In this special live episode from the M&A Summit in Las Vegas, hosts Brad and Michael team up with the Skytale Group to share essential financial and legal tips for preparing your exit strategy. Discover the five phases of an M&A deal, the impact of reputation on your practice’s value, and key considerations for practice owners planning a sale. Whether you’re selling soon or years down the road, learn how to build a more profitable business for market.
Listen to the full episode using the player below, or by visiting one of the links below. Contact ByrdAdatto if you have any questions or would like to learn more.
Transcript
*The below transcript has been edited for readability.
Intro: [00:00:00] Welcome to Legal 123s with ByrdAdatto. Legal issues simplified through real client stories and real world experiences, creating simplicity in 3, 2, 1.
Brad: Back to another episode of the Legal 123s with ByrdAdatto. I’m your host, Brad Adatto, with my co-host, Michael Byrd. Now Michael, this is a special episode because we just got back from Vegas.
Michael: Yeah, it was amazing, great energy, and really excited to share this live podcast episode that we recorded at the show. We talked in a panel talk how preparing for an exit builds a better business. And it was really cool, Brad, as you know, because we focused not just on planning for access, but how when you’re building your business in a way that is positioning yourself for a sale, you’re actually optimizing your business for the current time as well. And so we went through a bunch of questions and answers through [00:01:00] various perspectives on the panel that I think people will find really insightful.
Brad: And it’s amazing because it’s not just lawyers. We actually had some of our friends from Skytale be a part of that, so hopefully the audience will love it as much as we enjoyed doing that live broadcast from Vegas.
Brad: You know, there are a lot of great quotes out there about preparing for things, and so I’m going to lean on Benjamin Franklin, who once said, by, by failing to prepare, you’re preparing to fail. And then if you like good quotes and you’re a Dallas Cowboy fan, which I’m not by the way, but if you are, coach Landry once said, setting a goal is not the main thing, is deciding how you will go about achieving it and then staying with the plan. Now, to counter that, a philosopher named Mike Tyson once said, everyone has a plan till they get punched in the mouth? And finally, the most important quote I could find on this is, Abe Lincoln once said, don’t believe everything you read on the internet just because there’s a picture with a quote next to it. So whether or not you believe any of these quotes were actually [00:02:00] said by the individual, what we’ve seen in business and success, those who do have a plan and they learn how to execute that plan, it ends up going really well for them. So as you’re thinking about taking your med spot to the market, this is a great opportunity to really start thinking about what do you need to do to prepare yourself if you end up going in that direction. So I think we’ll first kind of bring on our illustrious panel as we open it up and you did introduce them, but I would love for y’all to kind of give any more background you’d like to go, so that ByrdAdatto team, whatever y’all do. When y’all introduce the lawyers, you want to introduce yourself.
Jay: I’m Jay Reyero, CFO partner at ByrdAdatto. I’m based in Dallas.
Brad: Go, Tedd.
Tedd: So I am not part of ByrdAdatto. I’m Tedd Van Gorden. I’m a director of investment banking at Skytale Group.
Michael: Michael Byrd. [00:03:00] I’m a partner and founder at ByrdAdatto. I am in my 30th year of practice. Translation when Brad’s talking, I’m old.
Brad: This is true. He’s known as a dinosaur lawyer.
Annie: Hi. I think you all know me by Annie, President and Head of consulting at Skytale.
Brad: Well, awesome. And so we were talking about this earlier, but I want to give you some more context because I think it’s important for you to think about it, is in a typical M&A deal, there are basically five phases that you go through. One is the letter of intent phase. This is the phase where, sometimes called a memorandum of understanding or statement of understanding,ut generally speaking, this is the moment in time where both parties or have some alignment as to if we’re going to go forward and become a partnership, or we’re going to buy you guys, that’s that letter of intent. Once that’s executed, you start moving to these next phases. So the due diligence phase, Ben McConnell talked a little bit about this. This is the phase where you’re trying to prove to the buyer that everything you said is, and how sexy you are, is true. So this is where typically they start going through your underwear drawer [00:04:00] or your sock drawer, and those that are better organized, it’s going to, the due diligence phase is going to be a lot smoother. Then you quickly move into the definitive agreements. This is another fancy term, meaning that this is where the purchase agreements, your stock purchase agreement, your asset purchase agreement, the employment agreements, the assignment or lease, this is all where the lawyers will come in and really start negotiating on your behalf, these documents. And finally get to closing; that’s where the billion dollars goes into your bank account, and you go buy a private plane that Michael still won’t let me buy, and so that way you’re closed. Sometimes there’s a fifth which is the post-closing. This is when the deals are moving pretty fast. There’s some things that have to happen post-closing. It could be name change stuff, assignment of a document you couldn’t find to close, but it wasn’t a big deal – new employment agreements. So that’s the fifth stage. Although these five are very important, we’re not going to talk about on this panel. This panel’s really going to focus on the prequel of what do you need to do to really get your house in order so that you can start going to that. So we’re going to [00:05:00] start off with the first question, and I’m going to go with, I think I’ll start with the Skytale team first. What indicators suggests it’s an optimal time to sell?
Tedd: Yeah, I’m happy to kick that off. So I’ve done over 17 transactions in the space in medical aesthetics alone that have been publicly made. I’ve been in investment banking for over 10 years. And I think across industries, across clients, even within medical aesthetics alone, I think that as you all in this audience think about exiting, it’s always dependent on your personal goals of what you’re trying to achieve with a sale. There’s a spectrum of results that you can achieve, whether you want to sell to scale and grow; that’d be identifying a partner that has done it before in other industries, or even with medical aesthetics that can give you capital and expertise to achieve that goal. That’s a separate and completely different goal than I want to retire. [00:06:00] I want to identify and exit off, ramp off the highway into retirement and be able to cash in some chips. Regardless, within this industry, particularly in medical aesthetics, there’s going to be a post-close timeline that you have to remain on as an employee of the buyer. Now, whether or not it’s 2, 3, 4 or five years is entirely dependent on your personal role within the organization. If you are a provider, a big component of the production and revenue and therefore financial stability of that company, you’re going to be asked to stick around for at least five years. If you’re more on the business end, that’s more commodifiable for private equity or any other buyers; that’s typically three years. And if you’re pretty good, you can maybe get down to two, maybe one, but I would plan for three years. So whenever we’re talking with groups, we like to think about those two things of what are you trying to achieve with a sale, and then what is your personal timeline and then reverse engineer [00:07:00] back from there. So at least five years out to be conservative.
Brad: Legal team, what are your thoughts?
Jay: Yeah, I’ll echo what Tedd said. I mean, first we have to acknowledge it’s a personal decision, a lot of different factors that go into it. But now I’ll put my legal hat on and Brad, you mentioned optimal. Brad mentioned getting your house in order. I think once you have your house in order, and all things being equal, when’s the perfect time? It’s after you’ve done that process. And we’ll talk a lot about what that means and the things to think about. And really the reason why is twofold. One, Ben said it earlier, if they’re opening up your sock drawer and they don’t like it, you know, that they’re red. Well, at least you’ll know that by having your house in order, you’ll either have changed the sock color to white or you’ll say, I’m comfortable, and I know they may not like it, and I’m okay with that. And you’ll be able to talk to your advisors about what the impact on the sale, the valuation, all that would be, because those socks are different colors. And then the second reason is if you have your house in order, you’ve done [00:08:00] the prep work for what comes later during the process. Brad mentioned due diligence. That is such a painful process, and we have some nice metaphors and analogies that we’ve used in the past that I won’t repeat here, but it can go so much more smoothly if you’ve taken the time to get your house in order to understand what you have. I mean, think about when you go to sell your house. You fix the things that are broken, you accept the things that aren’t fixed, you know what the cost is if they’re going to come back and debate you on cost and value and purchase price. So it’s all about preparation, all about having the most information at your disposal so that you and your team are able to navigate that process in a much, much smoother kind of way and meet one of those 90 to 120 day timelines.
Brad: Excellent. Anything else from legal or Skytale? No? Well, I think y’all were kind of hinting to this, but what are some of the key steps involved in developing that comprehensive exit strategy? [00:09:00] You’re kind of talking about from business, regardless of the timeframe. And I guess I’ll start with the legal team.
Michael: Yeah, I think I’ll echo a lot of what you’ve heard already. You hear the term exit strategy, it’s a common term and absolutely agree that you can’t have a strategy if you don’t know your vision, why you’re doing what you’re doing, so what Tedd says is so important. You have to know what your why is as to why you’re trying to sell it. And a lot of people think of exit strategy is once they know that, then that can help inform the buyer. I think exit strategy, what we’re trying to reinforce today, the strategy part actually starts way before then. Once you know your vision, your strategy becomes, okay, what do I need to do to best prepare my business to be able to accomplish that vision? And so, it may be you need to scale because you need [00:10:00] to diversify your revenues because of what your vision is for who you’re trying to sell to. It may be that you’re having to clean some stuff up. You may have some problem employees that you need to exit out. You may need to tighten your retention strategy with your key employees. You may have some of your services that are not profitable that you want to kind of clean off the books. And so, the strategy part is really important in this kind of early phase to really, obviously know where you’re trying to go and that helps inform kind of the steps that go into this, this cleanup process.
Brad: Skytale team?
Annie: Yeah, I would say this is actually sort of one of the most common reasons that folks will come to our consulting practice. They’ll say I’m thinking about potentially going to market. [00:11:00] I’m not really sure exactly when, but would love to just sort of at least start the process of making sure that I’m ready. And we love when that happens because as I always like to say, you can always slow down a process, but you can never speed up preparation for a sale. And it turns out that doing the things that make your business most attractive for a potential buyer are also the things that make your business just the most stable, sound business as well. And so, I think truly the first step I like to think is make sure you know your business. And oftentimes the best way to do that is sort of think through, “okay, if I were a buyer, what are the things that I would want to know about this business?” And buyers tend to be finance folks. They love to look at the world of metrics. And so, “how do I get my financials in order?” And one of the things that we tend to find is that it can be incredibly illuminating as to where you should focus your energy for the next period. [00:12:00] Sometimes there are areas where, “wow, this piece of my business is actually going really well. It’s very in line with my benchmark,” but oftentimes folks are surprised where they’ll discover, oof, this is an area where maybe I should spend a little bit more time, put in a little bit more love before they go to market. And I think the wonderful byproduct of really getting to know your business and understanding your financials and putting together those reports is that organized financial reporting is an incredible signal to buyers that you have an organized business. It’s almost like putting your lipstick on before you leave the house in the morning, or I don’t know what you all do.
Brad: Michael put lipstick on.
Annie: Perfect – aesthetics. But you know, if you have organized books and you know your numbers and you know this, I think it’s such a great signal of you are a really competent business leader who’s on top of your business. And for a buyer, that’s an incredibly attractive thing.
Michael: [00:13:00] Yeah. I’ll add to, I mean, a relatively common scenario is cleaning up your ownership group. So you’re preparing for an exit and you may have some early friends and family investors that may not be aligned, or you’re maybe wanting to give key employees some ownership as part of your strategy to retain them. And so, there’s definitely some planning that goes into what is the, speaking y’all’s language, cap table, the ownership group that you want to be taking to market with your business.
Tedd: A big component of that is compliance. And we’ve got a law firm up here, so I feel compelled to mention it, but it has real material impacts on sellers and individuals who are looking to sell. As money pours into the space, we’re going to see more and more compliance and regulatory oversight on the industry. It’s inevitable. And so we’ve seen deals blow up because buyers bring in lawyers who look at the rules and regulations for a state and under and realize that there are providers practicing out of the scope of medicine. So it’s important to understand, like, are all of my providers practicing in the correct scope? Are they credentialed? Do I have their licenses up to date? And then from an entity and organization standpoint, is that all in order? Do I have documentation of people providing capital? Is my organizational structure set up properly to bring in outside investors, if that’s a thing. So no longer can it be a handshake agreement and you just trust each other to exit and to divvy up assets in terms of the cap table. But there’s got to be documentation in order for a buyer to step in and say, okay, we believe this to be true. We’re going to give funds to you and your friends because there are ramifications that impact sellers if they don’t do it correctly.
Brad: Yeah. Great points. And I’m going to, [00:15:00] you brought up some ideas, but I’m going to go back to something Annie said real quick. You talked about getting real sexy for those buyers, right? Putting the lipstick on, maximizing the value and the attractiveness of that practice. So now we’ll take, we have some free time here, so we’re going to say over the next 12 to 18 months, what other things should – as an owner of a med spa, what should I be considering to really address so they can look sexier? And maybe you kind of talked a little bit about that, but any other thoughts you had? And I think I’ll start with you guys, Skytale group first.
Annie: I’m happy to. Do you want to start?
Tedd: Go for it.
Annie: Happy to chime in. You know, I think there’s two focus areas that I would emphasize. One is sort of ironically proving out that your business can run without you. So if you’re a buyer, most likely there’s going to be some sort of contract to your point of, the seller will be with us for, let’s just say five years or so. But you know, [00:16:00] that five years will go really quickly and then they’ll still have this practice and want to make sure it’s successful. And so, I think just making sure that you have the team really importantly, and the systems and the processes in place so that if you go on vacation with your family for two weeks, that’s a good litmus test for, does the firm survive without you? Or do things run as usual? And I think really just focusing on making sure those things are up and running. The other piece I would say is that most likely a buyer, when they’re looking at a business, the goal is not necessarily to just keep that, maybe single location. The goal most likely is to replicate that several times over. And so, the ability to prove out the repeatability and consistency of opening your practice. So say if you open another location or open another location in a different state, and just proving out that you can really, you know what makes [00:17:00] your business successful, and therefore you can do that kind of over and over and over again in other instances.
Brad: Yeah. Legal team.
Jay: Yeah. So I’ll kind of take a giant step back and hopefully it’s been clear and it’ll be clear throughout the day, but you can’t be a lone wolf doing any of this. And so, one of the very first things you should do is surround yourself with the team that knows the process, that knows the legal, that knows the taxes, that knows the financials, that knows your personal. You need to surround yourself with the team. So 12 months, 18 months, whatever, it’s starting to surround yourself with the experts who can help lead you and guide you through, not just the getting your house in order, but then the process itself. And from a legal perspective, 12 to 18 months, what we’re doing is we’re going to go back to square one. You could have been operating for five years, 10 years, 15 years. And we hear it all the time. I’ve never had a problem. We’re totally fine. But we have something that’s called compliance drift. [00:18:00] It’s very easy to start off and be totally compliant on day one. You work with a health care attorney, it’s great. And maybe three years down the road, four years down the road, six years down the road, your organization has substantially changed. The market has substantially changed. The state and the industry have substantially changed. Are you still operating within the parameters? And so going back to the basics, reevaluating what Tedd said earlier, your corporate structure, what do you have? Is it compliant? Are there any holes? Are there any gaps? Are you missing anything? Did you have an owner that you never really got signed that document? What is the impact there? And what’s the risk associated? Looking at your clinical process looking at how do we clear patients? How do we make those treatment plans? Who’s involved? Are we doing it within the right framework of what the industry expects and needs and the standard of care? And then Tedd mentioned the scope of practice. Who do we have doing the things that we are offering to our patients? Do we have a whole set of providers that we have hired [00:19:00] because at the time it was somewhat okay or gray and everyone was doing it, but now has more scrutiny on it because of a bad outcome two years ago with someone similarly involved? Everything changes every day in this industry. Tomorrow’s opening panel is going to talk about the wave in Texas and how it’s starting to move and the things that are going to happen from that. So you have to kind of go back to square one, say, yes, I was good 10 years ago, but where am I today? And so, kind of going back, making sure that you don’t have that compliance drift. And if you do, then working with the team to have a plan to deal with it to address it, and to fix it.
Brad: Yeah. Go ahead, Michael.
Michael: I mean, I want to just acknowledge that we’re talking about this 12 to 18 months. Most of our clients they’re starting off as small business operators, they’re entrepreneurs. One of our friends called that kind of like “pirate mode” where you’re just like going fast and breaking things. And so, something, because you [00:20:00] are wearing the hat of all the different functions, and you may outsource some things like legal and compliance to make sure you’re set up right, but there’s something that are gaps that are establishing. And so, that advanced time period is where you kind of have to mature and do all the things that we’ve been talking about to kind of not go to market as a pirate – although Brad would like to.
Brad: Yeah. Pirates are awesome. Annie said something I think is really a great point to take away is, if you are thinking about going to market, and when you do sell, if you don’t want to be doing that anymore, fire yourself now from that job. So whatever the job is that like, I want to slow down from doing this particular thing, find someone who can do that for you so that when you finally go to market, you’ve proven that you don’t need me to do this particular deal anymore. In fact, I’m more profitable because I’m not the one doing it. So that when you go to market, because they’re going to come to you and say, okay, we need [00:21:00] you to still continue to do the exact same job you’re doing for the next three to five years, but if you’ve already fired yourself from that job and you find someone else to replace you and it’s repeatable and profitable, then you’re in a better position. So, it’s a really important thing when you’re thinking about the future, about what you want to do when you do sell. Let’s keep moving on a little bit. We are talking about aesthetic practices here, and I want to focus on financial metrics which is, I don’t really like financials, but I know it’s important, right? And so when a buyer comes along, let’s talk about what you guys see what they scrutinize and look really closely at and why they care about whatever they’re looking at from those financial numbers. And I know that – I’ll let legal team talk, but I think Skytale Group can jump in here first.
Tedd: Sure. I’m happy to start it off. This is where I wish I had a whiteboard so I can like write out. So valuations in the space, what are they based off of? They’re based off of multiples of cash flow, operating cash flow, specifically – the financial jargon for that would be EBITDA earnings before interest, taxes and depreciation. [00:22:00] But you can think about it in the context of your business is, how much in the normal course of business, excluding investments in CapEx, does my business produce? If I were to fire myself, I would have to pay myself. That is factored in there. And so, if you think about the calculation of that number, it’s really in simplistic terms, your revenue minus your cost of goods sold, so the product costs the cost of payroll for the providers, minus your operating expenses. So that would be like payroll for back office people, marketing, rent, utilities, etc. That is your operating cash flow. So if you were to break out each of those components, let’s just combine the two expense components, let’s say revenue minus expenses. Those are the metrics, the metrics that support those components are what buyers and private equity and therefore owners should be really honing in on. So for revenue; simplistically, it could be your service mix. [00:23:00] How much of my income is coming from what types of services, products, sales, injectables, whether neurotoxin or filler lasers, medical weight loss, we’ll talk more about that later, and wellness, etc. And then also your provider production. So production per provider is important because they’re going to look at where is that coming from, who’s generating, this is a people business. If one person is generating a hundred percent of the income, that has way more risk than if it’s five different people all producing the same amount.
Tedd: And again, it’s all about the most valuable, the highest multiple businesses, the most valuable businesses are the least risky. So as you think through these metrics, it’s like, all right, what’s the least risk through the metrics and the lens, and how can I achieve that? On the expense side, they’re going to be looking at your cost of goods sold as a percent of revenue. How efficient are you at buying product, leveraging your relationships with [00:24:00] your vendor networks to kind of squeeze and twist their elbow to get more free product or lower that down. And then payroll, how much are you paying your employees? Like, how are you paying the market? Or are you overpaying? And that can kind of speak into the utilization of those employees, like how efficient are they, how busy are they? The room set up, like production per room. I can go on and on, but that’s how I would think about, it’s just simplistically breaking it down into a math equation and then drawing the lines from there and going like a pyramid going from the top and then all the way down to the bottom.
Brad: And Ted, I’m going to put you on the spot real quick, but you were talking about scrutinizing things. So when the buyer comes along and starts asking questions about a number, what is something that surprised the seller that like, why are they scrutinized this particular number? It doesn’t make sense to them. What would be something that jumps off the book for them, but the seller has no idea why the buyer cares?
Tedd: Yeah. I think one of them is as owners, you pay yourself as you see fit. There is a concept of fair [00:25:00] market value for your role and position within the company. And so, after a sale, you’re going to be a W-2 employee. And thematically, they’re trying to create these into long lasting, sustainable businesses that will operate for years beyond our lifetime. And so, that implies then it’s kind of morbid, but they have to replace you. And so what does it cost to replace you? That’s what the fair market value is going to be. So they’re going to scrutinize like, what are your roles and responsibilities? What do you like doing? What do you don’t like doing? Alright, if you don’t like to do X, Y, and Z or how much is it going to cost to replace that? We’re going to have to factor that in. And how much are we going to pay you? If you’re a producer that’s typically seen as a production of revenue, if you’re a physician, alright, well you have to pay you as a medical director. These are all things that you’re probably not doing as you should be pulling out income from your business in the most tax efficient way possible. Another thing are non-operating expenses. So personal expenses that owners are allowed to flow through the business. [00:26:00]
Brad: They’re called personal expenses.
Tedd: That’s right. So, it’s Brad’s personal jet, Brad’s liquor bill, whatever.
Michael: Pirate mode.
Tedd: That’s right. Whatever he does in pirate mode and he gets a credit card and starts swiping, they’re going to look at that, and it is totally judgment free, by the way, continue to do this. Like, no one like this is very standard. So, don’t feel embarrassed if you are doing this. They’re just going to want to quantify it. And so in terms of like preparing, it’s like document that right now, have it written, understand where the personal expenses are flowing through, how much they are, and then be able to justify them because that’s cash flow going back, so they want to look at that. And again, like if you don’t ask for it, they’re not going to give it to you. So it’s on incumbent upon you as the owner to track all these things because they won’t give you that value unless you justify it yourself.
Brad: Yeah, and I know it sounds weird because we talk about financials, but I know from our perspective, [00:27:00] Michael, there are a lot of things we look at when we look at the financials because of how it impacts the legal side. So, maybe you can kind of explain that piece.
Michael: I mean, I think what I’m thinking about are the documents that tend to come under attack in a transaction that can trip up. And I’m curious from the audience how many are familiar with the MSO model? So the MSO is a corporate structure. In a deal, they’re almost always going to come in, in this model. And in many states there’s a law called the Corporate Practice of Medicine that says that if you’re a business providing medical services, you have to be physician-owned. And so for our entrepreneurial clients or non-doctors that are providers, the solution is the MSO model where you have a doctor owned entity and you have an MSO, which is the entity that is [00:28:00] the “business” that you would own, and that’s married through something called a management services agreement. There’s a lot that goes into that. And for that reason, when you’re in a deal, the management services a agreements are going to be looked at. They’re going to be looking and picking apart both the financial risks, to Brad’s point, because that’s where flow of funds happens and there’s a lot to unpack there. And then they’re also going to look at from a compliance perspective. Even if under the acquisition it’s going to be a completely new structure, there’s risk that they can find when they’re looking at those management agreements or the lack of management agreements. We had a client that came to us a week before closing. They used their cousin to help close the transaction. We had set their MSO [00:29:00] up a couple of years prior and the management agreement was perfect. It was designed exactly like you would want. And then they started getting a bunch of questions about it and two weeks before closing, he confessed that they never actually started doing the stuff in the management agreement, they didn’t change anything. And so, they had a piece of paper that was a contract, but that there was nothing done. And so, those are the kind of areas of attack. The other things that will be looked at are your medical director agreements. There’s a lot that goes with that. A lot of people think, oh yeah, check, I’ve got a medical director agreement. And you’re in some states that document may actually be the Exhibit A that you’re not compliant just by having that document. And then in other states, it does help represent is there sufficient compliance on [00:30:00] the chain of care and oversight by the physician. Employment agreements are another thing that will be scrutinized. Clearly the providers and understanding risk as it relates to what’s the financial risk if that person’s no longer here and how are we protected by the employment agreement? And so, there’s a definite connection point between kind of the financial analysis that Tedd went through and things that that will be scrutinized and the key legal documents that are connected.
Brad: And the concept here is, and Michael was talking about the MSO example, it’s form and substance, right? So you have these different entities, multiple different entities. Are there financials locking up or is one entity the only, the one gate receiving the funds? So Michael’s example is, it had an MSO in place, but none of the money ever went into it; it was all still going through the same entity. So, they never really implemented it. So you have a great form, there’s no substance surrounding that. [00:31:00] And we see that often with the financials where you have a P&L that doesn’t make sense ’cause there’s four or five entities, there’s only one P&L. So you’re trying to explain to the buyer why is there only one P&L but you have all these multiple entities, and what do they stand for? So that’s an important piece. Michael also threw out CPOM, corporate practice of medicine, so you don’t go in panic mode. Not every state has it. It’s only about 25 states that have some version of the corporate practice of medicine. So don’t feel like you’re doing anything wrong. I know there’s lots of speeches throughout this weekend on corporate practice medicine, so we won’t spend too much time on it, but I didn’t want anyone to come up and try to murder us afterwards because you thought we were doing something wrong.
Michael: I have an add on too, Brad. The operating agreement of your entity is going to get scrutinized as well. Going back to the conversation about who your owners are and they’re going to really want to understand who your partners are and who they might be inheriting as partners, and so that also is going to be scrutinized in the process.
Brad: And Annie know you have an add-on.
Annie: [00:32:00] Yeah, just one quick add-on there too. I think one of the things that buyers will typically do, buyers know numbers but they will often bring on a third party who understands the industry, so understands, okay, within these numbers, what are the specific metrics that matter more or less. And actually on the consulting side of Skytale, we’re oftentimes that partner, and so really do start to understand the world from the buyer’s perspective. And I think Tedd said something really important, which is risk. Where, of course they’re excited about the upside of a potential investment, but they also are stewards of other people’s capital and so they’re taking risk exceedingly seriously. And I think two of the things that we tend just really tactically that they spend a lot of time looking at are provider retention and provider churn. And so, making sure that you have a business that is not only dependent [00:33:00] on one person, maybe you because should that person leave and how often are they leaving, that could pose a risk to a business. I also think increasingly so one of the questions that used to be asked a little bit less, but is asked a little bit more now is sort of around, and I think this is just because of the macroeconomic environment – just sort of consumer loyalty and demand, right? And so things like pricing sensitivity and oh, if folks get spooked or are they going to go? Are they going to skip on their Dysport or their Botox? And so, patient retention I think is another thing to really, really focus on because we spend so much energy and love and care bringing folks into our doors. And so making sure that once you have those incredible folks, they are loyal stewards of your brand come back to you over and over and over again, especially just in light of the fact that bringing in new folks, it’s hard and it’s expensive.
Jay: [00:34:00] Yeah, and I’ll add that this is one of the areas where our worlds collide. Brad mentioned form and substance, but the legal documents and the financials, they tell a story. And whenever that story gets questioned or there are gaps, that creates doubt and concern on the buyer side, which is going to impact the deal potentially. And so, you want to eliminate that. You want to have a clear and clean story. So some of the issues that I’ve seen is practice has been opening up multiple locations, and like everybody does in real estate, let’s put all the different locations and different LLCs, but then there’s not good tracking of the flow of funds between the entities because I own all of them, right? Some way I own all of them and so I can shift funds from one to the other, but these are all legally distinct entities and there’s real legal risk to just kind of commingling things and giving up some of that. And so you want to be really kind of clear with how money moves, how it’s being tracked, why it’s being tracked. That’s where the financial side can really [00:35:00] create that story to match the legal documents, the legal documents be created to demonstrate the accounting side. Because the moment you start having gaps and they’re like, why is this entity over here, but it doesn’t have any assets, but it’s generating all this revenue, but the providers are employed over here? How are you getting money over here? And why is this other entity getting money? Like, there’s nothing in the ledger to describe – all that creates concern. All that creates doubt. That’s the worst thing you can have when you’re getting in due diligence because now you’re spending an hour on a phone call trying to explain it, telling them everything, they’re going to want to see documentation; if you don’t have it, that’s going to create concerns and more questions. And so the more that you can create a cohesive story with the form and substance, the financials and the legal and the accounting all talking to each other, the better you’re going to be throughout that process to maximize value from the deal side of things.
Brad: Jay, you bring up a good point, which I think would be a follow up question. A lot of times again, we’re building our exit plan and exit strategy here, [00:36:00] so we’re thinking about what does it look like in the future. And the question I get sometimes is, well, I have two, but I want to open five locations before I go to market, so I’m just opening as fast as I can to make sure I look sexier because of five locations. I’d love to hear y’all’s thoughts. Is it the number of locations that matter or is it another aspect that they’re looking at?
Jay: I’ll let Skytale.
Tedd: Yeah, it depends. I mean, it all matters.
Brad: It depends. It’s the lawyer’s answer. Can’t use that.
Tedd: That’s right. Well, I’m stealing it. I would say number of locations is an important component. I’d say profitability per location is way more important. You can have five locations and they’re all producing a dollar a year and that’s worth pretty much nothing. They’re going to want to look at as you open locations, how long does it take for that location to get profitable? And is that time to profitability getting shorter as you open each subsequent location? Meaning, your playbook is getting refined and better, [00:37:00] your introspective about what you did, what went well, what didn’t go well. And it’s important because each market that you open a location is, is going to be different. And the true value that gets unlocked in this industry is for the businesses that are able to take their playbook and take it to somewhere entirely new. And so to do that, you just have to do the basics of understanding each subsequent location as it opens.
Annie: And I think just chiming in there, interestingly, I think consistency really matters. We once worked with a buyer that made us plot the ramp up curve, I think of 50 new locations. And what they wanted to see most of all was not necessarily if it looked like this or this, but to what extent the openings were decently consistent. Because what that shows is, I have a formula, like I know how to do this, I know I need to start working on marketing at this point, maybe I have an opening event at this point and sort of proven out that model. But interestingly speaking, [00:38:00] I think just making sure, if you don’t necessarily know you can be really successful in your next location; it could be time to sort of make sure you have your ducks in order a little bit before opening up a ton of new spots.
Tedd: A little bit add to that, to go back to the first question about timing, like when is the right timing to sell, and the response to that and being your goal with respect to opening locations. Financial buyers are not going to give you money to open up new locations if you haven’t been able to prove to do it at least like three times. One to two is good, two to three, that means you’re able to demonstrate that you have something special. And usually the operating model on the consulting side that we’ve seen within Skytale is like, once you go beyond five, that’s when you have to re-break the model and start again. And with respect to value, obviously more locations are better if you’re able to demonstrate they get more profitable over time, [00:39:00] and that playbook is demonstrably true, they’re more likely to give you a higher multiple more value. And then with respect to timing, let’s say for example, you want to exit at five locations, you can go to market if you are able to show a successful track record of opening locations. As you open that fifth location and have a strong leverage to negotiate for value of that fifth location, even though it’s not truly profitable, it’s probably going to be a cashflow negative for a certain period of time. But if you’re able to go to a buyer and say, Hey, look at my track record, historically, this is what the profitability of each location looks like, this is what we’ve done and I want to get credit for that. It could impact that your timeline and the value you can negotiate for that value upfront. Most likely buyers will want to structure something contingent on when that location hits X number of hurdles we’ll give you money at that point in time, but it’s always better to get it upfront. [00:40:00] So if you’re able to demonstrate sequentially that you have a successful model, you have a lot more leverage to negotiate for that.
Brad: Yeah. Michael, you mentioned earlier my favorite term, pirate mode, right? When you’re first starting off, you have that first and second location. What Ted’s talking about now is you’ve moved from pirate mode to navy mode. Because to get that next level, you have to figure out how to run a Navy versus being a pirate. That means that the people helping run the organization is going to shift. The founders may still be involved, but they’re bringing in more structure into it because you really can’t be in pirate mode and grow that quickly. Well, grow and be successful as if that’s what we’re trying to get to. Go ahead, Michael.
Michael: Yeah, no, and add to this playbook. When you’re scaling, you’ve got this playbook; as you go from state to state, the compliance playbook looks different oftentimes.
Brad: That’s going to lead us perfectly into my next question.
Michael: Okay, well go.
Brad: Because Tedd brought up compliance early on, and so I said, wait, he brought up something I want to get back to. And again, [00:41:00] everyone here is going to have to step the practice, you’re in the practice of medicine whether you like it or not. And so if you’re running medical services, that’s going to be a part of it. I know AmSpa takes compliance really seriously in the sense they have a hashtag: #compliance is cool. But Michael, as they’re preparing themselves to go to market, well, let’s talk about compliance. What are the things that buyers get nervous about that a seller should think about getting their house an order through compliance?
Michael: Well, I’ll start with just kind of touching on this playbook mode, and I’ll let Jay chime in as well. But when you’re scaling to a new state, if you have your playbook and you have aestheticians doing A, B, and C and then you go into the next state, they may not be allowed to do those treatments. And so, that’s one thing to identify who can do what in that state and what’s the flow. But again, going back to the interplay between compliance and your financials, if you have to go and hire [00:42:00] NPs and PAs instead of estheticians; your P&L’s going to look significantly different from a cost perspective. And so, any change to your business, whether it’s a new service, a new state, a new location, you have to run a filter through your business of looking at it from a compliance perspective, looking at it operationally, which speaking to the Skytale team, and what’s the impact on your operations and then from an accounting tax perspective.
Brad: Thanks, Michael. Jay?
Jay: Yeah, and we see this a lot when you’re in border states where you’re kind of let’s say Kansas and Missouri and you’re trying to play in both worlds and they have different rules and different things you have to think about. And to Michael’s point, every state’s going to be different. You have to filter it. And so, this is where the kind of the strategic business structuring kind of [00:43:00] process structuring in the very beginning is really critical to do that upfront, so that you can build the model in such a way that can withstand not only the scrutiny from a compliance and a financial perspective, but can also uphold your brand, right? Because to Michael’s point, if you have RNs that are doing everything and you bill yourself as, we only have licensed health care providers that do it, and then you go to another state that you can actually probably get MAs, phlebotomists, estheticians to do it because legally it’s totally fine, do you want to do that?
You start creating this question of, well, does that really represent the brand? And the brand is such a strong, important factor in all of this. And so you want to kind of understand not just the rules, but then how does it impact, how does it work within the brand what you’re building. You can go into a state, open up a practice and there’s all types of rules – you can get it done. Like we always say, there’s a solution for everything. [00:44:00] There’s a way to do it. But then kind of the next level is, okay, but does this represent what I want to build? Does this represent my vision? Does this align with all my other locations in the other states? Because the consistency of the brand is so valuable and powerful. That’s a real, real big key to kind of take into account.
Brad: Yeah, Skytale team?
Annie: I think the one thing I would say from a compliance perspective would be candidly, most owners are worried about something being not – like, it’s difficult. The regulations are changing. It’s hard to navigate, and my sort of main ask at least for all of our clients and would encourage you all to do so, is share with your advisors what you’re worried about. We have seen it all. So if there’s a dead body in this closet, if there’s this thing you’re worried about over here. If your provider did something weird a few months ago, like that’s really what your advisors are there for, to be stewards of your business [00:45:00] and sort of take anything that you throw at them and help remediate some sort of plan. So I would say over communication – key, and then be just again, tactically I would say selecting advisors who specifically know this industry. There are many lawyers that do compliance, health care lawyers that do compliance, accountant, all of those sorts of things. But this is a really nuanced industry. It’s changing really quickly. There’s a lot of gray. And ironically, I think even if those advisors look more expensive on paper, the number of hours it’ll take them to do something might be a lot shorter just because they know it already. So making sure that you’re with like trusted hands, I think will serve you well.
Brad: Well, I just learned something that if there’s a dead body, I’m calling the wolf because apparently that’s something that y’all do consulting at Skytale how you deal with dead bodies in closets.
Annie: You didn’t hear from me.
Brad: Well, I’m a little nervous. I’m going to stand a little bit further this way. I got one more question because I want to [00:46:00] leave time in case there’s some questions from the audience. And again, if you do, please go to the mic. But Ben mentioned this in the beginning in the state of the industry. He started talking about the employees that you have. And so one of the questions I have for you guys is, how does the reputation and the personal brand of certain key providers impact the valuation, and what legal steps, I’m going to start with the lawyers first, should they take to kind of protect this asset? So I’m going to go with you first legal team.
Michael: Well, when I get the call from a client that they’re super excited because they’ve hired an injector who has a gazillion Instagram followers and a huge following, motions start rising up because I know it’s a double edged sword. It is a great boost in the short term from a cash infusion perspective and can be for the long term. But the flight risk of someone like that is pretty significant because they have their own personal brand, their own personal following. And if they were to leave [00:47:00] that cash that you’ve grown dependent on is gone pretty quickly, and buyers look at it in the same way from a risk perspective. And so, it does become harder to use some of the delicate strategies that go into employee retention. But nevertheless, you want to look at it again, well, you’ll hear this multiple times today. There’s carrot and stick approach. You know, is there some incentive way that you would keep this person happy and feel like they’re home? And then are there protective measures that you would put in to make it hard for them to leave?
Tedd: Yeah, from our perspective as a investment bank and how we look at it; we’re always trying to frame it in the light that reduces the risk of the business, therefore increases valuations. And so a provider that is a key opinion [00:48:00] leader or famous on TikTok, has a following on Instagram, whatever, is as Michael mentioned, a double-edged sword. It provides a lot of revenue, but in the short term, or I guess in the long term I should say, it prevents a lot of risk because that individual can leave. So it’s a matter of, if you’re in a state that allows it, have they signed a non-compete? What are the terms of the non-compete? Is your structure set up such that you can provide employees with golden handcuffs, whether it be cash bonuses or some terms of equity ownership or a form of security that mimics equity ownership in the company such that if they were to leave, well, there’s a ton of value. There’s a punitive value on that movement away from the business.
And then from an operational perspective, and Annie can kind of dig in deeper, a lot of the things that we look at is, how do you harness that fame and attention and [00:49:00] have a halo effect on all the other employees, be it provider or non-provider. Simple things like their Instagram handle has to mention the company brand. Everything that they post maybe has to have multiple employees, so it’s not all about them. Everything that they stack in terms of social media is reviewed and approved by the company and so on and so forth. Basically, trying to make it more about the team as opposed to the individual. And it’s the same thing for yourself as an owner. It’s not about me, it’s about what we’ve built together. And so when we’re looking at practices, we’re digging into that, we’re thinking critically about, well, if this person were to leave, how does that impact the business? And if you’re able to say, well, we set up these structures around that, that reduces the risk that if they were to leave patients aren’t going to follow them. They’re there for the company and the team. They’re not there for that individual. [00:50:00]
Brad: Yeah, and the carrot and stick approach is a great point there because in some states, non-competes and non-solicitation aren’t enforceable. So that’s the states like that. So let’s jump to California where it’s nearly impossible to have an employee with a non-compete, so that’s where you see a lot of carrots being offered, where there is some type of ability to participate in some liquid event or if there’s a sale or something like that. So you can kind of use the golden handcuffs that you mentioned. Michael or Jay, any other thoughts on that one?
Jay: I’ll add on. A lot of times this discussion causes people to go the complete opposite way. So you have the one hand, let’s hire the experience, TikTok famous injector’s going to bring in tons of money right at the beginning and everything that they’re talking about is absolutely correct. And then you go the opposite, so then people say, okay, well, I’m just going to the opposite and I’m going to hire a nobody, but then I’m going to train them up. And then they start wondering, okay, well what if they leave after two years? I just trained up my competitor and so now I want some things to go after. Kind of two things you have to keep in mind with this discussion, [00:51:00] and I always kind of start off with this is, one, we have to be okay with people leaving because it’s going to happen, and we have to understand that it’s going to happen and all we can do is put ourselves in the best position to deal with it accordingly.
But the second is, there’s really no magic solution that’s going to keep everybody, and even if it does, sometimes that is going to cause you to have to spend more money to enforce it. So even a non-compete, you have a non-compete, well, if they go compete, what do you have to do? You have to go enforce it. You have to spend money to go enforce it. If you have a training repayment program, what do you have to do? You have to go and demand the money. And if they say, yeah, I’m not going to do it, I have a 13-year-old and I get that all the time. There has to be consequences. You have to spend money to go after the money. So you have to kind of just be mindful of that. You just have to put yourself in the best position by doing the most that you can. Some of the things that Tedd was talking about to create the value within the business itself and create links to the business that can’t be really taken away are really key. [00:52:00].
And the last thing I’ll say is the most expensive thing you can give away is equity. Like when I have a client that says, I want to bring on so and so, whether it’s an injector, whether it’s a consultant, whether it’s whoever; they promise they can build this, they can open my new location, whatever, and I want to give them some equity. That’s the most expensive thing that you can give away at that time, and so be very careful with that decision. There are strategic reasons why partnering with someone on an equity play in a location or giving equity to an injector is great idea. There’s a lot of times when it’s not, and it’s not like a contract where you can just say it’s not working out, I want it back. Taking away equity is extremely difficult, so be very, very selective in giving away equity to friends, family advisors, injectors, employees. You want to have a strategic reason why you’re doing that and just understand the financial implications later on when you go to a sell.
Brad: Yeah. And on that point, we often see situations where you do have somebody who’s a key person and you want them eventually to have some type of ownership, but there may be a [00:53:00] vesting schedule that over the next five years you get X amount. But as Jay’s point is, we’ve seen startups that are like, ah, we’re not worth anything, and all of a sudden they’re giving 20% to this person, 20%. Well, all of a sudden that 20 percent’s worth 10 or $15 million it seems like overnight. And they’re like, this person did nothing. In fact, they do nothing. They left and I don’t have any mechanism to take them out, so be very, very careful about when you give it away, how you get away and what protections you’re going to put in place so that if you this person does leave, that you can get that ownership back. So we have just a few minutes left. Again, if you have any questions, go to the mics, ask for your friends, but I’m going to ask for a panel to start kind of walking us through some takeaways here. So maybe I’ll start at the end and work our way all the way to Annie. So Jay, you want to kick us off with some takeaways?
Jay: Surround yourself with advisors that know what they’re doing and know this process. They’re going to be the ones to guide you through it. You shouldn’t have to do it alone. It’s hard. It’s difficult, it’s long. There’s a lot to it. Rely on those people that do this every day that know how to guide you through it and guide you in the most efficient way. [00:54:00] I think that’s the number one thing that we see is that the people who have all the right advisors in place, not only maximize their kind of end game on the deal side, but the process is so much more smooth, and they’ll be up here talking about how enjoyable the process was in the afterlife of the post-closing is. So surround yourself with people that do this for a living, that know it and can help guide you and answer your questions. And don’t let the due diligence call with the other side be the first time that they learn about something. Like Annie said, share everything. There should be nothing left that they don’t know about.
Brad: That’s a good point. And we have, we do have a question on the floor, so I’m going to jump to that before we get to you, Tedd. So go ahead sir.
Mike Kelly: Hi, I’m Mike Kelly. I’m a plastic surgeon. I sold my practice in Miami in 2018. Now I own a med spa in Atlanta. My goal is to sell that in the next couple years. I wondered, how do you see the current environment in terms of number of deals [00:55:00] that are taking place, the multiples that are being paid, the effect of interest rates on that process, and also the effect of timing on the sale? Is this a time where we should be holding off to see if interest rates can go lower or is it something that there’s still deals going on and we should be trying to sell now?
Tedd: I’m happy to answer those. I’ll try and remember all the questions.
Mike Kelly: I tried to make it as complicated as possible.
Tedd: Yeah, and I’ll try and make it as…
Brad: Was there an option D? All of the above.
Tedd: If I make it simple, why hire me, right? Right before this conference we were at another separate conference about private equity finance investment banking where it was more industry agnostic, so I’ll talk to the macro impacts that we’re seeing. Tariffs aside, that’s unknowable perhaps right now since it’s so nascent. [00:56:00] But in the medical aesthetics industry, it’s so fractured and uncentralized in terms of the ownership that the values of each transaction are so low that the impact of interest rates isn’t as big of a deal as you see on the higher end of the M&A market. So interest rates have an extreme impact on transactions that are above 50 to 75, a hundred million in enterprise value. And so we saw as interest rates rose, the volume of those transactions and the multiples on those transactions decline. And this is across all industries. Where you didn’t see that as big of an impact was on the lower end of the market.
Particularly within medical aesthetics. It’s, it’s still less of an impact because we’re so early on in the consolidation phase that a lot of the buyers are using disproportionately more equity than debt to finance the transactions to get going. And they’re also more willing to be aggressive to get a platform because of supply and [00:57:00] demand dynamics that there is a lack of scaled supply of sellers and there’s a great demand of buyers that are looking to get in. Now, that’s not to say that interest rates haven’t had an impact on valuations. We are seeing that multiples are somewhat holding, however, there’s more structure to the multiple. Whereas before, in 2022 and 2023, it was simplistically just cash and equity, but now we’re seeing more of the structure to include seller note components or contingent structures like earnouts or holdbacks, contingent on certain things happening in the future.
In terms of the timing of sale, that sale timeline, I know that earlier we mentioned that the average was somewhat between 90 to 120 days after you sign an LOI. We are seeing across industries that the length of a transaction is getting longer, and that is a direct result of interest rates going up and lenders becoming more scrutinous of their capital [00:58:00] that they deploy out to buyers or private equity buyers and investing in that sense. We’re seeing buyers be a lot more diligent than they were in 2022 and 2023 when capital was a lot cheaper. Capital’s a lot more expensive, and so they need to be making sure that when they are deploying that capital, because they are using leverage, which is impacted by interest rates, that they are more certain about the business that they’re buying.
Brad: And can that be your takeaway too? Did that help you answer your question, sir?
Mike Kelly: Yeah, I still didn’t hear a number from multiples.
Jay: Multiples depends. We can probably talk about that offline or maybe we’ll have that another one, but what we’re seeing is right around a million in EBITDAs when you start to see multiples six to seven times, and there’s a multitude of factors that go into it. That’s why we’re seeing the platforms in the space, what they’re trying in they’re hoping to get is in the [00:59:00] mid to high teens in terms of multiples. And so to reverse engineer from that, so that’s what the platforms are hoping to achieve when they go to market. We’re seeing multiples in aesthetic space kind of teeter out right around 10 times, and you’re looking at four to 5 million in EBITDA, multiple locations, training academy, provider diversification, de novo, M&A engine. It almost truly professionalized company at that point, and so that’s what we’re typically seeing.
Annie: I would add just one small nuance, which is, the sort of one caveat to this; I think consistently, fairly like upbeat sentiment of the investors that we spoke to earlier this week would be around GLP-1s. And so, I’d say if you’re looking at revenue, looking at what percentage of my revenue is from weight loss, semaglutide and GLP-1s, and I think that is an area where we’ve seen some softening just because of nervousness. And so trying to concentrate maybe away [01:00:00] from those services and diversifying could be beneficial in terms of multiple maintenance.
Brad: And to keep us on time, I’m going to have Michael give us a thirty second takeaway. We do have time afterwards to have questions into the networking piece, so let’s just close out this piece of it.
Michael: I’ll go back to our pirate conversation. For those of you in pirate mode, just be mindful that you’re trying to build a Navy ship and not a pirate ship. And so, you may be going fast and breaking things, but create flexibility and a framework so that you can mature into a business that’s attractive.
Brad: Thank you guys, and like I said, we’ll be up here afterwards if you have any questions, but again, we’ll be here all day, so thank y’all. I love that.
Brad: Well, hopefully you guys enjoyed that episode live from Las Vegas. What a special event that was for us. But we are back next Wednesday [01:01:00] show and we’ll continue to discuss Unintended Consequences with sports medicine.
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