Introduction to healthcare company valuations
Valuation is a complex subject and is often correctly referred to as "an art, not a science".
Having said this, online guidance and accountancy professionals are often misleading in stating that valuation is performed using a number of different methodologies. Whilst theoretically this is true, in practice there is one standard method which is widely accepted across the vast majority of healthcare businesses.
We will walk through each of the elements, but put simply, the calculation is as follows:
EBITDA x Earnings Multiple = Valuation
What is EBITDA?
EBITDA stands for Earnings before Interest, Tax, Depreciation and Amortisation. To non-accountants, this won't mean much....
EBITDA is a useful metric as it essentially provides the operating cash profits generated by a business excluding the impact of working capital swings, capex, financing and tax. This allows acquirers to analyse the cash flows that will be generated by a business without the impact of financing structures which they will not inherit (as we discuss further below).
As a quick way of calculating EBITDA, take the operating profit of your business and add back depreciation and amortisation.
As part of the valuation exercise, it's important to remember that the EBITDA figure used should be the "underlying" EBITDA that an acquirer will inherit.
The EBITDA figure taken from your accounts should therefore be adjusted to remove the impact of exceptional items or costs which will not continue in the future. Examples include the following:
Removing Directors' salaries and benefit costs where these Directors are exiting as part of a transaction and no replacement cost is required;
Exceptional legal and professional fees associated with a specific non-recurring item (e.g. legal fees for a bank refinancing).
When looking to maximise the value of a business, it's also worth considering the period over which underlying EBITDA is calculated. Rather than simply presenting the EBITDA figure from the latest statutory accounts, looking at trading performance over the last 12 months or a run-rate period (often the last six months annualised) can be highly beneficial. This is particularly relevant for high growth businesses.
How is the Earnings Multiple calculated?
Similar to how estate agents use prior house purchases as a guide for values, M&A professionals and acquirers utilise precedent market transactions as a key method of calculating an appropriate Earnings Multiple.
This is primarily via two information sources:
Precedent transactions: analysing data from previous acquisitions which are similar to the business in question, to understand the Earnings Multiple that was applied;
Quoted comparable companies: using public markets data to analyse the current valuations of comparable companies listed on global stock exchanges. These valuations are then discounted to be made more relevant for a private company (i.e. to account for the lack of liquidity of shares).
This analysis will provide general guidance on Earnings Multiples which are applicable within a particular sector. A number of other factors will then influence the multiple of the specific business being valued, including:
Regulatory / Quality (e.g. CQC or Ofsted ratings);
Capital expenditure requirements (both to maintain current profit levels and to support future growth);
Strength of management team;
Over and above the factors outlined above, the scale of the business will be a key driver of the Earnings Multiple. In almost all circumstances, a business with larger EBITDA will generate a higher Earnings Multiple. Whilst this varies materially across different sectors within healthcare, crude guidance of multiples for healthcare services businesses is as follows:
EBITDA of >£1m = 4-6x Earnings Multiple
EBITDA of £1-3m = 6-8x Earnings Multiple
EBITDA of £3-5m = 8-10x Earnings Multiple
EBITDA of >£5m = >10x Earnings Multiple
Valuations on a cash-free, debt-free basis
It's important to note that valuations of healthcare businesses are generally produced on the basis of being "cash-free, debt-free".
In simple terms, this means that any cash in the business is retained by the seller and that all debt is repaid by the seller upon completion. Transactions should also include an adjustment to "normalise" working capital. This prevents the acquirer from having to inject funds into the business if there is insufficient working capital to run the business after completion.
This adjustment is usually calculated by comparing the working capital at completion of the transaction against the average working capital over the recent past.
The table below sets out a very simple example of this:
Underlying EBITDA of £500k x Earnings Multiple of 6
Plus cash on balance sheet
Minus debt and debt-like items
Hire purchase creditors
Any outstanding corporation tax liabilities for the period up to completion
Plus/Minus working capital adjustment
Generally calculated by deducting the average working capital over the last 12 months from the working capital at completion
Value payable to the shareholders
How can we help?
At Eclipse Corporate Finance, we are specialist mergers & acquisitions advisors to the UK healthcare sector. We have access to a range of data in order to provide guidance on suitable valuation expectations for both acquirers and sellers across a range of healthcare sub-sectors. Areas we cover include:
Specialist residential care
Children's services (children's homes and fostering services)
NHS insourcing and outsourcing
Physio & MSK
Reproduction and fertility / IVF
Please get in touch for an initial conversation to explore how we may be able to support you.