By: Michael Lloyd
The home-based care M&A marketplace is ever-evolving and looks different than it did 24 months ago. Many owners have trepidation around today’s values and how the current financial climate affects the enterprise value of their business. Fortunately, the demand for quality home-based care agencies remains exceptionally high. This has kept values higher than historical norms, despite the general perception. However, buyers have become more disciplined. They need businesses to “check all the boxes” to pay a premium in today’s market. Below are some areas agency owners should consider to best position themselves and their business for a successful sale in 2024.
Financials
While keeping organized financial records is usually directly correlated with successful agencies, owners should know how buyers will look at their financials during a sale process. Buyers all have their own valuation models but have much in common.
One of the main adjustments will be a conversion from cash basis to accrual. In order to remove revenue cycle lumpiness and match revenue with its corresponding expense, buyers will want to account for revenue and payroll expenses based on the date of service (vs the date of payment). This exercise will smooth out the monthly numbers to reflect payments and costs more accurately.
“If I could give owners one piece of advice on the financial side, be sure to have accrual-based numbers, broken out by month, before going into any kind of negotiation with a buyer,” Mertz Taggart Managing Partner Cory Mertz said. “Signing a letter of intent with a buyer based on cash financials is a no-win situation for a seller. If the accrual numbers come back and they are worse than the cash-basis numbers, the buyer may want to renegotiate, which is not what you want to hear halfway through diligence. On the other hand, if the accrual numbers come in better than the cash numbers, you won’t hear anything from the buyer, but more likely will leave money on the table, which can be considerable.”
The ultimate goal is to present an Adjusted EBITDA that will serve as a proxy for normalized cash flow to interested acquirers of the agency and minimize any surprises during due diligence. Accomplishing this is both an art and a science. A competent M&A firm will ensure this is handled correctly.
Transition Risk
Beyond regulatory and reimbursement risks that affect every healthcare company in some way, the biggest driver of the multiple is transition risk. To command a premium value for your agency, transition risk must be low in the eyes of your ideal buyer. This is the risk that the business (and its cash flow) will deteriorate after closing, usually due to the transaction itself, and it’s often a function of the owner’s role before the transaction, especially around leadership and business development. When exit planning, an owner should work towards removing themselves from these functions. This is easier said than done, but will help alleviate transition risk for the buyer and make them comfortable with current staff’s ability to continue operations without significant disruption, and grow the company after a short transition period. This is often referred to as “bench strength” and is correlated with premium valuations.
“The first question strategic and financial buyers will ask, after they’ve read and understood the financial statements, is ‘Who’s on the bench?’ Who can run the business in the owner’s absence,” Mertz stated. “As an owner who is considering an exit, hiring or promoting quality leaders is an investment in the business that results in premium valuations when it’s time to exit.”
Valuation
A current valuation will help any business owner understand the value of the business today and the delta between the current value and their goal for an eventual exit.
The valuation exercise from a trusted third-party M&A Advisor allows owners to set realistic expectations for their business's purchase price or enterprise value. In today’s M&A environment, premiums will lie in the details, so putting in the work beforehand will give the seller leverage and confidence entering into what can be an emotional process.
Compliance
Across the industry, compliance issues slowed deal volume in 2023. As buyers have become more disciplined, compliance around home-based care agencies is a significant factor in the success of a transaction.
The service line will dictate the focus from a compliance standpoint. Hospice, of late, has been under a microscope from ADRs, compliance reviews from CMS, and enhanced oversight in certain states. Quality hospice opportunities are still in high demand, but compliance and legacy liabilities will remain factors for buyers. Identifying and addressing potential issues with the right experts and often having outside guidance and legal opinions will comfort buyers.
For home health and hospice providers alike, buyers will look at both conditions of participation and conditions of payment. This is very different from a survey. We encourage owners to hire a 3rd party consultant to perform a billing audit on a small sample of the agency’s current and historical census. This can be accomplished with a relatively small investment, saving would-be sellers' heartache during diligence. It also signals to the buyer community that the agency is prepared for diligence, which adds value.
For non-medical home care agencies, the compliance priorities are different and generally focused on caregivers employed by the agency. Every state has its own requirements for caregiver employment, but generally speaking, wage and hour compliance, ACA (Affordable Care Act) requirements, and other caregiver benefits must align with local, state and federal mandates.
“If you look at home-based care valuations over the past 20 years, they remain historically high. How do they stack up to 2021 and 2022 valuations? For premium agencies, values have held up very well. However, not all agencies are considered premium in the eyes of today’s buyers,” Mertz added. “Preparation is key. And as self-serving as it sounds, having an experienced advisor who is well-versed in the rigors of diligence, can help mitigate potential surprises, and is respected by the buyer universe can make the difference between a successful transaction and a failed process.”