Selling Your Home Care or Hospice Business is a Complex Process – Let’s Demystify Some Deal Terms
While sellers often want to focus on the top-line purchase price, the deal structure and payment terms are just as important. This blog will explore two key deal components: holdbacks and earnouts—what they are, why they’re used, and what they mean for you.
Sellers often confuse holdbacks and earnouts with one another in Healthcare Mergers and Acquisitions (M&A), but they impact the deal in entirely different ways. When it comes to negotiating deal terms, having a solid understanding of these concepts is crucial to structuring a deal properly.
What is a Holdback?
A holdback is a portion of the purchase price—typically between 10% and 20%—that’s withheld at closing, usually in an escrow account, to cover potential liabilities that originated before the sale. This money is earned at close and is released to the seller at the end of the hold period, assuming there are no deductions related to pre-close liabilities. It’s a standard term in most home care and hospice M&A transactions and serves as the buyer’s “security deposit” or short-term insurance policy against unresolved, pre-close issues that arise post-close.
A standard holdback in the 10-20% range is commonplace in most home care and hospice transactions to account for potential unknown liabilities. That amount, however, can be adjusted upward if other issues are present or discovered during due diligence. These can include pending litigation, open compliance investigations, or other issues that might impact the business after the sale has been completed.
From the seller’s perspective, it’s important to remember that a holdback doesn’t reduce the total sale price. It simply delays a portion of the payment until a specified period has passed, and the business proves free of those concerns.
The holdback period varies based on business type. In non-medical home care, a 12-month timeline is typical. For Medicare-certified home health or hospice agencies, the window is often between 12 and 24 months. Often, parties will negotiate early release periods as in the example below:
Early-Release Holdback in Home Care vs. Home Health & Hospice
Case 1: Home Care Holdback of 10% for 12 months with ½ released at 6 months and the remainder at 12.
Case 2: Home Health or Hospice Holdback of 20% for 18 months with ½ released at 9 months and the remainder at 18.
While no seller loves the idea of delayed compensation, holdbacks are a well-established practice in healthcare M&A designed to protect both parties in the transaction. Assuming no post-close liabilities surface, the full amount will be released to the seller, but if something does arise, the buyer has access to funds to offset that pre-close liability. Sellers often fear that they will not be paid the escrow amount, but it’s worth noting that the buyer is contractually obligated to pay this money when the escrow term is up.
What is an Earnout?
An earnout is a conditional post-close payment that is tied to the business hitting specific performance targets—usually within the first one to three years after the sale. Unlike holdbacks, which are meant to protect the buyer from pre-close liabilities, earnouts are meant to either 1) mitigate post-close risk or 2) bridge gaps in perceived value between the buyer and the seller. They are not earned at close like holdbacks, but are conditional payments based on future performance, and there’s typically no escrow account involved.
Mitigating Risk: Earnouts are Common When There is Inherent Risk in the Business
Earnouts are commonly used to help buyers mitigate risk when there are concerns about how the business might change after closing – particularly when the business has inherent risk factors, such as heavy reliance on a few referral sources or a concentration of high-revenue clients (i.e. 24/7 cases in a private pay scenario). In these situations, the buyer is looking to protect itself from a post-close decline in business due to a loss of a referral source or any high revenue clients that could have a disproportionate impact on the business.
Case 1: Consider the risk associated with purchasing a business with a few high-acuity 24/7 patients that make up a large percentage of the business’s revenue. The business will look different to the buyer if any of those 24/7 clients go off service post-close for any reason, including such things as hospitalizations. An earnout will protect the buyer from an unforeseen drop in revenue associated with those clients.
When it comes to mitigating inherent risk in the business, earnouts are a standard method for buyers to protect themselves, and sellers should get comfortable with the idea that buyers will look to use earnouts for this purpose.
Bridging the Gap: Seller Beware!
Earnouts can also be used to help bridge a gap in valuation between the seller and the buyer, but the seller should approach this term with caution and careful consideration. Because earnouts are tied to future performance and not guaranteed, they pose significant risk to the seller, who often has little control over the business’s performance once ownership has transferred to the buyer.
Case 2: Let’s say the seller and the buyer of a growing business cannot agree on valuation, with the seller not believing that the valuation multiple presented by the buyer on a TTM AEBITDA adequately reflects the value of the company on its current growth trajectory. An earnout can be used to bridge that gap, with the parties agreeing to future payments based on the company meeting or beating predetermined post-close metrics. While this might sound like a win-win situation, it leaves the seller at risk of not receiving those post-close payments if the business does not meet those metrics while in the hands of the buyer.
Earnouts can be especially risky for the seller when used for this purpose because performance metrics like AEBITDA can be influenced by post-close decisions made by the buyer—such as staffing changes or increased overhead. Even when metrics are based on more objective indicators like top-line revenue, the buyer’s post-close decisions can have a negative impact on the business outside of the seller’s control.
The Bottom Line on Earnouts?
Unlike holdbacks, earnouts face considerably greater risk and should not be treated as guaranteed compensation. While earnouts are commonly used in transactions that involve businesses with inherent risk to the buyer, the seller should beware when proposed as a means of bridging a gap in valuation.
Final Thoughts: How to Navigate Deal Terms Like a Pro
Holdbacks and earnouts may sound similar, but they play very different roles in home care and hospice transactions—and they can have very different impacts on the actual payouts related to the deal. A holdback is a standard part of most deals and, barring any issues, will be released to the seller in full.
An earnout, on the other hand, is far less predictable. It’s based on future performance and can be influenced by factors outside the seller’s control once the business changes hands. While an earnout will be standard in deals with a buyer looking to mitigate inherent risk in a business, sellers should beware of utilizing this approach to bridge a gap in valuation.
As a seller, it’s essential to ask the right questions early on:
– How much of the purchase price is secured at close?
– Is there a holdback, and what’s the timeline for release?
– Are any earnouts proposed—and are the targets reasonable and clearly defined?
Working with experienced M&A advisors can help you understand these terms, push for clarity, and structure a deal that protects your interests.
An M&A Guide You Can Trust
Stoneridge Partners is a national healthcare mergers and acquisitions advisory and strategic consulting firm that manages complex transactions for home care, home health, hospice, and behavioral health companies.
We’ve been in business for over 24 years and have assisted owners just like you sell their healthcare-related businesses. We have accumulated a deep network of motivated buyers during our 25 years, and we have years of experience as operators, attorneys, and development professionals. We’ve been in your shoes, and we know the daily challenges you face.
If the thought of a potential sale is of interest to you, let us help you optimize your prospects for a successful transaction and the highest valuation.
So how do you start? Please visit our website at www.stoneridgepartners.com or contact us at 800-218-3944 for a confidential conversation.
Ben Bogan, J.D., Partner and Managing Director at Stoneridge Partners, has been a leading figure in healthcare M&A since 2014, specializing in home health, home care, and hospice transactions. With over 70 successful closed deals, Ben’s experience and expertise have set him apart as a skilled and invaluable intermediary in the industry.
With a law degree from Albany Law School, a BSBA in Economics from the University of Florida, and his background as a former Assistant District Attorney and Assistant District Counsel for the U.S. Army Corps of Engineers, Ben combines his legal background and M&A expertise to deliver exceptional results in every transaction. Available to his clients 24/7, Ben builds strong relationships with his clients and has garnered rave reviews.
For more information, please contact Ben directly at 520-991-4653 or [email protected]. All communications are confidential.
