By Andrew Colbert

Wouldn’t we all love to sell our company for 20x revenue?
There is nothing more fun than talking about that huge exit multiple that XYZ company just paid. However, too often today, health care industry chatter is focused on the multiple itself and not the unique attributes of the target and the buyer’s specific situation. These impressive outcomes often distract attention from the fundamental attributes that truly create value. A company is worth the cash flow it generates. Long-term business value is created not by building a nice storefront window, but by building a set of unique products and services that are in high demand and capable of delivering both growth and profit.

It is important not to construct a business with the exit in mind, but to build a solid company with strong fundamentals. There will never be a shortage of buyers for good companies, especially in the health care space, which is made up of so many subsectors such as physician practices, hospitals and health systems, payers, information technology, analytics, diagnostic therapeutic and biomedical companies, and so forth. The list is massive and represents nearly 20 percent of our GDP.



Focus from the get-go on the foundational components is critical to building a strong company that will be in high demand. There are six core pillars that are critical to driving enterprise value: strategic organization; technology platform; industry dynamics; “best of breed” perception; financial performance; and management team.

Pillar one: Strategic organization
The foremost pillar is strategic organization and professionalizing. We believe that at least 20 percent of a company’s value is tied specifically to the external appearance. Regardless of what’s inside, it’s a lot harder to sell your house when the outside paint is peeling and the front lawn is covered with weeds. Generically we might just call this good housekeeping. This can cover a wide range of intangibles that are essential to smooth operations and future transaction success.

For instance, proper HR policy documentation, secure confidentiality protection regarding source code and other intellectual property, accurate and complete contract databases that indicate when renewals are coming up and a host of other similar data and documentation. A company needs to be able to provide appropriate information and proper documentation at the press of a button.

For example, one area often overlooked is strategic tax management. Many companies underestimate state tax compliance, which can become problematic. Categorization of employees is another complex area. Younger companies sometimes see an advantage in 1099 status, but this can become problematic if the IRS believes the individuals should be W-2 employees. If such elements are not in place, a company can look unsophisticated when a larger corporation or investor assesses its policies and procedures. These are all things that a company can address proactively from its inception, and thereby greatly enhance its valuation from startup to exit.

Pillar two: Technology platform
Regardless of whether a health care company is providing software or services, the technology backbone is of critical importance to outside investors. If it is a software platform, is it truly a multi-tenant platform or is it a single-tenant model with a separate instance for each client? Is it a recurring subscription fee model, or an upfront license fee model? Unfortunately, many young companies woo their clients by agreeing to build custom code and custom deliverables. This can be great early on when companies need money to grow, but it can have a devastating impact on long-term scalability of the platform.

Unfortunately, this will significantly lower the value of the company in the long run, since each client has a different instance of the source code that requires individual updates for each customer. This is going to really hamstring the company down the road when it’s looking to scale up to 100, 500 or 1,000 clients.

Technology documentation is extremely important when health care software companies are looking to raise capital or sell. This includes: a comprehensive list of all source code and third-party components with copies of each license agreement; signed invention assignment agreements and NDAs with all former and current employees; and supporting commentary/documentation inside the code base. Additionally, it is important for companies to maintain a comprehensive product road map that is continually updated with a timeline for new product enhancements/developments.

If the company is providing services, the technology backbone is just as important — regardless of whether it is owned or licensed. Finally, it is the data and analytics that companies are able to extract that is becoming more important to competitive differentiation. Companies must be able to demonstrate high-quality service levels, return on investment and benchmark hard numbers against the competition. The winners in the health care 2.0 ecosystem are those who can truly analyze data and benchmark it across the enterprise.

Pillar three: Industry dynamics
The third major pillar driving business valuation is accurate positioning around health care industry headwinds. Most importantly, why should an investor invest in your space versus another sector. You’d be surprised how often CEOs are unable to articulate the size of their industry and specifically the size of their addressable market. It is essential to know, and be able to explain, exactly which market your solution addresses, how big it is and who the other players are. Key to value maximization in this sense is being able to affirm how a company is poised for success relative to its own positioning. Being the first mover in a sector can be good, but over time an initially hot subsector can become crowded with other players.

For example, how many companies exhibiting at HIMSS use the term “population health” to describe their offering? How does your particular set of capabilities stack up relative to the rest of the landscape? Are you the market leader and first mover? If so, why is that a good thing? If your company is a second or third mover, how do you stand to grow relative to stronger, better capitalized competitors? What percentage of the market do you need to gain in order to generate at least a three or four times return for your shareholders?

Pillar four: ‘Best of breed’ Perception
“Best of Breed” perception conveys how you stand out relative to other competitors. Simply put — is the company perceived as a leader in the market? The most common differentiator that companies use is scale, asserting that they are the biggest, or the fastest growing, or the most profitable. It is logical to select whatever metric is higher than the rest and trumpet that. That may be great, and certainly being “No. 1” is helpful. But can that be banked on as the longstanding, or only, strategy? What happens when all of a sudden a company is No. 2? That pitch just won’t work anymore. So leaning on scale is really a shortsighted tactic.

Best of breed perception has to be based on more than just immediate metrics. There needs to be a deeper capability differentiator. Why is this product better? It might not just be a matter of functionality. It may be delivery. It may be user experience. It may just be that sales model is simpler. While it is great to have the best product, ultimately the winning player is the one that sells the most.

The key here is perception. Above all it is about how the market perceives a company and its product. Best of breed perception is ultimately driven by your customers, how sophisticated they are, how they perceive you and how they communicate that opinion through the health care market. Real value is based on market sector reputation, no matter which features are the underlying bases for that.

Pillar five: Financial performance
The fifth pillar is financial performance. This goes much deeper than just scale, but pertains to how quickly your company is growing and how profitable is that growth. Fundamentally, a company is worth the cash flow that it generates, not in the past, but what is expected in the future. The greater the visibility a company has into future growth, the higher the value that outside investors/buyers will ascribe.

One key element to valuation is how much of your revenue is truly recurring. At the beginning of every year, are you out on the road needing to literally sell everything to get back to where you were last year, and then sell even more to exceed last year? Or are you in a recurring, subscription model such that you already have contracted revenue at the beginning of the year, that means you’re going to exceed last year’s performance unless something goes horribly wrong?

If you have the ability to execute subscription agreements, they really pay better recurring dividends in the long-run. The other big financial performance indicator is gross margin. Everyone loves to focus on EBITDA and revenue, but gross margin is one of the single most important metrics in evaluating a company’s health. If you can grow your company from a topline perspective, but the costs that are required to deliver that revenue are basically equivalent to the revenue itself, you’re not really adding any value. Better is a model where each dollar of incremental revenue can be delivered proportionately for less cost.

If a company is getting into the 70-80 percent gross margin range on software products, the ongoing subscriptions are heavily weighted toward a profitable revenue stream. That’s really where you see the biggest exit opportunities. So gross margin is absolutely critical to focus on, especially when companies are sub-scale and have not yet reached mature EBITDA margin potential.

Alongside that comes customer retention. Related to best of breed perception, retention rate is one of the single most important metrics for determining a company’s health. In the instance of an exit scenario, it’s much easier for buyers to take an existing brand that has a verifiable customer base and upsell it into their existing customer base, as opposed to presenting a product that has no brand awareness in the market.

The last point under financial performance is demonstrable return on investment. This is a metric that unfortunately is often overlooked by early-stage health care entrepreneurs. All too often companies say they don’t worry about return on investment because the market already understands the need for their product, but there is a great deal of noise, especially in the health care technology market, and making this assumption is a mistake.

No matter how mature a market is, you always need to be able to articulate how someone can get the value back from what they’re paying. It may be worth approaching some of your key customers and offering some discount in exchange for the ability to truly measure the impact of your technology, particularly in health care, where validation may come over many months or years, as well as authorization to take credit for it. Then put out a press release and shout it from the rooftops. Not only will this help drive future sales, but will significantly enhance the future exit value.

Pillar six: Management team
The sixth pillar is the leadership team itself. A business might have the best strategic plan in the world, but if this team can’t execute on it the company’s not going anywhere. What really drives outsized returns is leadership with more than just health care expertise — someone who has really proven that they can scale and build companies, perhaps more than once. When a buyer or an investor evaluates a company, often the most important factor is management team experience. Without this pillar, the other pillars would not hold up.

Ideally a company in the health care space has not just one, but two levels of talented leaders, with folks who are really taking ownership over their respective areas according to a deep sense of accountability regarding their own chain of command. This is far superior to a situation where everyone is reporting in to the CEO, who is truly irreplaceable or the business won’t continue to operate.

Management bench strength is absolutely the core and it sums up the key element of what drives business value: leadership emphasizing strategic elements founded on true fundamentals. A health care platform may have a team of rocket scientists — the smartest guys in the world, who have built the most sophisticated predictive model that might literally predict cancer. But if they don’t know how to monetize that product and turn it into a lasting revenue opportunity, then it’s not really worth much.

Many young health care companies have ridden the bandwagon of building tools in hot spaces, and are gaining value because they landed in the right place at the right time. As a result, too many assume the short-term view that a business is really valued on the basis of a capability set. But a much longer-term view based on fundamental attributes is what a business really needs to achieve the highest possible value in the long-run.

About the author: Andrew Colbert is a managing director and founding member of Ziegler’s Healthcare Services & IT Corporate Finance Practice. Colbert has represented seven radiology groups on innovative transactions. He specializes in advising physician groups on strategic and financing alternatives, including mergers and acquisitions, capital-raising transactions and partnership development.