Clinical Laboratory Acquisitions – Guide to Determining and Maximizing Value
June 3, 2016
Clinical laboratories have been increasingly attractive acquisition targets for several years. At Fleetridge, we have closed two laboratory transactions in less than a year, and have had several interested sellers approach us in the last two months. We feel that there is currently an excellent market for small laboratory acquisitions, and owners seem to appreciate this as well.
The reasons for increases in laboratory acquisitions are numerous. The marketplace for small, independent labs is highly fragmented, and acquirers can realize great economies of scale in sales, marketing, and operations by growing. Combining smaller labs with hospital systems can lower the cost of capital and improve profitability by generating orders within each facility. In addition, many buyers are individuals with strong laboratory/business experience and funding, and want to enter an industry with strong potential for cash flows and growth.
Determining Value for a Small or Middle Market Laboratory
Before deciding to sell their labs, most owners ask a question of primary importance: How much is my lab worth? Large or publicly owned laboratories can often be evaluated using stock price, potential of cutting edge proprietary diagnostic techniques, or research and development capabilities related to specific and rare diseases. For small or middle market laboratories, though, valuation is often related more to financial performance.
It is difficult to arrive at a specific formula that works for all businesses, but in general, the valuation of a private laboratory starts with cash flow. For most buyers, cash flow represents the “fuel” that allows a laboratory to operate and grow. While clients, contracts, equipment, and other features of a laboratory are all desirable, cash flow often represents the distillation of a business for buyers.
Cash flow calculation begins with net income. Non-cash expenses, interest, and taxes are added back to net income, as are expenses that are unrelated to the core business of a lab. Then, this “adjusted cash flow” is multiplied by an appropriate multiple to arrive at a preliminary value.
Another similar valuation method involves applying a multiple to total revenues. This is usually viewed as less relevant, however. While generating strong revenues often implies that a laboratory is doing well, how those revenues are used to operate the company and generate cash flow is a better reflection of a laboratory’s strength. But, if a laboratory is young or growing quickly, it may have significant value but no earnings or cash flow. In such a case, total revenue offers a good starting point for determining value.
Other Valuation Parameters
Laboratory owners need not focus entirely on cash flow and revenues when justifying a maximal value for their businesses. Many other aspects of a lab can be featured during negotiations to raise the sale price. Examples include:
- Certifications, such as CLIA, CAP, and COLA;
- A long history of stable growth in financial and operating performance, number of samples tested, and addition of services;
- A wide range of clients, such as physician practices, skilled nursing facilities, contract research organizations, and veterinary clinics;
- New and/or state of the art equipment;
- Large territory from which to generate samples;
- Multiple payer contracts;
- Absence or minimum of compliance issues; and
- Strong marketing department featuring strong relationships with referral sources.
Ultimately, the value of any offer will depend on how each buyer appreciates a laboratory’s unique set of qualities. Obtaining multiple offers is always the goal. Not only will this help sellers determine what the market is willing to pay, but each offer will serve as a reference point against which other offers can be compared and improved.
Case Studies
Fleetridge has advised two owners of laboratories in the past year, leading each to successful closure. A brief summary of each, with a focus on valuation parameters, is presented below.
- Clinical Laboratory: Fleetridge represented the seller of an CAP-accredited, independent laboratory in Texas. This laboratory offered routine clinical tests, including basic blood and urine analyses. While these tests were fairly standard, the business differentiated itself by excellent customer service. The lab employed phlebotomists who traveled throughout a large territory, collecting samples from the place of care for its patients (skilled nursing facilities, home health agencies, private homes, and physician offices). The processing time for its samples was significantly shorter than its competitors, and its reporting system was simplified and efficient. The laboratory showed consistently strong net income and cash flow margins. By emphasizing these unique strengths, multiple interested buyers were discovered, and several offers were submitted. This business was sold to the owners of another independent laboratory who wanted to expand their scope and market.
- Cytopathology Laboratory: Fleetridge represented the seller of a CLIA-certified cytopathology laboratory in California. Features of this business included a very attractive service area, a moratorium on issuance of new laboratory licenses in California, a long history of operation, an experienced and loyal staff, and consistent profitability. This laboratory was sold to a large diagnostic device manufacturer in Asia that wanted to expand its operations in the United States.
Valuation is Just the Beginning
Determining and justifying a strong valuation represents only the beginning of a successful laboratory sale. Assembling the deal team, marketing the opportunity, compiling a list of buyers, soliciting offers, completing due diligence, and signing the closing documents make up the bulk of the work. Given the complexity of these tasks, it is understandable that the process can take several months. Like sellers in other healthcare sectors, laboratory owners need to be patient, and willing to balance their value expectations with what the market of buyers will offer. However, a successful outcome is likely for those who can accomplish these objectives.
About the Author:
David Hicks, M.D. is the Vice President at Fleetridge Pacific Healthcare Mergers & Acquisitions. He gained significant investment banking experience while working for the high technology mergers and acquisitions group at Morgan Stanley in New York City. David’s understanding of the goals of Fleetridge clients is augmented by his clinical healthcare experience, which includes earning a medical degree, briefly practicing clinical medicine, and conducting award winning basic science research. He earned a Bachelors degree in biology at Harvard College, and an M.D. at the Columbia University College of Physicians and Surgeons.