By Tom Schramski, PhD, CM&AA and David E. Coit, Jr., DBA, CVA, CVGA, CM&AA

Volume 4 Issue 11, May 23, 2017

The valuation model for healthcare businesses is evolving as quickly as the healthcare marketplace itself. While multiples of adjusted EBITDA (eaarnings before interest, taxes, depreciation and amortization) remain a standard for a quick-and-dirty analysis, this approach can't provide an accurate and complete picture of a company's potential value.

Here are the specific issues that make EDITDA less comprehensive as a valuation methodology:

1. Start-ups have unknown potential.

Now that investors have culled through many of the more established healthcare companies, they are realizing there is tremendous potential in start-ups. While we often think of the healthcare industry as being well understood, a hotbed of new ideas and even new business models are cropping up —far more so than in industries like manufacturing and retail sales. The EBITDA model simply doesn't encapsulate future potential.

2. Managed care organizations can pull the rug out.

While some investors studiously avoid Medicaid/Medicare, managed care organizations (MCOs) are increasingly managing these funds across the US. While it's simple to calculate EBITDA valuation for firms that are paid via MCOs based on current revenue, how relevant is that valuation when all or part of their reimbursement is subject to the whims of an MCO?

3. Strategic plans are becoming more flexible.

Given the rapidly evolving healthcare market, many healthcare entrepreneurs are moving beyond traditional strategic planning in favor of scenario-based planning that offers greater flexibility in adapting to sudden market changes. The EDITDA assumes a company's business model will remain similar in the future. How do you value a company with multiple growth options that may significantly depart from the current strategy?

4. Independent contractors are replacing employees.

In the past, healthcare workers tended to be employees. However, with margins under attack as the result of reductions in reimbursement, many healthcare firms are starting to use independent contractors to save on personnel costs. An EDITDA valuation based on the use of employees may not be relevant for a company migrating to the use of independent contractors.

5. Technology changes everything.

Not only is technology galvanizing the healthcare marketplace, it has become the price of admission for becoming a provider in many healthcare environments. With this in mind, EBITDA doesn't account for qualitative measurements, including a company's technological readiness. A company well positioned to incorporate new and disruptive technology may be far more valuable than its current EDITDA suggests.

At VERTESS, we've always viewed valuation as a mixture of art and science, highly dependent on context. For example, a company being sold because of a divorce is fundamentally different from one being acquired strategically. Past cash flow measurements like EBITDA will always have a role, but a realistic valuation must take into account the rapid evolution of the market and a company’s potential to adapt and prosper as the market evolves.

Check out David's video series Creating Healthcare Company Value. These brief, informative videos will help you understand the critical steps to creating value.