If you have spent any time reading about selling medical practice to private equity, you’ve probably heard the phrase “rolling equity”. But can you define
- What exactly rolling equity are
- the different sale structures in which you can roll equity
- or when you can use it as a strategy to maximize your practice sale price?
Whether you are selling medical practice to private equity or reading about rolling up dental practices, this article will increase your fluency in rolling equity. You’ll learn about this tool that could take your practice sale from high dollar to life-changing.
So, what is rolling equity?
Rolling equity refers to the decision to hold on to a portion of ownership in your business or take a portion of the proceeds of your sale and invest in the parent company that is buying your business.
To break it down, when a practice seller
- Retains equity in their practice
- Uses a portion of their sale to invest in the buyer’s company
- Does both
The industry uses the term “rolling equity” to refer to how the seller invested a portion of their sale.
Example
Dr. D serves as an example. Practice Transitions Group negotiated a sales price for her that amounted to six times her practice valuation, which worked out to be $5.3MM at close. Even though Dr. D retained 30% of that in her practice, the industry would say she “rolled equity” in her practice.
(Dr. D will likely earn around $5MM more through distributions over the next five years, netting her a ~$10MM deal.)
Why Roll Equity?
Most sellers roll equity to grow their wealth.
While no investment is 100% safe, we have seen sellers across the board grow their wealth through rolling equity and receiving the associated distributions.
Growing wealth through rolled equity is also referred to as “the second bite of the apple” because the seller continues to receive payment from the original sale.
When Should You Negotiate Rolled Equity?
You should negotiate what you’re doing with the equity in your business throughout negotiations with the buyer.
Practice Transitions Group negotiates the amount of equity being retained or rolled while negotiating the enterprise value. The enterprise value, in the buyer’s eyes, can change depending on how much equity you’re retaining or rolling. Certain groups might value you rolling equity into their holding company differently than you retaining equity, or vice versa. And some buyers might be willing to pay a higher enterprise value than others based on how much you roll. Rolling equity is just one piece of the deal that works together with the other terms.
In short, we do not negotiate enterprise value first and then advise our clients to roll 20% or 30% of equity. Again, the amount you’re going to retain or roll can affect the enterprise value of the business in the buyer’s eyes.
At Practice Transitions Group, we negotiate the retained or rolled equity throughout the letter of intent (LOI) phase.
An Overview of the Structures
1. Retaining equity in your practice
When a seller retains equity in their practice, they sell, let’s say 75% of the practice, and retain ownership of the other 25%.
There are advantages to retaining practice-level equity. Partnership with a group can
- Help you recruit new providers
- Immediately decrease your costs because of negotiation and purchasing power
- Introduce new systems that lead to growth
As these factors play out, your earnings will likely increase, increasing your practice value. And if you retain equity, you will directly benefit from this growth, which comes in the form of actual cash distributions from the practice.
For example, let’s say your practice produces one million dollars a year in earnings. You retain 25% of equity in your practice. You should be receiving about $250,000 a year of distributions.
- Disadvantages of retaining practice-level equity
The disadvantage of retaining practice-level equity is in the definition itself. (You still hold equity in just your business.) If something unfortunate happens to you or your business and earnings go down, the risk and the downside are concentrated. You have not spread that risk anywhere outside of your business.
- Who retains practice-level equity?
Practice Transitions Group typically sees younger doctors retain equity in their practices because they feel like they have room to grow. The reason they will partner at a young age is to grow equity over time. As the practice grows, the group they partner with will keep getting recapped every three to six years.
So they’ll retain at the practice level because they like that arbitrage opportunity every time.
- So how, exactly, do I keep making money?
You continue earning money through distributions. Like many investments in which the investors receive periodic distributions from profits, you will receive cash distributions from the parent company.
2. Roll equity in the holding company, Private Equity (PE) Group, DSO or MSO
When a seller rolls equity, he or she takes a portion of their sale and invests it into the new holding company that’ll own their business.
- Advantages (and nuances) of rolling equity
The primary advantage of rolling equity in the parent company is the value of the equity.
For example, your equity could double the day you close. Let’s say a private equity firm buys your practice, for seven times your EBITDA. The holding company is worth somewhere between 12 and 20 times your EBITDA. (The holding company’s value, of course, depends on a lot of things, like the healthcare vertical, etc.) So that same day, your 7X equity is now worth 12-20x.
Note that you will be required to hold that equity until the group sells. Only then will you have the opportunity to sell all or a portion of that equity. But perhaps you’re beginning to see the value of the opportunity to roll equity.
In addition, the value of rolling equity depends on when you get in. If a DSO buys you when they are young, and you invest, the industry says you’re in early. Your shares will likely cost or be priced lower than they will in the future and could grow significantly over time.
However, even if the parent company equity does not double your equity value and even if you do not get in early, there is some safety in rolling equity. Because you’re now taking money out of your single practice or a few practices, and putting it into a big diversified group of practices. Your financial future no longer sits only on your shoulders.
Think of it as taking money from a stock and putting it in a mutual fund. The risk is now spread across 50, 100, 500 or more practices.
For these reasons, rolling equity in the parent company is considered a fairly safe investment.
Further, sicknesses and life crises happen.
(As an extreme example, we have sold a dental practice for the family of a deceased dentist.)
If your practice profitability goes down, your investment in the parent company isn’t affected as acutely as if you had retained equity in your practice.
- Disadvantages of rolling equity
Typically, when you’re rolling into a holding company, you’re not going to see any cash distributions. The company is using all of that money for growth and is more focused on multiplying the invested capital. They aren’t in a distributable cash situation. So they’re keeping all their capital to buy practices, and their investors will get their money back when the parent company sells.
Whether or not you see the parent company holding your capital as a disadvantage, of course, depends on your goals as a seller.
In addition to the growth being held (versus distributed), getting in late can curtail your returns.
For example, we sold two practices for a husband and wife team. They chose a group that required them to roll in the parent company, which worked for them because they wanted diversified investments. Within a year that particular group recapitalized and the husband and wife team got all their equity out. However, their equity had only grown a couple of percent, which was less than the actual stock market growth that year. Investing late in a holding company’s recap cycle means you might be buying shares at a high valuation, which limits the growth of the investment.
- Who rolls equity in the parent company?
We see a lot of sellers nearing retirement (<5 years out) interested in rolling equity in the parent company. They aim to diversify their assets as they head into retirement in the next three to five years. After their few-year commitment to their partner, they find a doctor who can replace them and they can walk out the door. They do not have to worry that much about their single practice, because they know it’s in the group.
Because equity terms are decided upon when the holding company is formed, they often aren’t negotiable. You need to know what they’re valued at the day that you put your money in. Then you must determine if you feel like the equity has a chance to increase at a rate of return that’s equal to the risk compared to the market or other investments.
Many times multiple doctor practices also choose to roll equity in the parent company. Not only do multiple doctor practices demand better terms with private equity-backed groups, but each doctor may have different financial and time horizon goals. Investing equity in the parent company often allows doctors to exit when they’re ready, independent of the others’ plans.
For example, Dr. R was an older doctor. And she knew that no matter what, after three years, she mentally had to be done. She was certain she had three years left – but no more. So she chose to go with a very large group, that had parent-company equity opportunities because she felt like it was safest for her.
Dr. R loves her practice. But now, if the doctor they chose to replace her doesn’t run it well, the impact is minimal on her financial stability. Her equity doesn’t change because it’s now spread out amongst 800 practices.
- So how, exactly, do I keep making money?
You earn money from your practice sale to a private equity group through your equity sale at recap. When the company recapitalizes, or sells, the portion of its portfolio that includes your practice, you have the opportunity to sell your equity and collect on its growth.
Note that
- Generally speaking, private equity groups hold their investments for three to seven years.
- Your ability to enjoy the payout from a recap will depend on the last time the private equity group recapitalized, or when they might next.
Questions to ask PE companies when you’re looking at offers
- How are your shares valued right now?
- What can happen to my equity?
- Can it be diluted, changed, bought, or sold?
In Conclusion
At Practice Transitions Group, our goal is to get multiple offers for you. We negotiate all possible terms with those buyers to ultimately negotiate the best deal for you. One of the terms that will most impact your financial future is the equity roll.
Some sellers want to roll as much as they can. Some clients want to roll and/or retain 49% of their enterprise value and only sell about half.
A lot of it is dictated by the groups that they’re partnering with certain groups have parent company-only opportunities, and some at practice-only opportunities.
Ultimately, private equity buyers come to the negotiating table with a completely different set of parameters and financials than you as a seller. It’s critical that
- You know your why and
- what equity roll you need from the deal.
We will be there through the entire process to ensure that your sale protects you, that you are fluent in the terms and know what to expect, and ultimately negotiate a life-changing close.
