Private equity (PE) investment in physical therapy has been growing steadily over the past decade, driven mainly by:
- Physical therapy’s low cost and strong clinical outcomes, both of which support the healthcare system’s shift to a value-based care paradigm;
- Increased consumer demand for PT services, which has caused the PT market to grow to more than $34 billion; and
- The rehab industry’s heavy fragmentation, which has created a prime opportunity for practices with capital to increase their size through acquisitions.
The pandemic and subsequent economic dip have only accelerated merger and acquisition (M&A) activity in rehab therapy. This, in turn, provided clinic owners with the opportunity to either:
- Exit the market via sale (at a potentially lucrative price), or
- Become a part of a bigger organization.
Plus, it has given investors a foot in the door to a promising industry.
If you’re an owner who is thinking about selling or partnering up with an investor, you may be wondering about the biggest factors that influence the valuation of your practice—and how you can influence those factors to maximize your sale price. Read on to find out.
How to Measure Your Practice’s Worth
When it comes to valuing private practices, there is one acronym that holds significant sway: EBITDA (a.k.a. earnings before interest, taxes, depreciation, and amortization). This figure provides investors with an accurate snapshot of a clinic’s operational efficiency and profitability. The standard equation to calculate your EBITDA is as follows:
Earnings = Net Income + Taxes + Interest Expense + Depreciation and Amortization
You can find the value of these variables in your clinic’s income statement—which is a summary of your clinic’s revenues and expenses over a period (e.g., quarterly or annually). For tips on how to prepare your practice’s income statement, check out this helpful guide.
One thing to note: Not all taxes apply to this calculation. For instance, real and personal property tax, payroll tax, use tax, city tax, local tax, and sales tax should not be included in this equation. A general rule of thumb when calculating EBITDA is to stick with your clinic’s state and federal taxes. Additionally, if your clinic has any outstanding loans with interest charges affixed to them, you can add those back, too.
You’ll also want to use your clinic’s EBITDA number to determine its EBITDA margin, which you can calculate by dividing your EBITDA by your clinic’s total revenue. Your clinic’s EBITDA margin is helpful when gauging the effectiveness of the business’s cost-cutting efforts. The higher your clinic’s margin, the lower its operating expenses are in relation to its total revenue—and the higher EBITDA multiple it will garner, which is a crucial factor in determining your clinic’s worth.
A Crash Course on EBITDA Multiples
The EBITDA multiple is a valuation ratio that measures a clinic’s return on investment and therefore helps investors determine its purchase price. Over the past five years, the average EBITDA multiple for the physical therapy industry has been 3.6x—but this will fluctuate depending on a number of unique factors that impact your clinic (more on this below). The EBITDA multiple formula is as follows:
EBITDA x Multiple = Clinic Value
Let’s plug in some numbers to drive this point home. Say your clinic has an EBITDA of $1.5 million and an EBITDA multiple of 3.6x. Based on the equation above, your clinic would be worth approximately $5.4 million.
In short, your goal as a clinic owner is to obtain the highest possible EBITDA multiple, as this will directly impact your clinic’s purchase price.
Ways to Increase Your Clinic’s Valuation
Now that you are all experts on calculating your practice’s worth, it’s time to explore the ways you can increase its value. This depends on your ability to drive up that aforementioned multiple. So, ask yourself, “What can I do for my business in the next 12 months that will result in an increased multiple?” Here are a few suggestions:
1. Get your house in order.
Creating a sound foundation for your business is the most important thing you can do to drive up your clinic’s valuation, as it shows investors that your practice is a sophisticated business that is ready for purchase. Plus, it’s something you can tackle independently—and proactively—so you’re prepared to demonstrate it when the time comes. Best practices to get your house in order include:
- Clearly documenting all policies, procedures, and hiring practices;
- Reviewing and updating all documents, processes, and contracts regularly (but especially prior to negotiations);
- Ensuring your clinic’s financial statements are clean;
- Having your practice’s operational metrics at the ready; and
- Making copies of your leases and insurance contracts.
It may be in your best interest to hire both a legal and financial team to help streamline this process and ensure nothing falls through the cracks.
2. Hire top talent.
Whether you’re hiring a therapist or a front office staffer, you want the best. After all, these are the people who are responsible for making great impressions with your patients, keeping your schedule filled, and moving your clinic forward in alignment with its mission. Having a strong, experienced staff can add significant value to your practice—especially if you’re looking to retire or exit the industry.
3. Maintain a stellar reputation.
A reliable, passionate staff can also go a long way toward enhancing your clinic’s street cred. As the saying goes, “Reputation is everything.” This is doubly true for investors. Financial partnerships and exchanges require a high level of trust, and if there’s something out there that reflects poorly on your business, your clinic could be flagged as a reputational risk—and that could push investors away.
In addition to providing an exceptional patient experience, managing your clinic’s online presence can help you maintain—and even boost—your practice’s credibility. Investors will always do extensive due diligence when evaluating your practice—and an assessment of your online presence will factor heavily into investment decisions.
4. Show you can grow.
Clinics that demonstrate their ability to scale are often considered more stable. That’s because they typically have higher revenues, are more profitable, and have a larger market reach—all qualities that are highly attractive to investors. To put it simply, people want to buy businesses that have a promising growth trajectory, whether that potential comes in the form of same-store growth, successfully opening new clinic locations, or even spearheading an acquisition or two.
All of the above are best practices to strive for regardless of whether you’re looking to sell. However, it will take time and diligence to achieve these goals. Keep in mind that your clinic is more than a business—it’s an asset. And as with any asset, you want to make it as valuable as possible. This philosophy will help ensure that anyone who interacts with your business—especially potential investors—can easily see that your practice is built for long-term success.
Still have questions relating to M&A, PE, and EBITDA (holy acronyms!)? Leave them below, and we will do our best to answer them.