REPLAY: 3 Challenges and “A Real Threat” That Owners Must Face, According to This Acquirer
Aaron Kraai, CEO of Doctors of Physical Therapy, joins Paul to discuss the labor shortage, expectation gaps with new clinicians, and why he sees health systems as a real threat to private practices.
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. We are continuing in our series talking to thought leaders in this industry and our series that we've called how to maintain value in a declining market and very recently some banks getting into some major issues and today we have with us certainly one of the thought leaders in the country Aaron Kraai who is the CEO of doctors of physical therapy Doctors of Physical Therapy is a private act private equity-backed physical therapy company that is based out of Neapville, Illinois.
We have had Aaron on before and this company just continues to grow with really solid growth. They are now in five states, Illinois, Michigan, Wisconsin, Iowa, and Kansas, and they have over 80 clinics. Aaron is a doctor of physical therapy. He received his degree from the USC in California. He also has degrees in biomedical science, molecular biology, and cellular biology. Aaron, it's great to have you with us today. Great. Thanks, Paul. Appreciate you having us on. So, Aaron, you know, there there's a lot of angst in the physical therapy world right now with all of the things going on economically.
This new bank crisis that we're seeing and it seems as though this is resulting in major challenges for private practices across the United States. What would you see right now if there were kind of the top three challenges that you see for 2023, 2024, let's call it the foreseeable near future for private practice business owners that they're going to have to overcome in order to continue to drive value in their business? Yeah, thank you. Well, we can go many ways for sure. But you know, I think the top three have to do with number one, the labor constraint.
Is probably the largest one. We also have in my opinion an expectation disconnect in regards to that labor and then also I think health systems as well. We can also get into you know cash within inflation and all of that but I think that to stay focused in the private practice section space I think our bigger picture needs to be focused around labor academic world and expectations and then in my opinion our biggest challenge is the health systems. Yeah. Yeah. So let's start with the first one labor restraints.
What from doctors of PT as well as what you're seeing on practices that you guys have acquired and are now working with what do you see are some of the best practices or strategies that you have seen to overcome this issue of labor restraint and if you have any examples of things that folks have done we'd love to hear those as well. Yeah. Well, I think it's a very serious issue. And I think it starts way upstream. Quite honestly, I think it the academic world has been so good to the PE private practice section providing outstanding research and literature to allow us to do what we've been doing for specifically in the last 30 years where we've gained a ton of credibility in the health care space.
I do think it's a time where the academic world should step back and look at the model. We lost 22,000 therapists during the COVID pandemic. We're graduating only 11,000 students a year right now. Right now, we've had a lowest first pass rate due to the COVID pandemic. Not because of academics, because of the pandemic. So we're just not we just don't have enough therapists or clinicians out there to meet the demand as we continue to push the boundaries of a PT profession which we should be the muscularkeeletal experts in.
We really need that supply to come of great clinicians. And I think that going upstream and working with the academic world to look at a maybe a hybrid model where the manual component is on site where the you know the didactic world is on a hybrid really would start to fill up the funnel more. So I think that's really the fix of it or the upstream one of the fixes. What we've done with DPT really has to do with that first year out. We're fortunate enough to have a really strong reputation in our markets in regards to being a high quality employer and doing the right thing over a long period of time.
And you know that snowballs over time and doing this daytoday doing the right thing dayto day really adds up and gains credibility. So, we're able to recruit, you know, clinicians that have been in the market for many years and have had other experiences with other companies. And we've been able to get those, you know, the new graduates, come in and there's companies that provide very large big companies that provide very large signon bonuses, which, you know, a typical private practice can't do. Even someone of our size won't do.
So we really have, really invested in that first year of mentorship. We our new grads come underneath a mentor for a year in my opinion it's the most important year of the entire professional career is that first year you have all the school skill sets and you get coupled with a master clinician who's been in the trenches that can really teach you what the real world's like I think that's what we've succeeded the best on with our new graduates and again we've been able to recruit seasoned clinicians because of our reputation as being a good quality employer over a long period of time.
So Aaron, you are hiring folks with a lot of experience and one of the advantages to those physical therapists with experience is that they'll now have the opportunity to mentor one or more of your first year you know physical therapists. Is that is that am I hearing that right? Yeah. You know, it actually goes both ways, right? Those those new grads have a ton of education and a great base of research and literature that you know, as much as you try to read on the outpatient side of things, you know, you just aren't you guys aren't engulfed in it as you are in the academic world when you're as a student.
So, you know, the relationship and the education goes both ways. This isn't a one-way relationship. They actually and they give energy. They give energy to some of us older clinicians that you know are kind of into a day-to-day and really it is a wonderful relationship and we've been producing outstanding therapists at two three years out. I mean way better than I ever was at three years out because of this mentorship program. I it's that first year is the most important year that a new grad could have.
Or it could really be detrimental. You get put into a bad environment where you know you're just a cog in a wheel and you know expected to produce whatever. That could go the other way as well and that's why we might be seeing a such a big burnout rate at five years in the PT profession right now. Yeah. And so in addition to clinically what you know your mentors are able to pass on to you know new upand cominging physical therapists. Is there also an element of you know making sure that they're taking responsibility operationally financially etc.
Just give me a understanding of kind of how broad that is for the mentor. Yeah, it really goes right into my next, you know, challenge. I think the expectations, again, this is not a knock on the academic world. I think it just needs to be a better partnership between the private practice and the academic world. And again, just specific to I don't know anything about hospital or neuro or anything like that. I know private practice and I think that the expectations or the education for private practice is it could be in increased in the academic world really understanding you know what makes a business work what is a private practice how do you get paid I don't pay the clinicians I transfer I transfer funds from our cli our clients to the our clinicians they have to really understand especially because as the supply and demand curve has really pivoted a little But you know they are driving or expecting pretty significant salaries as new grads.
Well that has to get paid for but somehow and so that expectation of coming into the private practice world and understanding what makes the world turn is really important. And if we could get upstream into the academic world and really give them some financial foundation and some real life expectation and not just a 16we go in and learn how to be a clinician because that's vitally important because if you're a bad clinician you're not going to make it in private practice anyways but having an understand world of it.
You know it's I've been working really hard with USC to to enhance that and it's going well. I just I think that there's an opportunity there. But that mentorship program absolutely includes that. Absolutely. Because it they go hand in hand. You can be a good clinician and still run a great business. We've proven it now for 17 years. It's it's possible. And I think, you know, in our experience, what we see and we're certainly not on the front lines of, [clears throat] you know, talking to physical therapy schools and students just coming out of that, but our what we hear as feedback from our clients as well as prospects across the country is that there's such a gap between what the educators believe needs to be taught versus what actually is happening when these physical therapists get out into the real world.
Yeah. And to think that every one of these therapists coming out of school are now going to work for, you know, small mom and pop physical therapy private practices, which is what our business has been grown on. Y with the number of large private equity-backed companies a large number of those physical therapists are going to be going to those companies which will have expectations. How are we ed I'm just curious. How are we educating the I know at USC how are you seeing that we can educate you know schools to make as a part of their curriculum to really truly prepare students who are coming out for what they're go for what they're going to see as challenges working for most companies.
Yeah. Well, you know, in my opinion, this is on the private practice world. This isn't on the academic world. You know, we know where the gap is. We see it. We're downstream of it. So, this is on us. We need as private practice owners to be more proactive in partnering with these academic facilities to get what we need. This isn't on them. They don't they they're not in our world. We are. And so, in my opinion, the private practice world and the private practice section and a lot of us, need to be more active and more, open to going upstream and getting to these academic worlds and putting in a business, you know, you know, a quarter or an elective or something so that we can show the expectations.
The world is changing. The the private practice world, I've been in the private practice world since I was 14 years old. It's a lot different than it it's ever been. And so we have to start to ensure that our these new grads have the all-around education that they need to succeed because if they're missing a component that's a big lift for the outpatient world to private practical world to kind of fill and we do it but you know it'd be a lot better if we could have them starting off on third base versus first.
So it's on us. Absolutely. Absolutely. So Aaron, talk to me a little bit about health systems and the threats that you see coming from health systems as another one of our biggest challenges kind of moving forward. Yeah. You know, I speaking and talking to a lot of small private practices, mom and pop shops, you know, they really are concerned about the consolidation about the big groups. I think that this is not their this should not be their biggest concern. It's absolutely the health systems that are should be our biggest concern.
And it's primarily because of the fee schedule. Health systems are on you know 150 180% of our fee schedule. And what that leads to is them being able to recruit therapists away from us at prices or compensation packages that would bankrupt any private practice. Yeah. You know, just had one last week where it was like a $100,000 for you know a year out person. I mean that that's you can't run a private practice with these type of metrics and they can do it only because they're getting 180% of our fee schedule.
Yeah. So, we'll battle we'll battle anyone in the private practice section or in the private practice world. As long as we're on the same fee schedule, as long as we're on the same playing ground, I then let competition win. Let let capitalism win. And, you know, the best will survive. And that's why private practices, especially mom and pop shops for 50 years have always survived. Always have survived because they're providing the high quality care, the intimate settings, the one-on-one stuff that you know was really driven markets.
And so the you know, in my opinion, the mom and shop shouldn't be worrying about the big groups that are rolling up things. That's that's a different you're on the same playing field. As long as you keep to your pillars, you'll be good. The problem has is that we're not playing on the same field as these hospitals, health systems. They're getting paid a lot more for the same service actually sometimes less of a service 45minute units and so they're able to now recruit and you know and I can't blame I can't blame these clinicians they can go work at a hospital system and make more money and treat you know seven patients a day I mean I can't blame them this isn't a blame it but that is an absolute challenge to our private practice world and something's going to have to something's going to have to change otherwise it's a real threat a real threat.
Yeah. And you know, you're the first CEO that has brought that up. And having built my business way back when, a third of our business were hospital contracts of which we saw with the hospital was being reimbursed. You know, we got the EOBS. You know for a $90 session on our side there were times they were being paid almost $300 a session. How do you compete with that? How do you compete with that? And so I think what we're seeing is hospital systems are finally now saying hm now maybe we can make some money in physical therapy if we are able to bring in the providers.
We're able to do a little training. Were able to give our doctors what they've been looking for years and years, which is good, solid orthopedic care. And maybe this could be another cost center for us that would actually make money. I see health system after health system either bringing companies in to help them do that or just hiring their own and do that. And like you just said, h how can you possibly compete with that on the level that we started our discussion which is you know there's the supply and demand issue for physical therapists right now.
Yeah. And in full transparency, Paul, we also have u you know MSAs with hospital systems. I'm not saying it's part of what we have to do to survive. I'm not judging that at all. I what I'm saying is that is an absolute threat to the monops to all of us until they figure out this fee schedule. Now, the way to fix it or how we've battled it is just and transparency. You know, the consumer gets stuck with that $300 bill and that 20% co-pay. So, you know, you know, transparency is a wonderful thing, especially if you're doing the right thing.
And that's how we built this company is on honesty and transparency. So yeah, you can go to the hospital and get seen and you'll get a EOB that would be significantly more and you're going to owe 20%. You know, let them make their decision. So I again, I'm not I'm not here judging the model because we're part of it. So, I'm just saying it is an absolute threat to the private practice and the mom and pops specifically should be concerned about them because they don't have the ability to scale or partner like we have or some of the big companies have really grown their whole company on these models.
So, that's where I think that the real threat should be focused on. Yeah, for sure. And no, we're big advocates of aligning with hospital systems. Finding ways that you can work together because, you know, as we just discussed, if you don't, you're going to you're going to you're probably going to get beat at some point. And as I said, they're finally figuring out that they can do this and be profitable with it. So, yeah. Yeah. No, I think that is an enormous threat and one that yeah, as private practice and PPS, etc.
We really need to continue to challenge and fight. It just makes absolutely no sense. And yeah, we need to keep fighting that for sure. Yeah, absolutely. So Erin, as a physical therapy bone, as a physical therapy owner that wants to sell their business in the next six to 18 months, where would you tell them to focus their attention? What are you for you guys? What's most important to doctors of physical therapy as an acquirer in the targets that you're pursuing? Yeah, I think it's a great question specifically, Paul, because we've only focused on mom and pop shops.
We we haven't done we don't do big acquisitions. We feel really comfortable in the mom and pop space. We've done it a number of times. Have had great outcomes with great people. So you know this is something that I know pretty well. I you know if you ask me about buying a 40 location company I would have to defer to some of the bigger CEOs. But you know this mom and pop shop wheelhouse I feel pretty comfortable in. You know, for us the metrics are the metrics.
The metrics are almost the second thing I look at. The the first thing for us has to do with reputation. The reputation in the local market is absolutely key. More importantly probably is the legacy. So, is there a second is there a junior therapist or someone underneath the matriarch that is looking to grow because you know typically we're acquiring companies and the matriarch she's on her sunset years you know maybe two three years left something like that but that legacy needs to carry on that's really what we're buying you know the tables have no value and a Swiss ball has no value the value is you know grandma Sue and Grandma Sue PT.
That's the true value that we're acquiring. And so ensuring that you have grown a leader or someone that is really willing to kind of step up and take on the legacy and then grow with us because that's what we do. We really take, you know, Grandma Sue PT and try to turn it into three of them with three of their therapists that are on staff. So really giving them an opportunity to grow. So in my opinion, the numbers are the numbers. You know, you can't sell a business that is, you know, not profitable or typically but, you know, really focusing on that leadership and that mentorship of that next generation that's going to take your legacy and run with it.
We're just going to provide the gas and some of the support. We really need the local therapist to continue on that legacy with those referral sources and that and those people in the market. So that's the most important thing in my opinion. Sure. That's interesting perspective because again one would think that you know the larger practices that are being acquired that you know that legacy would be so important. But when you have a clinic with you know I'll call it three or four PTs and one of those PTs is the owner.
And that owner leaves you know one of those PTs better be able to take over or you know the whole thing you know usually with the larger companies there's regional manner managers or there's managers in each clinic and you know but yeah I can see where that would be even more important in what we're calling kind of the mom and pop practices which is again what looks like what it sounds like doctors of physical therapy has been grown by and this profession has really been was the base of this profession.
So yeah that's really interesting. Well again that reputation if it is a larger practice 15 or so you know that that's distributed over a greater amount of people. So you're not as much risk like you said on one person as you are in a in a local mom and pop shop. We are really relying on a great reputation and a good relationship with me. That I'm going to take care of their baby and their people as we move forward. And again, we've been lucky I want to say lucky, we've been good to make sure that we've kept our word with all of them.
And and as the roster gets bigger, it's been easier to say, "Oh, go call so and so and see how it's been for them." So, yeah. And you know, we have had the opportunity to see you carry out, Aaron, what you just described, and it's nothing short of what you just described. Yeah, Aaron, I've always been impressed. You are someone who does exactly what you say you're going to do, and every one of our former owners that I talk to says the same thing. What he told us he would do, he's doing.
So, yeah. It's my word. It's all I have. Right. What's that? It's my word. It's all I have. So, that's exactly right. Aaron, are there any new offerings or services that you think private practice business owners should be exploring in today's market? Yeah, I in my opinion really focusing just going off the hospital conversation we just had in that in that in that fee schedule arbitrage really going after in my opinion again humbled opinion in a very narrow space you know really looking at risk-taking opportunities on the fee schedule side of things on the payment side of things really using the quality therapists that you have in the clinic and kind of putting your money where your mouth is.
We've done it for many years now and it's been very successful. And so really looking at opportunities where you can put take some risk potentially on the payment where you get a either a flat rate or a or you get an incident rate or whatever that might be. There's a couple different ways of doing it. And then the better you perform, the more you make, which it should be. You know, right now in this fee for service market, you know, the worse of a physical therapist you are, the nicer of a car you drive.
And I just don't think that's right. So we've always taken risk for many 17 years now in certain areas. And I think that I think private practices really have an opportunity to go to their local market in the work comp space or in the benefits side of things and set up a deal with the local manufacturer and take the middleman out of it. So, I think that's a really good opportunity right now to really because the self-insured employers are all paying the same fee schedules we are three times, four times and it's all going one way.
So, if you can help that local employer by setting up a direct to employer or a risk sharing market, I think that's an opportunity that if you got one clinician or two or five or 20, you can do that. Any of the private practice in watching this can do that tomorrow. There's no limitation to that. And and many times you know the local businesses want to work with other local businesses. Absolutely. And so they have that opportunity. And in many cases as you just said these are businesses that you know have been seeking very streamlined approach to that care that can be provided.
Also some preventative you know things that physical therapists can provide for these businesses. So yeah, no, I agree that that's a that's something that even the small practices can certainly pursue in their local markets. I bet you if you took a five mile radius around every private practice, there's at least 10 opportunities to do something like this. And then again, it derisks your your leverage to the payers. You're not reliant on that payer's fee schedule, and you're not relying on them cutting your fee schedule next year.
So, I think it's an opportunity that any private practice, large or small, should be going after. Yeah. Yeah. Great, great point. Great point. So, I'm going to flip that now. Are there new offerings or services that you have seen out there that private practice business owners should be avoiding? And it's something that, you know, as an acquirer, when you see these things in private practices, you're like, h, I see you do it, but we'd rather not do it going forward. [snorts] Yeah. Well, first let me say to each their own.
You know, I really I I'm not I don't have a crystal ball. We're not perfect by any stretch of the imagination. So, I'm not here to say one's better than the other. You know, if you want to offer a certain service, you know, to each their own. I think two things. The first thing is from a kind of higher level you know this race to the bottom with you know these networks that are keep just using one private small private practice against the other to reduce the pay that they pay you.
I think at some point we all have to just put a line in the sand and say no more, you know. Legally, you know, legally, I'm not I'm not sure discussing anything else, but legally, I just think the race to the bottom, and they know they can leverage the mom and pop shops, and I just don't think it's right. I think that's the one thing, but it's easier said than done. I've done it when we were small and we needed more bodies in the in the clinic.
But the reality is if you've got a 48 hour waiting list and you can't get someone in, there's no reason that you should be taking a $50 an hour or $40 visit fee schedule. There's it's just a reality. So, I think that would be the first caution and that's really hard to say to do or not to do. I mean, again, to each their own and what they should do or not. I just really hard for me to say that. I will say from an acquisition standpoint for us and I've made a couple of mistakes and that's why I know the cashbased business is really hard for us to acquire.
Yeah. The reason is that the cashbased businesses are getting $150 $160 a visit depending on geographic. I'm just talking about us again very focused. They have to come into our network legally when we acquire them. So we take a big hit in the revenue side of things. And again, I thought in the beginning that I could make it up in volume. So, three nickels versus one dime. That's failed twice now on me. We still are doing good with those. They're great companies. But I will tell you as an acquisition, we will step back if you've got a pretty significant or even a large portion of your revenue coming from a cashbased model.
Again, I'm not against it to each their own, but from an acquisition standpoint, it's really hard for us to roll have you join our network because we will take a revenue hit and that's Yeah. Or be willing to take a revenue take a valuation hit on your side. That's the other side of that, right? But not a lot of owners are [snorts] willing to do that, you know. So, yeah. So, it seems like you're on two ends of the spectrum there. So, it's companies cashbased getting, you know, $150 a visit.
And yes, we see the challenges there for larger companies that are insurance-based trying to migrate that into and I can see enormous challenges there. Yeah. And then on the other side, it's, you know, we're, you know, the insurance company came, they said, "Look, it's $40 a visit or we're out." And that's a company that has no empty airline seats. No empty airline seats. Like you said, it's, you know, two days waiting to get anybody in. And yet still with these and that's what we usually tell folks is if you have empty airline seats and it's 60 bucks a visit.
But you're trying to get more patients. Sometimes it may be worthwhile. But man, if you if you got a waiting list and you're accepting patients, you know, as you said, from payers, it's not the patient's fault. No, it's the payer fault. That are just underpaying for what we provide. Yeah, so I very interesting on both ends of the spectrum are things that private practice should be avoiding. I think that's great advice. Yeah, I think just again being in the trenches, everyone just has to make their, you know, do what's right for them.
But, you know, again, and again, you're right. You know, what these payers are doing are leveraging the morals and the ethics of us therapists. That's what they're doing. They know we're not going to let that patient walk out the door because they're in pain. We're going to do the right thing. That's what they're doing. They're leveraging it. It's it's Yeah. Absolutely. Absolutely. So finally, how have some of these economic changes impacted Doctors of Physical Therapy and you know kind of your approach to acquisition growth? Yeah, you know, from us again because we're not doing really large [clears throat] monster deals, you know, the debt side of it for us is isn't as a big of a component.
Now it is a little bit, but so the interest rates will affect us. You know, my concern really for the small private practice has to do with the inflation rate right now and you know, the cash on hand. Again, a lot of these private practices for a long time were really strong and you know, payers were good and cash was great. Well, things have tightened up on every single level of the market from inflation to market rate to payers to I mean there's a lot of pressure down right now.
So, you know, we're hopeful we can, you know, get to some of them before, you know, the last thing I would hate to see happen is just locking up private practices and just shutting the doors down and saying, "I'm done with it. I'm retire and I'm all my hard work is just my legacy is gone." You know, those master clinicians that have given so much to our profession, it just hurts my soul. Like I said, I've been in the profession since I was like 14 years old.
It just hurts my soul that they would go out that way. So, you know, I do see that, you know, for the last four years, well, Paul, you know this more than anyone, right? The four years, it's really been a sellers market for probably four years and maybe a little bit more than that. You know, I do think that that's starting to slide a little bit. Where I think that being able to demand a premium market, I just don't I don't I can't see it continuing.
I've been wrong many times before, but we've already started to see it kind of slide a little bit because yeah, primarily because you can't get the debt because of inflates and you know, capital market has gotten really tight recently and as of this week, I'm sure it's going to get even tighter. Sure. Sure. Yeah. Yeah. No, great advice. And you know our you know advice to folks is that if it's something you want to do probably better to do it sooner than later. It's probably not going to get better in the next 12 to 18 months.
How much worse it gets I think is really hard to say. We see that it's has slipped a little maybe back down to some normaly and still good solid strong deals. Oh yeah. Not some of the you know high sky deals of 21 and 22. So yeah and that's kind of the first conversation now actually just yesterday you know got a book and you know the first question to the broker is I what's the what's the expectation of this owner like what do are they you know because I don't want to waste anyone's time I don't want to waste the your time or their time you know if they have a different perspective which we all do right it's our babies so we all know that it's we think it's worth more than it is but you know especially now having a realistic expectation for the next year and a half, I think is going to be important to getting a deal done, I think, and it will try to help with a little bit of the emotions of the whole process, you know.
Sure. No, that is great advice. That that is great advice. Well, Erin, thank you. And for any of you out there who have questions for Aaron or myself based on today's discussion, do not hesitate, you know, click below and we can talk. And Aaron, I would like to thank you again for coming on. You are absolutely, as I said in the beginning, one of our thought leaders. And we really appreciate you continuing to have a willingness to come on and share your knowledge with all of our subscribers.
So Aaron, thank you. Well, thank you, Paul. I'm humbled that you invite me and invited me back even. So, thank you. I really appreciate it. I'm humbled and any way I can help, I'll absolutely help. Thanks very much and have a great day, everybody. Thank you.
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