What Is Private Equity, and Why Are PE Firms Buying So Many Medical Spas?
While the foundation for private equity (PE) was established in the early 1900s, the origins of modern private equity can be traced back to the mid-1940s. While PE has been around for a very long time, many people don’t know exactly what it is. According to Investopedia, “Private equity describes investment partnerships that buy and manage companies before selling them. Private equity firms operate these investment funds on behalf of institutional and accredited investors.” Simply put, PE firms raise money to create funds that are then used to acquire companies.
Generally speaking, PE firms take one of two approaches when acquiring companies:
- Hold and grow them as a long-term investment
- Sell, or “flip,” them in a few years, hopefully for a sizable profit (the average holding period for a PE acquisition is five years)
In general, nearly all businesses are valued on a multiple of their EBITDA (earnings before interest, taxes, depreciation and amortization), so EBITDA is our starting point. Pepperdine University recently published their Capital Markets Report 2022 in which they analyzed the sales of businesses in nine broad industries. They found that, on average, companies with less than $1 million of EBITDA sold for a 4.7 multiple of EBITDA. When the EBITDA figure increased to between $10 million and $25 million, that multiple jumped to 8.3, nearly a 77% increase! For context, let’s do some math together.
- The average business with $1 million in EBITDA is valued at $4.7 million.
- If a PE firm buys 10 of those businesses, they will pay a total of $47 million. The combined EBITDA of those 10 businesses is $10 million.
- The good news for the PE firm is they can now apply an 8.3 multiple to the combined $10 million EBITDA figure. So, the 10 businesses they purchased for a total of $47 million are now worth $83 million!
- Add in things like increased purchasing power, operational synergies and expected cost savings, and the value of the 10 businesses the PE firm acquired can easily be worth more than double what they paid for them.
- If the PE firm continues to acquire businesses and push the EBITDA significantly higher, the EBITDA multiple can increase to a figure well above 8.3, and the overall value of the combined businesses climbs even further.
- This is a great example of the old adage “it takes money to make money.” Properly executed acquisition plans can make a PE firm a LOT of money.
Now that we’ve covered a very high-level overview of what private equity is, let’s talk about why currently PE firms have such a tremendous interest in acquiring medical spas. To me, the answers are pretty simple:
- The U.S. medical spa market is currently valued at around $6 billion and it is forecasted to grow by more than 14% per year over the next five years. This means it will double in size by the end of 2028 to $12 billion. How many industries can you name that have that kind of growth potential?
- It wasn’t until very recently that PE firms discovered how profitable well-run medical spas are, and they have made acquiring them a priority. This has created somewhat of a feeding frenzy in the market.
- As of the end of last year, an estimated 90% of medical spas were owned by an independent operator. Only 3% were owned by PE. So PE firms understand there is an opportunity to acquire medical spas for many years to come due to the plentiful supply of independently owned clinics.
- Those PE firms with previous health care acquisition experience know how to set up an MSO (management services organization) to indirectly own medical spas in states that have statutes pertaining to corporate practice of medicine; these statutes prohibit nonlicensed individuals and entities from owning them directly. The ability of a PE firm to use an MSO has created an incredibly large buyer pool.
With all this recent activity, medical spa owners frequently ask me if selling to a PE firm is a viable option for them. The honest answer is “it depends.” Things to consider:
- How long do you intend to continue practicing? (Most PE firms want the owner/physician to stay on for at least three years after the sale.)
- Does it bother you that the entity the PE firm has set up to manage and operate their medical spa acquisitions will likely sell in the next three to five years, meaning there will be a change in ownership and possibly a change in direction and culture while you are still working there? (If so, you will want to select a PE firm that pursues a “hold and grow” strategy.)
- Do you like the idea of retaining some of the equity in your practice and selling that equity at some point in the future when it is, hopefully, worth much more? (Many PE firms require this as part of the deal structure.)
- What’s the current state of the market, and are you better off selling now or waiting a few more years? (This requires an analysis of your clinic’s current value, its expected growth rate, future tax implications, the state of the economy and numerous other factors.)
At True North Mergers & Acquisitions, we strive to help business owners identify and prioritize their objectives with respect to their businesses, their employees and their families. If you are ready to talk about your goals and get insights into how you might achieve them (and whether selling your medical spa to a PE firm helps you meet them), I’d be happy to sit down and talk with you and share some of the details of my recent medical spa transactions. Please feel free to contact me.