So, you decided to pursue an affiliation with a group and things are not going as planned?
Worse yet, it appears that the larger business is now struggling with leverage issues you were told “not to worry about” as you were going through your process. Maybe it was even discussed when you were negotiating contracts - subordination terms, rights and preferences, springing control, payment blockages, etc.
Private equity (“PE”) and debt are inextricably linked. The former really doesn’t exist without the latter, which has existed since the dawn of mankind. Further, leverage remains a double-edged sword.
Reading the headlines, it seems like nowadays another group is disclosing a debt restructuring nearly weekly. What does that actually mean?
All PE-backed companies employ leverage. It is the primary fat they use for their cooking. Too much fat though can cause issues. While some of the chronic issues can be fixed, some can turn out to be terminal.
At its core, a “restructuring” involves exchanging some or all of a company’s debt for equity in that company. Sometimes, the sponsors or lenders also provide new money as “exit financing” so that the company can maintain regular operations after their balance sheet has been recalibrated. This "new money" also determines who owns what when the dust settles.
Most of the time though, sponsors hand the keys over to the lender group and they walk away. The most common logic being, “no point in putting good money after bad.”
This leaves the lenders and non-private equity shareholders (doctors, founders, management) in a lurch. Banks are not designed to run companies (also, illegal, lender liability) and the non-PE shareholders often have insufficient liquidity themselves to shore up the company’s balance sheet.
WHAT TO DO?
The first thing that needs to happen is to determine if the situation is salvageable. They often are. How are core operations doing? Is patient flow OK? Staff stable? Schedules holding? Any RCM hiccups?
If the business is doing OK and the problem is primarily the leverage you may have an opportunity. If the business is struggling, the presence of leverage could mean the business is DOA.
If you are a doctor who is affiliated with a group that is underperforming, you often hold more cards than you think. The last thing a financially distressed group needs is doctor turnover. However, instead of threatening to quit, consider asking about your options to buy your practice back from the group.
Now, the group is likely to say “no way” on the first pass. However, in a financially distressed scenario (a/k/a “insolvency”) allegiances shift. The company’s board members are legally obligated to protect the creditors’ interests, not the shareholders. Often, existing leadership teams and decision making are replaced by restructuring advisors and/or steering committees of creditors.
You now have a different audience, often with entirely different motivations. Once debt goes sideways, lenders are usually required to mark their loans down. Once a loan is marked down, the game can change as most analyses shift to pivot around valuation relative to where the loan is currently marked, not its original face value.
Think of a falling knife. Ideally, the knife stays put on the counter. If it falls off, it behooves me to catch it as close to counter-height as possible versus my foot, where it is likely to do the most damage. That knife is the practice. The sooner I catch it, the less damage that it is likely to experience or impart.
The lenders to private equity (healthcare) understand that there is no tangible asset value in any of these platforms. They are 110% enterprise value/cash flow loans. So, what happens when the cash stops flowing?
If the relationship between borrower and lender gets too acrimonious, these types of businesses can nose dive at such a steep angle that it is mechanically impossible to pull back on the rudder hard enough to avoid a crash. Contrast that reality with that fact that banks never want to write-off more than they have to.
Groups are particularly sensitive to any practices that are EBITDA-negative under their watch as those practices are dilutive to all their credit metrics.
If insolvency is approaching or already present, most lenders are willing to have a conversation that is focused around maximizing their loan recovery versus eating a wipeout. Sometimes, but not always, there can be a proverbial Win-Win-Win conversation. It usually includes these component parts:
- A solid practice that is affiliated with larger, financially distressed group
- A group or sponsor that is no longer willing to financially support their investment
- A lender that desires to exit the credit
- Doctors who still believe in their practice and abilities and see the opportunity to push “reset”
What is the Win-Win-Win?
- Minimal disruption in patients care
- Continuity of employment for staff
- Maximum recovery for the bank
[A fourth Win could be the successful rehoming of a practice that was otherwise due to be put down.]
NEXT STEPS
If you find yourself in this scenario, the best first step is likely finding a good attorney to re-review all of your documentation. Visit with lenders and accountants about the feasibility of reacquiring your former practice. In extreme scenarios, a "sale" can be little more than a lease assignment and transfer of payroll obligations with nominal cash changing hands.
From there, it is a matter of getting a meeting with the current decision makers representing the company. This could be management, the private equity folks, outside board members, or a member of creditors’ committee.
If you don’t ask…
Good luck, have fun, don’t die!
Be well,
Sean