Quarter 1 2021 - Volume 26, ISSUE 1

Selling Medical Billing Companies in a Pandemic

Has the pandemic had a negative impact on business valuations in general and in the value of your medical billing business in particular?

By Dave H. Perkins

In early 2020, our economy was running on all cylinders: businesses were thriving, medical billing companies were benefiting from the rise in the average income of individuals, providers were doing well. There was so much hope and optimism. Then, like a sucker punch to the back of the head, without much warning, COVID-19 changed almost everything. If you own a small business, like medical billing, credentialing, or software services in the healthcare sector, you have not been exempted from the negative effects of the global pandemic. Healthcare, fortunately, is one of the most resilient markets and will recover in time. But what if you had planned to sell your business last year, or this year?  

• Are buyers still buying?
  
• Are companies still selling?
  
• Can deals get done?

Has the pandemic had a negative impact on business valuations in general and in the value of your medical billing business in particular?

In short, the answers to those questions are “yes, but.”

Impact of the Lockdowns/Slowdowns on Medical Billers
Owners had to react quickly to the lockdowns and restrictions, which dramatically reduced case volumes for most healthcare providers. Primary care providers were forced to use telehealth visits as patients could not physically come to the offices. Elective surgeries were canceled or postponed, to be rescheduled later. There was a rippling effect down the line: fewer cases meant cuts in production with fewer claims filed, resulting in lower revenue for the providers, which resulted in even less revenue for medical billing service companies who bill on a percentage of collections, which most do.

Billing company owners took what action they could but were really caught between the proverbial rock and a hard place. They did not want to furlough employees but had to find ways to reduce expenses. They were forced to move from a mostly office-based setting to a work-from-home business. Most adapted, but they still had to pay rent and incurred a lot of lost productivity in the process. Fortunately, most billing companies were able to get EIDL and Payroll Protection Plan loans under the CARES Act, which encouraged owners to keep their employees on full-time to prevent even higher unemployment and a major national economic disaster. This saved some billing companies, short-term, but nothing from the government comes without strings attached.

Many medical billing companies have a hybrid workforce with employees and independent contractors, including offshore BPOs that provide many critical services, primarily back-office data entry, coding, payment posting, etc. Companies using these outsourcing contractors thought this would protect them: they would not pay fixed costs if their contracts were volume or revenue based. However, India and other countries where these BPO contractors are located have been hit as hard or harder by COVID-19 than the U.S. and are less equipped than we to work from home. Companies have seen productivity from offshore contractors drop significantly in 2020. All of this has resulted in lower revenue without an equivalent reduction in expenses.

Effect of the CARES Act on Billing Companies Seeking to Sell
The value of medical billing service companies in the mergers and acquisitions marketplace is usually calculated as a multiple of free cash flow. It also can be valued as a multiple of “adjusted EBITDA” or “seller’s discretionary earnings.” There are many factors considered in addition to this that can move the value up or down within a range of multiples.

The time period considered for valuation is, mostly, the “trailing 12 months” or the 12 months prior to either the letter of intent or closing of the sale. This includes the “COVID” period for anyone wanting to sell in the next year or so.

You may think, “What about the PPP loans? Didn’t that make up for the lost revenue?” Yes, for about three months or so for most billing companies, but the pandemic has gone on much longer than was originally thought. The other problem is that the PPP loan is not “revenue” on the P&L. It is a loan that shows up on your balance sheet. From a P&L perspective, most billing companies took a big hit in 2020. Yes, many are seeing some of this come back, but revenue and profitability is still volatile. Depending on what part of the country you serve, COVID-19 lockdowns and restrictions affect businesses differently.

By now, most companies that filed for PPP loans have been able to file for forgiveness and most of the loan balance is off the books, so shouldn’t that resolve the problems?

No. Remember, nothing from the government is free. The loan agreements between the billing company and the lending institutions for the SBA-backed PPP loans contained a clause that restricted the sale of assets or change of ownership of a company with an outstanding PPP loan without the express written consent of the lender and the SBA. Most lenders held up M&A deals from closing because they were following the SBA guidelines and were not willing to deviate or look for workarounds. For example, some lenders allowed the seller to set up an escrow account for the entire PPP loan balance, then close the sale, with the provision that when the PPP loan was forgiven, or not, by the SBA, the bank would use the escrow to pay off the unforgiven balance, thus protecting themselves from a possible loss.

Other Factors Impacting Valuation

• Revenue trend over the past three years. Upward growth is good, downward is bad. Volatility is risky.
  
• Volatility of revenue or of your client base (churn of clients leaving and coming on) adds risk to the buyers. This was an unfortunate outcome of the pandemic era, lowering multiples and making buyers more risk averse
  
• Type of client: hospital or physician (pro-fee)
  
• Specialties of clients. High revenue-low volume or high volume-low revenue
  
• Degree of automation in processes
  
• Technology/IT/software
  
• Quality of staff (especially management team)
  
• Location
  
• Potential for growth in the market
  
• Status of client contracts (in place, in effect, assignable, auto-renewing, multi-year, reasonable termination and work-out terms)
  
• Anything else that affects the ease of transition of ownership

How Risk Affects Terms of a Deal
The pandemic has made buyers less willing to take risk. The future is uncertain. Hopefully, the vaccines will prove to be extremely effective, enough of the U.S. population will take it, and we can get back to normal, but what will that look like, how long will it take, and what happens in the meantime?

We are seeing deals with less guaranteed cash and more deferred payments that are contingent to some performance criteria in an earnout. This gives more leverage to the buyer.

Buyers are proposing other terms for added risk protection, including:

• Setting up an escrow for undisclosed liabilities.
  
• Longer payouts for deferred payments in seller’s notes or earnouts.
• Purchasing assets versus stock of companies.
  
• Requiring sellers to have skin in the game by retaining some equity.

What You Need to Do to Be Ready to Sell in 2021
First, get your books in order. Get that PPP loan forgiven and off the balance sheet. Make sure all tax returns are filled and taxes are paid. Get your P&L and balance sheet up to date. Clean up your books: intercompany transactions, loans to shareholders, bad debt write-offs, bad customer A/R, personal expenses run through the company, etc. If possible, separate property assets like office buildings and put them a different legal entity. Too many add-backs may be hard to explain and justify.

Second, identify clients that you are losing money on and either renegotiate the rates and/or systems/processes so you can make a profit or terminate them under the terms of the contract.

Third, do your best to wean yourself from day-to-day operations and train up a person to take over under new ownership if you plan to leave.

If you are planning to sell very soon, there are some things to avoid:

• Merging with another company. It’s hard for a buyer to know what the net profit will be for a while. There is too much disruption, duplication of work, multiple offices, and different billing software that make a sale more complicated.
• Converting clients to a new software system or EHR.
  
• Contracting with a new outsourcing company when a buyer may have their own.
  
• Buying new computers or software.
  
• Moving to a new office and/or signing long-term leases.
  
• Buying your own office building to lease back to your company.
  
• Hiring a lot of new people for work you expect you will get.
• Taking out new PPP loans. They will make the transfer of your company or its assets difficult if you want to sell until the outstanding loan is repaid or forgiven.

Selling your billing company may be one of the most important decisions you will make. If you are considering this soon, see a professional advisor to guide you through the process.

Dave H. Perkins is a senior consultant with Abstract Business Advisors, specialists in healthcare mergers and acquisitions. Perkins is a sales and operations executive whose career reflects more than 45 years of accomplishments in healthcare IT, revenue cycle management, electronic health records, medical billing software, and medical practice management solutions. He is a strategic executive who has founded several medical billing and software businesses and currently specializes in healthcare M&A.