Despite rising interest rates, bank failures, and a slowdown in M&A activity, valuations for healthcare services companies with adjusted EBITDA between $500,000 – $10,000,000 remain historically high.
There are two main reasons for this:
1. Scarcity of Quality Companies on the Market. There is a shortage of quality healthcare services companies for sale in the lower-middle market, primarily due to the mass exodus of owners of privately-held businesses that occurred in late 2020 and throughout 2021.
Healthcare Services Private Equity Total Deal Activity by Year
Source: PitchBook Source Document (Q1 2023 Healthcare Services Report) ● Geography: US & Canada ● *As of March 31, 2023.
There were two drivers of this bubble of activity: 1) COVID burnout. Operating a healthcare services company during peak, COVID was hard -- for owners, clinicians, caregivers, and office staff. Many owners, flooded with inquiries to sell, saw the opportunity to get out at peak valuations as too compelling to pass up; and 2) the threat, under the Biden administration, that the capital gains tax rate would increase from 20% to about 40%. During that period, if an owner was considering a sale in the next few years, the potential tax rate change made selling more attractive while rates were low. The current administration has continued advocating for the proposal as a means to fund its spending priorities, but is unlikely to get current congressional support.
2. Declining Private Equity (PE) Exits Creating Demand for Add-On Acquisitions. Private equity firms have faced challenges exiting their investments over the past few quarters. This is due to several factors, including rising interest rates and tightened lending standards.
Healthcare Services Private Equity Exits by Year
Source: PitchBook Source Document (Q1 2023 Healthcare Services Report) ● Geography: US & Canada ● *As of March 31, 2023.
PE exits are often highly leveraged. In other words, the acquiring PE fund will put significant debt on the transaction to achieve the returns their investors require. Since debt is more expensive, values for these platform transactions, in the $100 million+ enterprise value range, have decreased over the past five quarters.
As these firms find it more difficult to exit their investments, they increasingly seek to acquire well-managed, cash flow-positive, ‘add-on’ acquisitions. This allows them to increase both the EBITDA and their exit multiple, thereby significantly adding value to their portfolio companies. It also allows them to lower the 'effective' multiple they will have paid for all of the acquisitions combined. They can accomplish the 2nd objective while still paying premium prices by historical standards. This has driven the demand curve up for lower-middle market ($500K to $10M in Adjusted EBITDA) healthcare services companies, which has kept values high.
However, not all private equity buyers are created equal in this respect. Those buyers that won’t require a lot of leverage to transact will often have both the ability and the motivation to pay a premium in a competitive M&A advisor-led process.
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