Don’t Make These Common Exit Strategy Mistakes with Virgil Ochoa and Michael Ludwig

Bill Walker (00:04):
Welcome back everyone to another episode of Aesthetic Appeal, the definitive broadcast for the aesthetic industry's business side of the house, brought to you by Aesthetic Brokers. The views presented by our guests today do not necessarily represent the views of their respective firms, and we're delighted to welcome two very special and prominent experts in the field of the healthcare industry, both from the legal side and from the accounting side. Today we have Virgil Ochoa from Dykema Law Firm. He's an expert in the healthcare space and M and A transactions, and specifically when it comes to dental and medical aesthetics. And sitting alongside Virgil today is Michael Ludwig, a partner at Cherry Bekaert Accounting Firm, which is a financial analysis and accounting based company nationwide that services a lot of the typical healthcare transactions that you would see in this aesthetic industry as well as dental. Let's dive right in. I'm going to try and walk in a micro podcast today, some of our listeners through understanding some important topics when it comes to planning their exit strategy. And from a legal and from an accounting perspective of knowing what they're going to get themselves into when they ultimately reach that finish line of a transaction. And so let me start with you, Virgil. I'd like to ask, could you share maybe a bit about your background and how you got into the legal aspects of m and a and specifically how you got into aesthetics as a representative?

Virgil Ochoa (01:45):
Yeah, so just to give you a little background, I'm one of the partners over here at Dykema. Dykema is one of these big law firms. We've got about 400 lawyers spread out through the country that covers just about every field. I am one of the directors of our healthcare group and our healthcare group covers dental, aesthetics, surgery, general medical and veterinary medicine, so animal health also. So actually we kind of got into the aesthetic space from the dental world. The dental DSOs and the vet DSOs have been rolling up for quite a while and those same groups that have been working in dental and vet have now started venturing into the aesthetic world. So my first aesthetic deal, I don't know four or five years ago actually came from somebody that I knew in the dental world. So when we talk about aesthetics, we talk a lot about dental and vet because it's the flow from a legal side and from a structural side has grown out of those industries.

Bill Walker (02:53):
Interesting. So Virgil, when you think about legal structure with regards to practice owners who are thinking about selling a practice, does it differ or are there any subtleties that you would bring to light if somebody's selling a hundred percent of their practice versus only part of their practice to a buyer?

Virgil Ochoa (03:15):
Yeah, and this is one of the big considerations, and Michael probably is going to have a lot to say on this also, but the type of deal is very important and it's very important based on what the seller wants and what the buyer wants. These deals come in all different sizes, flavors and colors. And there are some where you're essentially selling, we use that term loosely here, but selling the entirety of the practice. So you're just going to go be an employee of someone else, you're just going to show up, do your job, and off you go. You're probably going to get some rollover equity in the buyer and get some cash there. But there's also partial sales or sub MSO models where you're retaining part of the ownership. And even those come in different flavors because there are some groups that have a setup where you're looking for distributions ongoing, and there are others where you don't have ongoing distributions.

(04:17):
So it really is important that if you are selling, you look at what type of deal it is and how it aligns with your interests. Some people tell me, Hey, look, I'm going to roll in and the group is going to roll a bunch of practices and there is sell it again. And that's fine. But then in that model, you probably are not going to anticipate getting distributions. And if that's what you expect, that's great. Other people like the distribution model where every month or every quarter or whatever, they're going to get some percentage of what they essentially sold back through the profitability. Now the trade off on that is when the whole thing sells, you're probably going to get less money as part of that sale, but you've gotten the distributions ongoing. Nothing wrong with either of these models, nothing perfect about either of these models or any of these models, but it's important that as a seller, you match your expectations with what the buyer wants.

Bill Walker (05:21):
I think that's a really interesting way of framing the conversation for someone who's thinking about their exit. Is this a recurring cycle of revenue in my life of how I'm going to plan for it? Or am I looking at non-recurring distribution type money, but I'm looking at maybe a different profile of trajectory for success? That kind of housekeeping item makes me want to ask you a question, Mike, from Michael of Cherry Bekaert here. I'm curious, what kind of services can someone understand at a high level that you guys provide and how does that tie into how they think about their exit strategy planning?

Michael Ludwig (06:10):
So I've been in the financial diligence space for the better part of the last 20 years, and what we do at Cherry Bekaert, a lot of our focus in working with practices in really any area of healthcare is on the buy side or sell side financial diligence. In certain situations, we do like to bring in our tax group or our valuation group where it's warranted because there is a lot of nuance in these deals similar to what Virgil was saying, and based on these practices, unique structures or the way they've been set up from a corporation standpoint, there are opportunities to structure deals that are more tax efficient for the sellers with really no impact to the buyers. And so if we can identify these situations on the front end, even though we've brought in, we've been brought in as a diligence provider, we do have other members in our team that can really bring added value to a deal and make sure both parties are getting the most out of it.

Bill Walker (07:22):
Man, I think of death and taxes and a good attorney and a good accountant. And as you bring up a great point about tax structure from a financial perspective, Mike, when you think about the everyday practice owner who's successful, fill in the blank number for 5, 6, 7, 8 million revenue practice, what are some fundamental metrics that somebody who's coming up through the ranks that wants to get to that stage in their practice? Success-wise, what are some of the fundamental key metrics that you think they should be looking at financially as far as planning to get to that success for exit strategy?

Michael Ludwig (08:04):
If you're thinking about what really drives valuation in the space, that's going to be really two areas to focus on. It's going to be revenue growth and profitability. If you can keep an eye on those two metrics, that's really what's going to drive valuations, and that's what buyers are going to pay for. If you have a business that's pretty flat on the top line and has decent profitability, you can sell your practice, but you're not going to get the upper end of a valuation range of whatever market you're participating in. But on the flip side, if you've got strong revenue growth and you can display high gross margins in your business, that's what's going to get a buyer excited. And that's really what's going to drive the valuation of your business.

Bill Walker (08:51):
So Virgil, for those practice owners that they go into a transaction and as they get into that evolution, what are some of the pitfalls that they should think about ahead of time that might prepare them?

Virgil Ochoa (09:07):
So this was one of the things that I always love talking about is plan ahead. And a lot of the things that you can do to plan ahead for a transaction is just good business decisions, whether you do a transaction or not, these are good tips. These are the things to do, make sure that you understand your agreements. Who owns the practice? And I use that term loosely. Who gets what, when it's sold, if it's sold, what happens if one of the owners dies or passes away or those type of things. If you have key employees, do they have employment agreements? That's always a big thing because remember, if you don't have employment agreements, those people can just kind of fade off and go other places. They can compete with you and that will affect the amount that you're going to get as part of the transaction. Not only that, but one of the things that we see is some of the PE groups will want employment agreements put in place. And if you don't have 'em in place ahead of time,

Bill Walker (10:11):
PE is for some of us.

Virgil Ochoa (10:13):
Oh, private equity. Yeah. So the buyers, some of the buyers are going to say, look, you've got these key employees, I want them to have employment agreements and you don't have 'em. And if they get win that there's a transaction going on and you want them to sign an employment agreement, what happens frequently is they say, well, what's in it for me? Give me some extra money. And now you're trying to deal with a transaction and an employment agreement and paying people more to keep them on board than you may be wanted to. So knowing your structure, knowing who gets what, taking a look at your tax structure, making sure that you have your organizational documents, making sure that you have key employees with contracts. These are all some of the important factors and whether you're going to do a transaction or not, these are important things I always think every practice should have in place. A lot of people don't even know what their tax structure is, and you really need to know what that is. You need to make sure that it's going to be efficient for the transaction. If you start planning ahead of time, there are things that Mike and we can do to help you minimize taxes. But if you come to us and you say, well, I've got this LOI, it's already in place and here's where I'm at, there's not much that we can do to help you from a tax perspective.

Bill Walker (11:32):
That is one thing that I always try to provide as a bullet point of advice for our clients early on, is to ask them, who's your attorney? Who's your accountant? Do they have M and A experience? Do they have healthcare experience? And do you have someone that can advise you on taxes that prevent defense way ahead of time to everything you're talking about? It's so invaluable for them. Mike, I'm curious about, you've talked about valuations. Could you please explain the concept of a business valuation for some of our listeners and a magical statement of quality of earnings and how they play into M and A transactions?

Michael Ludwig (12:20):
Yeah, sure. So most businesses are going to be valued as a multiple of ebitda, so earnings before interest, taxes, depreciation, and amortization. And so the metric itself is meant to be a decent proxy for the cash earnings of a business, which is why it's used. And the valuation is really going to be a multiple of that metric. And like I said earlier, the multiple is going to depend on a lot of factors, both micro and macro, but the growth of your business from a top line perspective, the profitability percentage of your business are going to be some examples of micro factors that impact the valuation. And then on the macro side, you're going to have things like the interest rate environment that the world is currently operating in or the general economic atmosphere that's prevalent at the time. These are all going to dictate how much is a buyer willing to pay for a certain type of business.

(13:28):
And so in the M and A process, the valuation is usually determined in the pre LOI phase, it's factored into the letter of intent. And that's really what the parties are planning to do. In almost every case, the buyer is going to hire somebody like me who's going to come in and do a quality of earnings. And really what we're trying to do is validate that whatever the numbers you all agreed to on the front end of the process are really what the numbers are. And so to the extent your books and records are in great shape and there's not a lot of issues with the business, everything usually comes out fine. But to the extent where your financial statements are either inaccurate or misrepresented, that's usually where we have our key findings in our process. And a lot of times it can lead to a material re trade in the price of a deal. It all comes back to what Virgil was touching on a moment ago. If you have everything in order leading up to a sale process, not just your legal documents or the structure of your business, but your financials as well, it's going to make the process a lot smoother and it really takes any surprises off the table. And that's an important thing in the process.

Bill Walker (14:51):
Virgil, I'm curious from your perspective, how crucial is it? This is a question that people always say, how good is your attorney? How bad do you need your attorney? You better be sure you had a good attorney before you needed an attorney. But how crucial is it to have a solid legal representation and due diligence when you're talking about debates over what could be possible financial implications of the deal structures?

Virgil Ochoa (15:21):
So this is one of those things where healthcare is specialized and if someone tells you differently, they they're just making it up. A lot of folks will say, oh yeah, I'm a real estate attorney. Or, well, I haven't done healthcare, but I can do this. They really can't. I mean, it's a specialized area. You really want professionals who do this type of work. You want accountants who do this type of work. You want brokers who do this type of work like both of y'all. And you want attorneys who do this type of work. I have horror story after horror story on both the buy side and sell side where somebody used their friend who's a real estate attorney or their neighbor who's an estate planning attorney, or even a family member. One of my favorite favorite horror stories is actually somebody who's a family member, and it was a good size deal.

(16:10):
It was about $20 million deal, and I was on the buy side. They were on the sell side, used a family member as their counsel, and it was one of the most miserable deals we ever had to do because they just had no clue about healthcare and about MSOs and about the agreements that have to go into place. And so they kept questioning things that made perfect sense to all the healthcare folks. And ultimately when we got to the end of the deal, and we did get there, even though it's much tougher and it should have been, the bill on both sides was astronomical, it was about four times what we anticipated on both the buy side and the sell side. And this was a family member, so I assume they got some sort of family discount it's still four times as much. So having professionals who are in this area is essential. That's why I like working with people like y'all that know the field that had the expertise. And I know that our clients are going to get good service from.

Bill Walker (17:13):
There's two stories that you both remind me of that I've seen in the past, and it is heartbreaking. One was somebody in the organization of the seller was taking cash money and it wasn't getting reported on the books. And had we been able to have complete and thorough access with a quality of earnings type reporting agency like Cherry Bekaert and Mike of what they do and the analysis of how we go through things with the general ledger and the bank statements that could have been avoided for them of heartbreak. And the second was entity structure legally build out, and it took hundreds of thousands of dollars extra for them to have it properly papered by the attorneys to match what they thought was actually in place because that's the level of lift that it took to get everything across the finish line so they could do their transaction and they all still want out in the end. But to Virgil, to your point in both those scenarios, it cost them extra money that was just heartbreaking to watch and a lot of anguish and anxiety. I'm curious, Virgil, what do you think of any type of legal developments that you anticipate or might anticipate when it comes to m and a transactions in the meds spa industry upcoming or maybe something that recently has come out that will be good to highlight at our listeners?

Virgil Ochoa (18:52):
Med spa is a very interesting area from a legal perspective because it is, as we call it, the Wild West or anarchy. There's some states that have a lot of regulations, there's some that have none. There's some that have conflicting regulations on what you need to do and how you need to do it. And it's all very much evolving though. We're seeing more and more states kind of jump in and say, Hey, this aesthetic thing, it's not going away, so we need to look at it. We need to get some good regulations on who can do what and when and how. Even the requirements like to give Botox. It varies greatly from state to state, and those are the type of things that you have to really be aware. And from a bigger perspective, from a global perspective, there's a lot of push both at the federal level and at various state levels to have more monitoring of any healthcare type investments.

(19:51):
So private equity investments into healthcare space and aesthetics falls in there and plastics falls in there. So we're seeing a push from, I think there's five or 10 states that are really looking at it and saying, look, if you're going to do these type of transactions, it could be okay, but you have to go to the state, report it and get clearance for it. A lot of those are in the early parts, they're not passed yet, but it's coming down the line. And to the extent that it will affect aesthetics, we're not entirely sure, but almost certainly it'll get pulled in. A lot of us say that aesthetics has been in this kind of situation because there hasn't been a lot of really big problems, but once there's some really big issues that come up, then states are really going to jump in it much harder. And you can see some of the states already doing that.

Bill Walker (20:45):
You mentioned the Wild West. Mike, talk to me, how important is a properly prepared financial statement as far as impact on a business, and what are some common financial mistakes that you see happen for business owners in this space?

Michael Ludwig (21:01):
Yeah, it's funny you use that term because we use the same term Wild West when it comes to these types of things. You actually never know what you're going to get from a financial statement perspective and just seeing how people run the business, it's all over the place. And sometimes that's okay, but sometimes it's not. And so to your question, as in life in a transaction, nobody likes surprises. And so if your financial statements wind up being inaccurate or misrepresented, your transaction's not going to go very smoothly. And I can't think of many cases where an accounting firm is not involved, and so it's going to get highlighted. And so to the extent you can again, get in front of these things on the front end, you're just going to be in a much better position. And as it pertains to Meds Spa specifically, there are three or four recurring themes where we always see issues.

(22:07):
And the first is the way these practices utilize their practice management system. And so this is where you're recording all your services, all your clients or your patients and all the data that pertains to the procedures. And so if you're not properly recording information there and those reports either can't be generated accurately or don't tie to your financial statements, it's just going to raise questions. Are the numbers accurate? How do we know what we're buying? And so putting some attention into those details is really critical, and that's got to happen before the deal even gets close to being signed up.

Bill Walker (22:52):
So if I put all of my production for the practice under my code as the nurse practitioner or the doctor, and I'm not really doing 5 million of revenue production, that's not a good thing.

Michael Ludwig (23:06):
It's going to be a problem.

Bill Walker (23:07):
It'll be a problem. Okay, got it. Good to know.

Michael Ludwig (23:10):
The second area that seems to always come up is inventory. A lot of people aren't tracking inventory, aren't accounting for inventory, but it's a big part of these practices. And so if you can't provide proper accounting or records of how these things are flowing through your business, it just creates another problem. The account's got to get involved and do a bunch of extra work, and the deal's going to take a lot longer, and who knows how the numbers are going to shake out. So it's just important. It's work, right? It's hard, it's accounting, but if you do it on the front end and you make it a process, it's just going to make everything go a lot smoother.

Bill Walker (23:58):
So you're saying I should not be off by 50 boxes of Neuromodulators in my inventory and not know where some of them walked off or where I got extras?

Michael Ludwig (24:08):
That's right.

Bill Walker (24:09):
Got it.

Virgil Ochoa (24:10):
And Bill, Mike's got a really good point here on the big diligence from both the legal and accounting perspective. If you go in and you're fairly clean and organized, the buyer is going to have less questions. If I'm on the buy side and I'm looking at everything, and let's say we make a request and say, Hey, can you give us your financials for last year? And we get 'em within minutes or hours, it's like, cool, going to take a look at 'em, and off we go. But if we make a simple request, it's like, let us get those for you. It's going to take a week. Okay, now you start thinking, okay, there's a problem there maybe, and then you start looking for other problems. It's just human nature. You see one or two problems, you're going to look for other problems as opposed to if everything's organized and together, it helps the transaction as a whole because everyone's confident that they know what's going on and what you're buying.

Bill Walker (25:06):
That's a great point.

Michael Ludwig (25:08):
Couldn't agree more.

Bill Walker (25:10):
Let me ask this final jeopardy question for both of you. If you're going to give one piece of advice to a med spa owner who's thinking about preparing for their sale of their practice down the road, I'll start with Virgil and then go to Mike. What do you give 'em as advice?

Virgil Ochoa (25:27):
I would say reach out to people in the industry who have done it and people who know how to do it. Attorneys, accountants, brokers who have knowledge of it, and then also other folks who have sold or who have bought whichever side you're on there. And don't just reach out to one or two. Get a lot of opinions, get some really good information, because if someone tells you the process is real easy and uncomplicated, it's not true. It takes some work, it takes some effort. Hopefully there's not a lot of complications, but if you've got the right team involved, when they see those complications and they see those issues, it's like, oh, yeah, this error, this problem, but we've dealt with this before we got it. So really having those type of people who know the space and are willing to work with you, help you ease the transition as much as possible, that's the best advice I can give.

Michael Ludwig (26:29):
Yeah, I'm going to echo that same sentiment for most business sellers. You're only going to do this once, right? You've built this really great thing, somebody else wants it and they want to pay you for it. It is worth making an investment and putting a team of advisors around you that can help you navigate the process, because without them, it's going to be a lot harder. You're venturing into waters that you've never been in and you're not really sure what to expect. And not all the time, but there's probably some times where people will take advantage of that. And so just to properly position yourself and your business, get the best possible outcome, make that investment, get some good advisors and everything should end up pretty smooth.

Bill Walker (27:20):
Ladies and gentlemen, you're hearing it from two highly credentialed and well-respected professionals across the country with an enormous resume of work that they've done. Virgil Ochoa, Dykema Law Firm, Michael Ludwig, cherry Bekaert Accounting. Thanks for the time.

Virgil Ochoa (27:40):
Thanks, y'all appreciate it.

Bill Walker (27:43):
Alright, that wraps up the show folks for Aesthetic Appeal. Please continue to stay tuned into Aesthetic Brokers broadcasting for all things in the business side of the house, for the aesthetic industry. I'm Bill Walker. Thank you.