In this column, I’m going to share my thoughts on today’s behavioral health and intellectual and developmental disability (IDD) markets. I’ll speak to the macro environment because those issues are impacting the decisions of buyers and lenders. In turn, these issues impact the values buyers are willing to pay for your company. I’ll also address how you, as an owner in this space, can use this information for your own planning purposes — that is, how to do what’s best for you.
To start, let’s talk about our economy. It is in a place very different from what one might consider “normal.” After years of unparalleled stimulus, we’re experiencing inflation that we haven’t seen in decades. Our central bank has been raising interest rates faster than ever before.
In July, I wrote a column for SalientValue. At the time, I warned of a continuation of price declines for various assets. The Dow Jones Industrial Average (DJIA) was already down 15% from January 2022. It has dropped another 5% since that column published.
One of the points of the piece was to explain that drops in asset prices across many asset classes are correlated. The public markets like the DJIA are correlated to other assets such as real estate and private companies. We see this most clearly in those companies sponsored by venture and private equity markets that are trying to get to the public markets. Markets are correlated because capital is constantly looking for its best returns.
Inflation in Behavioral Health and IDD
Now let’s take a closer look at how inflation is affecting the behavioral health and IDD markets. Sevita, formerly known as The Mentor Network, recently had its debt downgraded to Caa1 by Moody’s. (Note: Debt rated Caa1 is judged to be of poor standing and subject to very high credit risk.) Sevita is not the only company whose debt is being downgraded. I highlight them only because they are the largest provider of home and community-based services to the IDD industry, and the causes of the downgrade are affecting other providers. Jack Hersch of Moody’s explained the downgrade as being attributable to inflation (higher costs), dividend payments, and an aggressive expansion strategy that led to the provider being too highly leveraged. The downgrade means Sevita will face higher interest rates and greater risk.
In many parts of the behavioral health industry, including IDD, we’ve seen significantly higher costs due to inflation. Cost increases have occurred in the “basics” such as food, transportation, and occupancy. Costs are increasing faster than the reimbursement process addresses them. It’s putting a significant strain on the profitability of providers big and small.
From a seller’s perspective, the rise in inflation isn’t good. Buyers generally pay a multiple of profits. When costs are rising and profits squeezed, valuations contract and sellers have more difficulty getting their asking price.
There is some good news for sellers. If the Federal Reserve is successful with its rate hikes, inflation will come down and hiring will become easier. The Fed is expecting the unemployment rate to return to roughly 6%, up from a low of about 2%. Stimulus payments have declined, as have savings. The expectation is that people will be coming back onto the labor market. That’s good news for business owners looking to hire and reduce staffing costs.
How Buyers Are Approaching the Market
Despite the challenges that middle market companies are facing, capital is still being deployed into private equity. Pension funds, endowments, and other sources of capital are investing in private equity with the expectation that returns will exceed what they could get elsewhere. What we’re likely to see is buyers showing more discipline in their processes, valuations, and longer holding periods (i.e., periods of ownership).
Within the behavioral health market, buyers will invest in and consolidate those businesses where there is a clear focus on services, clients, payors, geographies, and other factors. It’s far easier to manage and extract synergies when maintaining discipline in operations.
Importance of Using An M+A Advisor
The past few years have been challenging. After dealing with the pandemic and labor shortages, operators are now dealing with inflation driving higher costs and margins getting squeezed — while they still deal with COVID-19 and staffing challenges. What this means to owners planning on selling their business is the need for a carefully devised plan has taken on even greater importance.
Selling your business is not simply about telling buyers “I’m for sale.” It involves marketing your company to a large number of interested buyers and telling your story. It’s about spelling out to each buyer how their own company will benefit by acquiring yours. Owners typically lack the expertise, experience, time, and resources necessary to execute these and other key factors that contribute to a successful transaction. That’s why selling a healthcare business without an experienced advisor is getting infinitely more difficult.
A good advisor doesn’t just know the buyers. A good advisor knows what each buyer is looking for, what they’re willing to pay, their holding period and strategic growth goals, their sources of financing (including a private equity sponsor), their diligence process, their operating culture, the likelihood of getting to close, and much more. Buyers are constantly in touch with the leading advisors in each field to ask for help. I can also tell you from experience that working with the wrong buyer or advisor is an enormous waste of a seller’s time — time that owners and their staff can rarely afford to waste.
As soon as you start contemplating a sale — whether you want it to happen in six months, a year, two years, even longer — it would be wise to take the time to sit down with an M+A advisor that has expertise in your field. Discuss your options and create a plan. At VERTESS, we offer a free business valuation to help owners understand what comparable companies are being sold for in today’s market. We’ll tell you how we’ll market your company. We’ll discuss the confidential nature of the process and how to keep your competitors and employees from learning about the sale. We’ll highlight any issues that buyers might want you to address before a sale and discuss how to best address them. There is no obligation on your part to engaging in this discussion with us and learning more about the transaction process and today’s market.
Working With Not-For-Profits
A significant segment of behavioral health is owned and operated by not-for-profit organizations. People are often surprised to learn that we manage transactions and they happen all the time. Transfer of ownership is required. There are unique facets and challenges to these transactions. State law plays a larger part in the transfer and approval process. I’ve been involved in these transactions for over two decades and have sold these organizations to both for-profit and other not-for-profit organizations. We’ve developed unique expertise in this area.
Assistance to Healthcare Business Owners
One of the reasons I chose to work at VERTESS is because, for many years, I was the person acquiring healthcare businesses. I worked with many advisors and found the VERTESS team was the best to deal with. They were the most professional and, like me, always had their clients’ best interests in mind. I believe that having experience on the buy side helps me in my role advising clients on the sale of their business.
At VERTESS, we look for ways to help clients and potential clients — even those that do not end up working with us. One of those ways is by writing these SalientValue columns. I encourage you to go to the publication’s website to see all the articles we’ve written for your benefit. Please let us know if there are topics you’d like us cover and provide insights on in a future column. We look forward to hearing from you.
About Dave Turgeon
Dave Turgeon has been completing healthcare transactions for over 30 years. He has managed over 400 transactions. He’s a Managing Director at VERTESS and works with business owners to maximize the value of the sale of their businesses. He can be reached at [email protected]. You can also find him on LinkedIn.
Thinking about selling your company? Unsure when you should start thinking about selling? Have general questions about selling? We’re here to help. Email Dave Turgeon Managing Director, at [email protected], or call +1.617.640.7239
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