t have to be physicians, and they can invest directly in the management company,” Frier says.
Alfonso says a recapitalization is a very effective tool in spreading financial risk because business owners are sharing the responsibility for capitalizing the company with other parties. Alfonso says in these situations, sometimes those parties have really good connections in the industry that can help an entrepreneur expand their business.
“While capitalization can help you, it is not a silver bullet for a bad business. If you have a business that can’t grow, just because you add additional capital to it, doesn’t mean it is going to grow,” Alfonso warns.
“If you are used to operating on your own and you now have a partner. You have to learn to work together and you have to educate the partner on the business and the partner has to learn how the business operates and what has been successful so that there is not a disruption of the business and it is positioned to grow.”
Frier also adds that there are financial risks involved with a recapitalization.
“With debt, one of the risks is signing personal guarantees, and if you can’t pay the debt, the bank is going to call the loan. If you choose the equity financing route, and take on a private equity group as a partner through the MSO model, the risk is that you dilute your ownership,” Frier says.
“If you enter into the model as described with a hospital, and the hospital doesn’t take an ownership interest but does invest in the practice by paying a higher rate, that can be structured in a way that minimizes financial risk, but often hospitals are going to want restrictive covenants in the contracts that present business risks of their own.”
Alfonso says the process of a recapitalization begins with having a good business plan.
“I think you have got to know the strengths and weaknesses of your company and where you need the recapitalization. You also need to understand the drivers that are driving you to recapitalize. That could be in different areas. One is the need for more qualified management; another is for subject matter expertise; you might need to enhance your infrastructure, or automate business processes to be able to expand and that requires capital. You might want to grow in a new market, or you are looking for additional leadership help. Sometimes it is hard to be the only person running the ship,” Alfonso says.
“For all of those reasons, getting additional partners in whether they are equity or debt can be a real advantage. But to get them to come in you have got to have a plan that lays out the “why” and where you think the capitalization will work.”
Alfonso advises that when a company is thinking about pursuing a recapitalization, the company has got to have a mid-term to long-term horizon.
“Recapitalizations are not typically performed if the entrepreneur is looking for an immediate or short term benefit. Also, an entrepreneur should consider the timing of this process at least six months prior to the intended date of the transaction. It will take time to negotiate, perform due diligence, and negotiate a transaction. Additional time gives the entrepreneur and the potential partner to align their objectives and plan the transition to achieve the recapitalization benefits. I think you have got to have the business plan in place and have got to be willing to share leadership and control,” she says.
Frier says the decision to recapitalize is really all a question of expansion.
“In this day and age, there is a ton of consolidation within healthcare. That consolidation sometimes can be done with low capital investment, but oftentimes, requires capital,” Frier says.
Frier says if a business is an organization or group and feels that they need to expand, that would typically be the time to seek capital. Any entity that is looking to maintain market share is going to have to grow and that is going to have to require a certain amount of capital, Frier says.
If you have an interest in learning more about the subject matter covered in this article, the M&A process or desire to discuss your current situation, please contact Blayne Rush, Investment Banker at 469-385-7792 or Blayne@AmbulatoryAlliances.com.
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