by David E. Coit, Jr., DBA, CVA, CVGA, CM&AA

Volume 6 Issue 20, October 15, 2019

This article on healthcare company valuation examines the amount private equity firms are paying for companies in 2019. Private equity is composed of funds and investors that directly invest in private companies or that engage in buyouts of public companies, resulting in the delisting of public equity. Much of private equity funding is spent on healthcare, manufacturing, and service businesses.

To give you an idea of the influence of private equity firms, in 2018, they invested $582 billion in worldwide merger and acquisition activity, according to Bain & Company. What do private equity firms look for when pursuing investment opportunities? They typically seek companies with the following characteristics:

• strong market position and sustainable competitive advantages;
• multiple avenues of growth;
• stable, recurring cash flows;
• low capital expenditure requirements;
• favorable industry trends;
• strong management team; and
• multiple areas where the private equity firms can create additional value.

Private equity firms usually pursue acquisition targets where the seller wishes to stay with the company post-purchase to help continue building value, although there are exceptions. They accomplish this by permitting the seller to buy an ownership position in the acquired company.

Most private equity firms have targeted rates of return for new investments. They look for a balance between risk and returns. Larger company acquisitions typically have less risk than smaller companies. As such, rates of return are higher for smaller-sized companies.

Current Required Rates of Return

Each year, Pepperdine University conducts a survey among private equity firms to determine the private capital market required rates of return. In its 2019 survey, Pepperdine found the following required rates of return on investments, depending on the risk being low, high, or median:

• Companies with earnings before interest, taxes, depreciation, and amortization (EBITDA) of $1 million to $10 million: 27.5% to 38.0%, with a median of 37.0%. These rates of return correspond to market multiples of 3.6x EBITDA to 2.6x EBITDA, with a median market multiple of 2.7x EBITDA.
• Companies with EBITDA of $10 million to $25 million: 23.0% to 28.0%, with a median of 25.0%. These rates of return correspond to market multiples of 4.3x EBITDA to 3.6x EBITDA, with a median market multiple of 4.0x EBITDA.
• Companies with EBITDA of $25 million to $50 million: 20.3% to 24.3%, with a median of 22.5%. These rates of return correspond to market multiples of 4.9x EBITDA to 4.1x EBITDA, with a median market multiple of 4.4x EBITDA.

It's important to note that there are outlier healthcare companies that will be purchased at slightly different market multiples. Moreover, certain sectors within the healthcare industry are more favored by private equity firms and thus sell at higher multiples.

Choosing the Right Buyer Type

What does this mean for your healthcare company? If you have a well-performing healthcare business with EBITDA of say $2 million, you should expect private equity firms to offer you between $5.2 million and $7.2 million for your company.

Are private equity firms the best buyers for your healthcare company? Perhaps, although that depends on your exit plans. If you’re looking for a partner to provide growth capital and strong business acumen, private equity might be worth considering. If instead, you’re simply looking to move on to other adventures, private equity firms might not be the best good fit.

Alternatively, strategic buyers may be more suitable for you, depending on your needs. Strategic buyers can immediately add value to your company through identified synergies. These synergies may increase revenues or decrease operating costs that result from added products or services, combined market share, expanded market entry, combined talent and expertise, intellectual property, and other opportunities.