The Advantages of Partnering With an Acquirer Who Has Gone Through One or More Cycles of PE
Larry Benz, CEO of Confluent Health, joins Paul to discuss what a second or third round of private equity means for sellers, from deal structure and equity options to growth expectations.
Full transcript
Generated from the episode audio and lightly edited for readability.
Good afternoon and welcome to another episode of Paul Martin's Crucial Conversations. Today we have back with us again Larry Benz who is the CEO of Confluent Health. Confluent Health currently has 30 plus partnerships representing over 500 clinics nationwide, 90 education partners, and 1,500 plus workplace injury prevention sites. Larry, welcome. Well, thank you, Paul. It's always a pleasure to be on here and I appreciate so much what you do for the profession and in particular what you do for private practices around the country. It's always been a joy to work with your group.
Tom and all the other Dave, all those guys are just great. And I just want you to know how much I appreciate what you do because a lot of a lot of folks don't realize that, you know, partnerships and your bankers or your representatives are critical and your consultants and it's a it's part of a larger picture of what makes private practice great. Oh, well, thank you. I can let you go on and on and on there, but we're going to stop and talk a little bit about you and Confluent.
You know what I really want to discuss today, Larry, is the opportunities that exist for companies like Confluent who are in their second and third round of private equity. We have so many business owners that call us and they, you know, we want private equity. We want or we want to get in on the ground floor of a company and what we try to explain is that you know private equity goes through these cycles. You guys are on a second cycle of private equity now. Are there advantages for a seller to partner with a strategic company like Confluent that it's in its second or even third round of private equity?
You know, it's a great question and it's a very fair question as well. You know, our history of Confluent is we're owner founded. So, we have been you know, just like other private practice and PT, we put our money where our mouth is and we grew primarily organically and through some, you know, mergers and acquisition, but primarily through adding new locations and building up our current locations using our own money and we combined with other practice and we did that collectively. Then we took in some very minority private equity dollars.
So technically that was our second case and now where we're at now is roughly at equal footing. And so I guess technically we're at our third or fourth depending on how many times I personally had to throw money into it. And are there advantages? I think I think there's intangibles for sure. You know size does make a difference in terms of your partner today who will be your partner in the future. So where we're at now with our company is we are not in a position where we could ever or want to sell to another private equity group.
We're just too large and we're just too, you know, complicated because we have all these partnerships and all of these 60some subsidiary arrangements. And so if there's advantages, they might be some intangible ones. In theory, the whole idea of getting on the ground floor is an old wives tale. Really unless you're taking a significant amount of your equity in the company that's buying you or partnering with you's equity, that shouldn't make any difference at all. And so, you know, whether you are an investor in Amazon when they started or five years later when they were at a certain price, you did well regardless.
So, this idea that, you know, it's a multi-level marketing scheme and the earlier you get in really just frankly is just not true mathematically. And again a lot of things dependent on that whether or not you take local equity which we believe in. We give our partners the opportunity to partner with us in multiple ways. They can just hold on to their local equity. They can roll some of their equity into confluence and they can have all three things kind of working for them. Some liquidity, some local equity and some confluent equity.
So it really is u you know really is a function of the deal structure. I think the advantage, if I could, you know, talk in terms of financial stability, probably does make some difference. I mean, we're a more stable company today than we were, you know, 15 years ago. But at the same time, we've got legacy companies that have been around since the 60s. We've got, you know, newer private practices that are 10, 15, 20 years old. So, it really is a function of your deal structure and what you're trying to accomplish.
But, yes, some stability and opportunities. You know, one of the things you can believe in if it's a company's second or third round, you could believe it's been highly vetted by very professional investors who are doing all kinds of deep dives and due diligence and that kind of can replace some of the due diligence that you're either capable of or would have to spend money on. So from that standpoint, I see some intangible advantages. Absolutely. So as a company, a strategic acquirer that now you know again and forgive me but in your third round of private equity do you find that the growth expectations from those larger maybe more sophisticated private equity groups that you have brought in are the growth expectations different from a round one firm?
Yeah, it's a great and very sophisticated question. It's also a very fair one. And one of the things that I try to coach companies that just want to talk about the whole M&A thing is that's a question you ought to be asking. And that question really is how was the investment that the private equity group made in you underwritten? And what I mean by that is they had to assume that a dollar they invested was going to get them some type of return. Either return on the invested dollar or what we oftentimes hear of is the return on invested capital which is traditionally now probably the better metric for how private equity companies invest.
Sure. Was it written to two to three times the invested capital over what period of time? And then you can mathematically back into that growth rate. So, for example, if they're trying to get to a three times invested capital return over a five-year period, you know, you could run the math and tell you that that's a pretty strong growth rate. So, it is a very good question. What I tell the groups that we partner with is first of all, I tell them the truth about how our investment was underwritten and whether at this stage we are exceeding that.
We've been fortunate to be always way ahead of our what we call our base plan. So our base plan for example was to get to a size of about call it two and a half over a period of five years. We exceeded that. The way we exceeded it was not asking our partners to go two and a half times over a fiveyear period. We're very much more realistic with them because we don't want them focusing on growth. We want them focusing on their business and the product that they do and how they grow and where we can optimize them for growth.
Is that in revenue synergies by better payer contracts and better lifts? Is it by newer programs? We have a very robust you know orthopedic and muscularkeeletal play. Is it through our pain squad product trying to attract chronic pain patients to it? Is it through opening new clinics? You know, we're much more about, you know, better off filling one big clinic than opening up two or three. And don't open up two or three until you know who's going to be that CL clinic director there. And then are there bolt-on or tuckin acquisitions that you can make?
I my biggest message to our newest partners is if you focus on sort of 5% same store sales and an overall enterprise of your enterprise of about 10%, you'll exceed it. But I'm not asking you to exceed it by focusing on that percentage number. I'm asking you exceed it by focusing on the individual dynamics and metrics of your own business. Do you find with again kind of the larger private equity do expect other expectations change and does it does it create a more corporate environment than maybe where you were in round one?
It very well could. And you know the private equity group is not a monolithic group. It is as varied as any other part of society. And you know one of the things that we did early on, this is sort of my second generation of private practice run here is I wanted to do things a little bit differently and I wanted to put the physical therapist owners at the same level as the private equity groups. Meaning one le one significant equity trench not preferred interest here series B here I wanted everybody with the same underlying security to be at the same level because it was my belief if you can align the pts with the private equity groups then you're going to have a better long-term you know relationship I just don't feel that you're going to when things become too corporate what that means to me is you've lost the pulse of your individual physical therapists, what are they struggling with?
Are they struggling with an EMR system that they're spending 20 to 25% of their time in rather than the patients? Are they struggling with trying to get, you know, 10 to 11 patients in a day because they got so many other regulatory challenges? Are you are they paying attention to their personal and professional developments? And how does that, you know, manifest itself in the practice? When you start to lose that, that's when I think you can become too corporate. Who is leading the cause here? As you well know, I'm a physical therapist and so I I really believe that physical therapists are equipped with great transportable skills in business from managing patients and learning the science of in the rigor and the discipline of being able to graduate from PT school.
So, you know, I always want to make sure you have strong leaders in a company that are PTs in background PTs. Doesn't mean every PT company CEO has to be a PT. But they have to think and act like a PT at the end of the day. Where are they focusing most of their sensitivity around and you know if you look at some of the mistakes which is what I try to do I try to find out what companies in the PT world over the last 30 years I've been involved now for 35 plus years in the PT world what have flourished and why have they flourished but what have failed and why have they failed and companies when they fail they do become too corporate they focus on growth for the sake of growth they lose the sensitivity they start treating PTs like fungeible commodities.
And when that starts to happen, you know, things tend to roll downstream. You know, as you describe your PTs, which some of them are owners, some of your PTs also can have the opportunity to have equity all the way up in the parent company. And you're proving how complicated a transaction in this industry can be. But it sounds like you guys have simplified that and the partners group has simplified that in that if I'm a former owner or I'm a PT that has equity up in that parent company, my equity has the same valuation coming in and going out as one of your private equity partners.
Is that accurate? That's absolutely accurate. It's the same underlying security and we do that for the sake of simplicity. We also value it we used to value it quarterly. We now value it monthly because our sense is if people are interested, we give them really good optics on all the financials quarterly. But I try to get PTS in private practice, whether they're part of private equity or their own private practice to think of their business in one lens, not all the lenses, but in one lens of how they would look at their 401k.
Well, the markets have gotten hammered, you know, the last several weeks. Have had a little bit of bump up here in the last three weeks which has been great but the tech stocks all the things that accelerated during co in terms of the stock market have gone down you know substantially so what has happened to your business and people don't think that way they don't evaluate their business as though there were an underlying security to it and you really should and it's important and it's important for us I mean one of the one of the things that u we're real proud of is we've got more ownership of pts more individual UAL PTS have more ownership in our company than any in the US by a long shot by a factor of almost 3 to one.
Wow. We have a well over a hundred and some PTs that own part of the rock here. But it's going to even get better. We're going to announce, you know, shortly that just like their colleagues that graduate from school that are in technology and other fields where they get stock options, we are going to effectively put in place stock options for every physical therapist that they will be issued every year and you know we're anxious to finalize the paperwork on it and it's very timely for us because we also think that'll help us in recruiting.
If you really are in want to be an organization and attract the best and the brightest to PT, we have to think outside of the traditional models of PT. Well, the traditional model is now you graduate, you get a job, you try to pay $1500 to $200,000 on student debt. If you're lucky enough to be in a private practice that cares about your development, you might have an opportunity there. And the capital cost of opening a PT business and the reimbursement pressures and the regulatory pressures are making it really hard for PTs to get into private practice.
Well, how can we do a better job of that? One of the ways we can do it is to treat them as though they were in a technology company and give them stock options. So, we're real anxious to do that. We're very concerned about the state of physical therapy education and student debt and the impact on it. And at the end of the day, if you don't have the PTS, you're not going to have the revenue. So, we have to as a profession, I don't mean that even as a company, we just as a profession have to rethink how we do that.
So, one of the big focuses that we give our clients is you have to find the partner that has the best culture match. You know, first and foremost, if we had one of your partners from your round one private equity, talk to one of our clients versus one of your partners who got in during the round two and round three private equity. Would the culture story for talking to one of our clients, would it be different from the round one individual versus the round two and three individual?
You know, I don't think so. I mean, every private practice group that we've met with over the years rates culture number one, number two, and number three. And we survey our partners and how did integration go? What could we have improved better? Because we don't look at Confluent as a corporate entity. We look at it as a conduit of sharing best practices and getting feedback. And we want to know how we can improve on integration and how we can help your culture. And I think the biggest surprise that we found over the years is that folks would not only say their culture has been maintained, they would say their culture has been improved.
Now, why is that? Well, we believe you have to be incredibly intentional about honoring the past, celebrating the present, and embracing the future. You know, we don't change practices names. We take it we take their culture and we blend it with team leader coaching and foundation days. And we have a culture commitment called commitment to commitments. And it's really hard to define culture, but we define it as when you walk in the room, what do people act like? How do they talk? What are your stories?
What are your expectations? The traditions we think are really critical. And we think of these as assets of a company and we embrace them. And so you have to be deeply intentional about culture or else you will ruin it. Now having said that there are changes and managing change I think is the hardest aspect of what happens in a relationship with private practices. And the way I think about that is there are simple cosmetic changes that you won't even blink at. You don't even know they're happening.
And so they're they don't cause any issue. And there are other changes that are like oh okay yeah I have to change my health insurance because now we're part of a bigger health insurance policy but it's better health insurance. It's still an adjustment right. And then there's other changes that are frankly a little bit harder. You know, for example, we manage all the accounting and the compliance. Now, everybody wants to get rid of compliance, so that's an easy one for people to handle. But, you know, we control all the cash in a company because we have to we have to pull it and we have internal control mechanisms and we professionalize the business in that aspect.
What we say is when that change becomes problematic or you're having a hard time dealing with it, let's sit down and talk about it and we'll introduce the change slowly. Will embrace your feedback in it. Have you be part of the change? But don't conflate changes with culture. Culture really is when the leader is no longer in that room. How do people act, speak, talk, and engage with one another and we view those as assets that we're trying to elevate rather than things of the past that we try to ignore.
You know, we have a NFL style ring of honor in our company. You know, we've got companies that preceded Medicare. You know, think about that. Think about having a, you know, we complain about Medicare. Think about not having a part B Medicare. You know, we have practices in our company that have been around that long. And so, we have a ring of honor where we honor those founders, even if they weren't even part of the company when we partnered with them because we think it's important that those traditions stay in place.
You know, I was I grew up a Cleveland Brown fan. I'm from Cleveland. And one of the things many years ago the mayor of the Cleveland Browns did when the Browns left when Art Modell left them and overnight went to Baltimore was that he negotiated with the NFL that when Cleveland was able to get a team back that they would keep their name, their color, and their traditions. And we, you know, that's been a shining example of a business case that I've tried to live by.
Yeah. So you're comparing and contrasting confluent with the Cleveland Browns, Larry. Yeah. It's tough. It It's tough. You know, we try to take the lunch pale to work every day and have that hard Midwestern ethic. And hopefully we've had a little more success in recent years than the Cleveland Browns, but absolutely. Well, right now you guys you guys got a nice gift with your quarterback only being out six games. That's appeal though. We'll see what happens. I got you. I got you. That's a tough one.
As long as he's not there when they play the Eagles, that's fine. Exactly. So geography is always a question that we get from business owners. You know where are they going next compared to your geography discussions with your round one private equity group to now round three when you know you guys are in 29 states about 31 states. How does that conversation and that strategy change from now again this you know third round private equity from when you were back in round one you know it's a it's an interesting thought you know years ago and Paul you're like me you've been sort of through three stages of consolidation in PT with this current stage lasting by far the longest which is great for the profession but there was a fundamental belief that you had to sort of dominate a region or an area and then grow from there.
But as we've seen, just like with remote workers, you can manage things from afar a whole lot easier and can cast a wider net more than you've ever been able to. And so, our criteria has always been really about the partnership, not the geography. We want to be in states where we can grow. We want to be in states that they have a good physical therapy practice act, direct access, and the like. We want to be in states where there is good reimbursement. Everybody wants to be in states where there is good reimbursement.
And then of course you want to be in states more importantly where you have an opportunity to get more and more pts in and grow in that way. So that's our chief criteria. So we don't look at geography as a strategic placement. We look at people and assets of our partnership as the strategic asset. So when we go into a market, we grow through our partnerships. We don't grow through Confluent. Confluent is a cost center. You know, I'm here at our, you know, corporate office, our new office here.
Alls we do is generate expenses. It's our partnerships that generate the revenues. And so how can we make them grow? We don't ever want to be in geographies and we will never be in geographies where we do not have partnerships. Local owners u that's our style. And then I think it's very different depending on which PT group you're talking to. Some are more dominant in urban areas. Some are more dominant in the Northwest. And so, you know, we've tried to take a more ecumenical approach to it and do it around our and do it around groups that we're you know, wanting to partner with.
So, we're we have urban areas. We've got a lot of locations in you know, Austin, Texas, Fort Worth, Texas. But we also have Norman, Oklahoma, and we have areas that are very rural. And it works for us. Yeah. Very interesting how you described a company that can grow, but I never heard you say, you know, if we're going to go into a new state, it's got to be 15 clinics with a single company. So, what I hear you saying is, you know, a three or four clinic company that has an owner that wants to stay in long-term, grow that business, and has a growth plan, even in a new state could be a target for Confluent.
No, that's absolutely right. I give you some examples of that. We have some partnerships in Colorado Springs and we have a partnership in Fort Collins, Colorado. And you know, some would say, well, why would you go want to go into a market where the reality is, you know, you've only got a couple three clinics there. Again, you can manage from afar a little bit better. You can still bring scalability to a practice in that way, but you also have the opportunity to grow through that partnership.
And so we'll be we add locations in those markets and grow outward. You know, again, it's really more the strategy that each group is trying to do. It's not about right or wrong anymore. Never probably was, but it's really about what works best for your overall strengths. Our strengths are finding private practices and building those practices to bigger private practices. Other groups strengths are they are geographically disparit and so when one state is doing better than the other you know there are certain you know collective you know agreements on which states have the lowest reimbursement are the toughest to do the flip side of it is the states that have the highest reimbursements right now which a state like Washington probably the hardest state to do business in everybody thinks California is I would take five Californiaiforns over one state of Washington just I'm talking legislatively and regulatory wise our practice is great our partnership is great there but very difficult state to do business in.
And so that has to be part of the equation as well. It's not just the reimbursement, it's the regulatory environment as well because all the regulatory environment does is it decreases reimbursement, you know, by increasing your expenses and most practices don't look at it that way. So it's a lot, you know, there's a lot more dynamics and data and demographics around, you know, referral patterns and those things were to grow. Very sophisticated tools. Sometimes that works, sometimes it doesn't. You know, when I first started in the business, we used to go to the local grocery store in Kroger.
I remember standing outside of one in Bstown and asking the folks, "Where's the best place to put a physical therapy clinic in?" Well, we didn't realize at that time, you know, 70% of the population had never even heard of physical therapy. So, okay, what about a medical office? Where would you put one of those? Where do people you know and so you know I don't know that the sophisticated tools are any better than the unsophisticated ones you know at the end of the day you know patients will only drive so far for PT and it needs to be accessible good parking good network effect all those kind of things but you know we're living in a time where data analytics seems to oftentimes you know trump over common sense absolutely so all ears and eyes will be on your response to this question.
And I'm so glad I have you here to ask you this question. You know, I don't get on a phone with a potential prospect or with one of our clients that we don't have the question of we're seeing rising interest rates, which seems to be one of the biggest threats. And, you know, our rising inflation is certainly not helping our economy in any way. And we don't need to make this political, but how has this affected the thinking and the behavior of acquirers out there in the industry today?
Yeah. So, there's a ton of dynamics. I like to reflect a little bit historically on this because, consolidation in PT has gone on for 30 plus years primarily through three different generations. This last generation which I would say started about 10 years ago has been the best bull run of consolidation for PT ever. And the valuations and the frothiness of the markets have been the best ever. And why is that? Well, you had lower interest rates, low interest rates and the debt markets always dictate valuations.
I know people don't like that correlate it, but it is absolutely directly correlated. High interest rates, lower valuations, and in some cases, the debt markets right now are in such bad shape, you can't even get certain acquisitions funded. So again, it depends on the financial stability, the debt ratios, and everything else of your partner. So I do believe that there are some indications that things are coming back down a bit. I don't think there's any I don't need to think this is earthshattering, but reimbursement has not kept up lock step to inflation.
You know, we're one of the few businesses where our wage inflation goes up. We can't pass that cost on to customers. We're blessed at Confluent and that we have three other business lines that are more businessto business and studentto business, educational oriented that do tend to be able to increase rates lock step with inflation. But inflation lowers margin. And so I think you know you have some effects of the regulatory impact which is again a hidden cost you know element that has it. Medicare fee schedules have not gone up.
In fact there's debate now on this latest one which looks like another reduction. So you have to have the economic understanding and the expectations of what's going on in the market. But like I tell folks though, while it may not be at its all-time high right now, it's coming down from its all-time high, which means it's likely still going to be higher than it was in the prior two generations of consolidations. And why is that? Well, one of the reasons is there's a lot of what they call overhang or money that's in the market that private equity has withtood.
And private equity has been one of the best asset classes, you know, returning 11 to 15% a year. Granted they're very illquid investments for a while, but it's still a tremendous asset class. And when that is there, you will still have an element of a great number of investors that want to invest in health care services. Health care services is believed and generally true to be resistant to recession. As we all know in PT, when recessions happen, we tend to do pretty good. Workers comp actually gets better during the initial stages of a recession.
So I think we have to be mindful of all of those kinds of things and we're coming from a position of very high valuations and so even if they're have been leveled down a bit, they're still going to be very good. But the real issue is for practices, don't try to time that part of the market. That's that's silly. Find out why you were going to market. If you're are you if you're just doing it to be opportunistic or fashionable, you better change your thinking because the graveyards are full of PT practices that did it only for the money or the opportunity.
What is your plan and does it make sense to do it by yourself? Does it make sense to buy services to contract services or to partner? And really what is your overall path and strategy? And if it's for the right reasons, it's definitely good timing. The timing will continue to be good for partnering because at the end of the day, at least in our case, our partnerships are more about the future opportunities. Most of our partnerships do better on the second and third and fourth bite than they did on the first because their valuations are tied to the mother ship here.
So, good opportunities for the profession. You're still at a tremendous time. As good as consolidation has been, if you really look at the industry, it's still a very fragmented industry. And so consolidation hasn't you know really worked in the sense that you know if you still took the top 10 players in aggregate that's still a very small percentage of the overall pie. So I expect there to be continued consolidation for sure. Yeah. Yeah. Really great advice too. You know, we continue to talk to prospects out there in terms of, you know, if you look at the metrics on the borrowing that has occurred and continues to occur not very often, you know, you're getting 5% down for a loan and you're getting 95%.
So, so the metrics are all so different that we also are looking fairly positively into the future that there will still be a market as you said, maybe not the booming market that we've seen over these last three to, you know, nine months, but there's still going to be a real solid market out there. And I'm glad I'm hearing the same thing from you as well. Larry, as always, you're so objective. You have such phenomenal information for our listeners. It's why we continue to bring you back over and over again.
Thank you. I really appreciate your time today. Certainly your expertise and again the value you have provided to our listeners today. Thank you. It's always a pleasure, Paul. And for our listeners, if you heard anything today that piques your interest on what's going on in today's market, and you want to have a chat with me about that, just click below and let's talk. Thanks for joining us today, and I look forward to talking to you in the very near future.
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