Why Are Private Equity Groups Acquiring So Many Medical Aesthetic Practices?

This is a question I hear all the time from owners of aesthetic practices (loosely defined as medspas, plastic surgery, or dermatology practices that have a medspa component). In my experience, many aesthetic practice owners have a hard time understanding the economics behind PEGs (Private Equity Groups) and their willingness to pay what often amounts to a significant premium for their practice.

As I will explain shortly, their strategy is actually very straightforward and, when executed correctly, can be very successful for all parties involved. But before we dive deeper into the economics, let’s discuss what a PEG is.

What Is a Private Equity Group?

You may have heard of some of the giants in this industry, like Bain Capital, KKR, and Blackstone, who helped pioneer and expand this concept. These firms have hundreds of billions of dollars under management. There are an estimated 4,500 PEGs in the U.S. alone, and the vast majority are considerably smaller than the giants.

Simply put, a PEG (or one of the funds they establish) starts with a pool of investors. The PEG uses these investor dollars, combined with money borrowed from banks and other institutions, to acquire companies for their fund; it is not unusual for a PEG to have dozens of funds spread out over a wide spectrum of industries.

It will be one of the PEGs funds (also referred to as a platform company) that acquires an aesthetic practice. This fund or platform company will ultimately consist of a group of aesthetic practices with key elements in common. For example, some funds specialize in plastic surgery, others in dermatology, and others in pure medspa.

At last count, there were roughly 50 PEGs active in the aesthetics industry, with more likely to enter the market soon.

What are the Economics Behind Private Equity?

A fundamental premise behind private equity is that they can grow their fund much faster by acquiring additional companies—bolt-on or add-on acquisitions—than they can by attempting to grow their platform company organically.

This is critical to their strategy as growth, particularly EBITDA growth, drives the economics. Of particular importance is that the value of the platform company increases at a rate much higher than the growth rate of its EBITDA. Said another way, if the platform company’s EBITDA increases fivefold, the value of the platform company should increase by a factor in excess of fivefold EBITDA growth.

Allow me to provide an example. Generally speaking, an aesthetics practice with EBITDA in the range of $500,000 to $1,000,000 is valued between a 4x and 6x multiple of its EBITDA; countless factors help determine what part of that range a given practice will sell for.

Now, let’s say a PEG has acquired a total of 30 aesthetics practices in the $500,000 to $1,000,000 EBITDA range over three or four years. In total, the platform company would grow to $15 to $30 million of combined EBITDA. At that size, the value of the platform company can be worth as much as an 8x to 12x multiple of EBITDA. In other words, the platform company is worth roughly twice as much as the 30 individual practices were each worth on its own. That’s the simple economics between their strategies.

So Private Equity Is All About Acquiring as Many Bolt-Ons as They Can, Right?

Not really. Growth through acquisition is just one part of the strategy and economics behind PEGs. It’s just as important to them to acquire aesthetic practices with key elements in common with their prior acquisitions, such as a similar patient philosophy, company culture, and core services provided.

Why is that so important? Because PEGs look to further increase the EBITDA of the practices they acquire by:

• Centralizing certain functions that increase efficiencies and lower operating costs.
• Taking advantage of increased purchasing power to drive down the cost of goods sold.
• Implementing relevant “best practices” throughout all of their bolt-ons that have proven to be successful throughout their platform.
• Investing in organic growth where it makes sense, such as adding equipment or staff, expanding the existing facility, or even opening additional locations.

If done properly, this further accelerates the EBITDA growth, creating an even higher value for the platform company when it comes time to sell.

With So Many Industry Options to Choose From, Why Is Private Equity So Interested in Acquiring Medical Aesthetic Practices?

One of the main tenets behind private equity is to identify a highly fragmented industry with long-term growth potential and then start consolidating it.

In the medical space, PEGs previously identified dentistry, ophthalmology, optometry, and cardiology (to name a few) as highly fragmented healthcare providers, and they have been consolidating or “rolling up” these specialties for quite a few years.

As recently as just a few years ago, it was estimated that fewer than 5% of the approximately 9,000 medspas and 14,000 aesthetics practices in the U.S. were either owned by private equity or a larger entity. To private equity, that equates to a highly fragmented industry.

Add to that the overall size of the U.S. medical aesthetics industry (currently estimated to be $14 billion), its high profit margins, and its future growth projections (estimated in the range of 9%-13% annually through 2032), and it’s easy to see why private equity has become so active in this industry.

Are All Private Equity Groups the Same?

They are not. Let me explain:

• Most PEGs employ a “buy and flip” model in which they build their fund over the course of three to five years and then “flip” it to another buyer, typically a much larger PEG. However, a few PEGs employ a “buy and hold” model in which they will keep their fund intact indefinitely. The former is more common because investors in the fund do not normally want their investment tied up for more than five years, and selling the platform company is the simplest way of cashing out their investors.
• As I mentioned earlier, some PEGs focus on plastic surgery, others on dermatology, and still others on pure medspa. So, their acquisition criteria are very different.
• If independence to practice medicine the way you always have after the sale is important, certain PEGs allow for a high level of independence, while others look to impose a level of conformity as to how the platform company operates.
• Performance between PEGs can vary widely. And since the aesthetics practice owner is almost certainly going to be required to accept part of the sale price in the form of stock in the platform company, the value of this stock will be tied directly to the performance of the platform company. So, a careful evaluation of the PEG, their platform company, and the reasonableness of their growth plan is an absolute must.

Is There a Difference Between EBITDA and Adjusted EBITDA?

Yes, and the difference can be significant, especially for smaller, solo practitioner practices. More importantly, adjusted EBITDA is the actual number you need to focus on when it comes to valuing your practice.

For those unfamiliar with EBITDA, it’s the most commonly used method to determine the cash profit generated by a business’ operations. EBITDA stands for “Earning Before Interest, Taxes, Depreciation, and Amortization.”

Adjusted EBITDA starts with the business’ EBITDA, and it is then adjusted to take into account the owner’s compensation, any owner’s discretionary benefits and expenses that are not required to run the business, and certain one-time, non-recurring expenses and income.

The EBITDA figure is then further adjusted to account for a fair market wage to either replace the owner (or more likely to compensate them for the services they will continue to provide after their practice is sold to the PEG), as well as potential fair market rent adjustments if you own the building that houses your practice. Some of these adjustments can be large and have a significant impact on the value of your practice. So, a careful and thorough analysis of these adjustments is essential in determining the true value of your practice.

Remember, your practice will NOT be valued on a multiple of EBITDA but on a multiple of adjusted EBITDA.

About the Author: Randy Krivo

Randy Krivo is the Managing Director of Medical Practices here at True North Mergers & Acquisitions. He has a wealth of experience, including:

• 35 years building, buying, and selling businesses
• 100+ medical practice transitions
• 100% medical spa industry closing ratio
• $44M enterprise value sold in the past 12 months

Connect with Randy today to learn more about private equity groups acquiring medical aesthetic practices.