Keep Your Valuation High By Keeping Your Risk Factors Low, Key #4: Market Risk
Paul breaks down market risk, including competitors, local payer and referral patterns, demographics, and acquirer alignment, plus three steps rehab owners can take before a transaction.
Full transcript
Generated from the episode audio and lightly edited for readability.
Good morning and welcome to another episode of Paul Martin's Guide to finishing well. Today, we're going to continue on our series of analyzing and driving your risks down in order to have a higher multiple as well as a higher valuation for your company. Today, we're going to focus in on what we call market risk and how that can impact how an acquirer and what an acquirer is going to be willing to pay for your company. Let's jump in. So as it pertains to valuation in this industry comes down to two things.
The EBITDA that you have, that's the earnings before interest, taxes, depreciation, amateurization, let's call it the cash flow, the bottom line cash flow of your company, and that's multiplied against a multiple. So EBITDA times a multiple is what equals value. Well, what drives that multiple higher or lower? It all comes down to the risk that is inherent in your company. And where we find most of the risk in a rehabilitation business really is in five major categories. First and foremost is earnings risk. And what I just described your earnings is that EBITDA.
So earnings risk is the most important risk factor and all of the other risks roll up to that earnings risk. We have referral and payer risk. We have people risk. We have market risk is which is what we're going to dive into today. The market risks inherent in your company. And finally compliance risk. So, how does risk actually impact your valuation? Well, it's simple. The higher the risk in those five areas, the lower the multiple and acquirers is going to be willing to pay. And the lower the risk in those five areas, the higher the multiple an acquirer is going to be willing to pay.
And why is that? Well, because acquirers are borrowing money. We call that OPM, other people's money in order to acquire businesses like yours. And so they have to pay back these sources. Remember, private equity groups are borrowing from banks. They're going to have to pay them back. And the way they do that is they use the earnings that they've acquired from your business going forward in order to pay those other people back. And that's why the earnings risks is so crucially important and the earnings of your company is so crucially important to an acquire.
So today what we're going to do is talk about market risk and depending upon your position in your market that's going to impact directly the ability for your company to continue to have an earning stream in the future. And that's why it's so important. So in terms of market risk, who are your competitors? Are they larger companies? Are they private companies? And most importantly, how and why are you better? Really important for you to have an understanding of your competitors in and around your market and how and why you are better.
What is the market payer and referral? What's the knowledge that you have that you'll be bringing to an acquirer about the payers in your market as well as the referral patterns in your market? Do you get a large number of referrals from the community or are they coming directly from hospitals? Are they coming more from direct referral sources, physician referral sources? And in addition, who are the payers in your market and how do they operate? Do they all just simply follow directly from Medicare and kind of or are they significantly different from Medicare?
Having a knowledge of that is going to be crucially important for you to have going into the market and understanding how you are positioned in that market as it relates to referral patterns and payer patterns. And then finally, do you have an acquirer market alignment? Okay, what we mean by that is, have you studied and analyzed who the acquirers are around you and how you align with them? Are you a larger company in a market and a an acquire outside your market could come in and use you as a pedestal as an initial acquiring company in a market and then you would grow or do you add to something that an acquirer already has in a market.
So it's really important to have that acquirer market alignment and the only way to do that is to have a map. And that's something that we do. We map all the acquirers around your company and show you what that market strategy will be going forward. Do you have basic demographic information on your market and an understanding is this a growing demographic? Is it a declining demographic? And the wise for either one of those things really important for an acquirer to see where your market is headed based on the demographics.
So what are the three things that you should do today in order to decrease your market risk in the future? Number one, do you have a statement on your position in the marketing? Meaning, can you describe in a very two or three sentences what your position is as it relates to the other competitors around you as well as the acquirers around you? Do you have a plan for your growth in your market? Now, we can define your market with as wide of a radius as you believe you have referral sources as well as potential patients.
And do you have that growth plan in place so that an acquirer can see where you're headed in that market? Of course, under confidentiality, this is. And then third, do you have a strategy? And notice we say strategies for acquirers that are both in your market as well as acquirers that are out of your market because both of those strategies could work as it relates to acquirers in this current market. Again, as we look at your map and look at the acquirers in your market, we're going to look at the position of your company compared to acquirers that are already in your market.
How do you align with them? What do you bring unique and different from those clinics that they already have there that could improve their position in the market? Or are you are you a benchmark? Or you were a new company in a market, meaning a first acquisition of a company in that market and they're going to utilize your company to grow from there. Really important. So if today you are considering at some point in the future that you would like to potentially take your company and explore this market and potentially find a larger partner for your company in this market and you're not really clear on what your market plan would be for those companies in the future, click below. Let's talk. I look forward to talking to you.
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