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Healthcare Transactions: Why 'COVID Dollars' Are Not All the Same


What are ‘COVID dollars’ and why are the important for valuation and sale price of a healthcare business?

If you're an owner of a healthcare business and contemplating a sale or acquisition, this column is for you. It concerns an important concept I've been describing as "COVID dollars" — a concept that affects a company's valuation and sale price but in ways that seem to be confusing some sellers and buyers.

To help understand this concept, we can look at the rollercoaster journey of urgent care clinics over these past few years. As they were opening back up following the pandemic's initial shutdown period, they experienced a big influx of patients — those patients who were concerned that they had caught COVID-19 but didn't need or want to go to the hospital for treatment. Patients also came in for tests because they had concerning symptoms. Others lacked symptoms but wanted get clarity on whether they had the illness. Urgent care clinics providing COVID-19 treatment, performing COVID-19 testing, and undertaking other initiatives specific to COVID-19 produced revenue streams for these organizations that weren't there prior to the pandemic.

It was initially believed that most revenue streams associated with COVID-19 — these COVID dollars — would be temporary (i.e., non-recurring). Consider that after COVID-19 hit, we saw instant and significant money made available to healthcare organizations through the likes of the Coronavirus Aid, Relief, and Economic Security (CARES) Act and other policies. Typical patient out-of-pocket expenses (e.g., copays, deductibles) were often waived to encourage patients — sick or not — to use testing and screening services as we worked as a nation to navigate the virus and get in under better control. Urgent care clinics and other types of organizations, such as laboratories, saw their revenue surge because of these initiatives.

For those of us on the transaction advisory side like myself, we needed to ask important questions about this unprecedented period in our history: How should we classify the revenue associated with these new, high-demand services? Are they likely to affect long-term revenue? If so, how? What is the value of these COVID dollars in a sale?

The answers to these and other related questions are very important for the valuation and pricing of companies that generated and continue to generate COVID dollars. Now, more than two years since the beginning of the pandemic, we finally have some clarity on them.

Evaluating COVID-19-Related Revenue: Recurring Vs. Non-Recurring

For most healthcare buyers, an acquisition is all about return of investment (ROI) and usually one generated over a 3-5-year period. In other words, in the next three to five years, will a buyer achieve its desired ROI?

As 2020 wrapped up, we started to get a better sense of how COVID-19 had affected healthcare businesses. While vaccines were just becoming an option then, and different variants were on the horizon, the craziness that defined much of 2020 was calming. This translated into 2021 starting to become a more accurate barometer for a healthcare organization's financial performance in this COVID-19 world.

As part of the valuation process, a company's profit and loss (P&L) and earnings before interest, taxes, depreciation, and amortization (EBITDA) statements are evaluated, with figures usually pulled from the previous three years. COVID-19 wreaked havoc on P&L and EBITDA, with revenue streams for most healthcare organizations swinging wildly over many months. Buyers needed to address many questions concerning any company they were considering acquiring during this period. How did COVID-19 initially affect the business? How did the company ramp back up operations? What new services were introduced? Has COVID-19 changed its operations? What has COVID-19 done to revenue and long-term viability and profitability? Most importantly, how can a business owner accurately forecast future revenue that can be supported and justified, thus providing an accurate valuation for the business?

Now that we're in the third quarter of 2022, we're finding that the most recent Q1 and Q2 performance figures are an ever better and more accurate indicator of long-term financial performance than what occurred in 2021 and thus more important from a buyer's perspective on how to navigate the effects of COVID-19 on a company's revenue. But to achieve such critical accuracy requires an understanding of which COVID dollars are recurring and which are non-recurring, which I will get into further in a moment. First, it's helpful to understand how some buyers have been looking at COVID dollars.

One way some buyers are trying to paint an accurate picture of current and likely future financial performance is to request any revenue tied to COVID-19 services be broken out from a company's proforma. The rationale for this request is that COVID-19 as a pandemic is largely over. Thus, the revenue and services associated with COVID-19 are likely to be non-recurring and will not have much, if any, influence on future financial performance. Another way of looking at it: Buyers who make this request believe COVID-19-related service lines will not help with generating their desired ROI following an acquisition.

On the surface, this may seem logical. Many COVID dollars were tied to funding sources and services no longer available or decreasing as we settle into a future with an ever-present coronavirus. But that latter point is exactly why breaking out COVID dollars will not make sense for many organizations.

To demonstrate why, let's look at the operations of urgent care clinics and laboratories. I'll provide a real-life example of how both sectors have been and still are being affected by COVID dollars. I am currently representing an urgent care clinic in an urban area. In the early days of the pandemic, it was performing COVID-19 testing "on steroids," and revenue followed suit. High levels of testing continued into 2021, but by the latter part of the last year, testing started to wane.

Due to the sheer volume of testing provided, the clinic's owners expected to see a decent decline in revenue in 2022 since that volume had cooled greatly. But when we looked at the clinic's performance through the first two quarters of 2022, revenue was nearly identical to the clinic's first two quarters of 2021. What had changed with the business over the previous year? Not much. While the clinic was no longer providing high-volume COVID-19 testing, a service that hadn't fallen off was the clinic's treatment of patients with COVID-19.

Different strains and variants of COVID-19 are hitting us all the time, and vaccines have not eliminated the possibility of catching the virus. They likely never will. Some people who get sick with COVID-19 will come to urgent care clinics for treatment, just as they have for the past two years. This service has been normalized and is now producing recurring — and likely long-term — revenue. Therefore, it should be included in the clinic's proforma.

Let's look at the laboratory side. I am currently representing a large laboratory on the market. Like the urgent care clinic, it made gangbuster revenue in 2020 thanks largely to COVID-19 testing services. In 2021, that revenue largely leveled out. In 2022, the lab has begun growing that revenue. How? It has acquired many new nursing home and assisted living facility contracts in California. The California state legislature has essentially mandated these facility types perform COVID-19 testing along with other panel testing of residents. This is not a short-term mandate. This is the new normal.

What this means is that the lab's current COVID dollars are different from those generated by the massive surges in testing during the first year or so of the pandemic. That revenue was primarily associated with the likes of setting up testing sites and performing well testing, with services covered by pandemic-related policies that no longer or largely do not still exist today. A buyer would be justified in requesting those dollars be broken out since the revenue from that testing would be considered non-recurring.

On the other hand, the dollars associated with testing the California nursing home and assisted living residents is a normalized, recurring revenue stream. Thus, this revenue must be included as part of the lab's current proforma.

Here's another way of looking at the different COVID dollars scenarios. We can classify the paths most healthcare businesses have taken as they've come out of the pandemic in three ways:

  • The business returns to its pre-pandemic model (i.e., business as usual). A good example here would be ambulatory surgery centers and office-based surgical practices.
  • The business takes on a hybrid version of its previous self. It continues with pre-pandemic revenue and incorporates recurring COVID-19-related revenue, such as the urgent care clinics and lab examples discussed above. The task for a seller in this scenario is to show its future projected growth is justified through guaranteed revenue based on lasting trends and tangible assets, such as contracts and mandates.
  • The last is a reduction of revenue based on a one-time opportunity that will or may not be repeated. This falls under non-reoccurring revenue, with examples such as well testing, opportunities created by the shutdowns and screening needs within communities, and utilization of government revenue programs (e.g., payer-deductible waivers for testing, PPP funds, Medicare advance payment) that have now expired. Furthermore, the business has no off ramp for its clients to self-fund these services or there is no longer a need for the services.

With an understanding of the path taken by a healthcare company, a merger and acquisition advisory firm can generate an accurate proforma for future growth that takes into consideration all recurring revenue streams. At this point, utilizing 2022 Q1 and Q2 financials should provide a benchmark for the successful development of such a proforma. If a buyer has concerns about the inclusion of any COVID dollars in a proforma, it can reduce its risk by providing earnout opportunities while keeping the valuation attractive for the seller.

Beyond the Pandemic: "COVID Dollars" Just Become Dollars

The novel coronavirus has had other significant effects on health and the delivery of healthcare services that will affect the revenue of many different provider types. For urgent care clinics, for example, administering of COVID-19 vaccines and boosters has become another new service that will likely become an annual occurrence, just like the flu vaccine.

Speaking of the flu, it looks to be making a comeback, and we're seeing respiratory syncytial virus (RSV) on the rise as well. As these illnesses increase, more people will go to urgent care clinics for diagnosis and treatment. Clinics can expect even greater volume of customers for respiratory and other conditions than they would have experienced pre-pandemic because consumers have become more comfortable with going to these clinics due to their experiences over the past two-plus years. There's also an increased sense of urgency to identify mysterious illnesses and start treatment because of the fear of catching a potentially quite harmful illness and spreading it to others, particularly the more vulnerable members of society.

That's an important factor when evaluating COVID dollars and considering whether to lump all these dollars under such a label. We need to largely stop looking at revenue streams as "COVID-19" but rather as treatment of a virus that's here to stay. We can expect people to become sick from COVID-19, with the likelihood and severity of the illness varying over time, just as we see with the flu.

If you own a healthcare business providing a COVID-19-related service not backed by patient trends or long-term policies, that's non-recutting revenue buyers are likely to question. But, for the most part, any recurring service and its revenue that falls outside of those qualifiers can likely be included in a current proforma.

All this points to another important consideration: calculation of valuation. Prior to the pandemic, it was commonplace to calculate a business's maintainable earnings valuation by evaluating sales, expenses, profits, and gross profits from the previous three years. That will simply not work today or for the immediate future because of the turbulence caused by the pandemic. Rather, the best way to perform a current valuation may be to look at a company's trailing 12 months. That should give you a fairly accurate idea of how a healthcare's business recovered from and had its services affected by the pandemic and how its operations are likely to look in the coming years.

To summarize, we're seeing urgent care clinics, labs, and other organization types with very conservative predictions for 2022 valuations because of expectations that the COVID-19 wave would close off revenue streams now doing exponentially better. They've added new services — in conjunction with COVID-19 — that is generating and will continue to generate meaningful, recurring revenue.

As more time passes and we put the worst of the pandemic behind us, our efforts shift to maintaining patient care and protecting populations. Services that support these efforts — including those concerning the novel coronavirus — will continue to be in high demand, meaning that businesses offering these services are likely to be as well.

J. Blake Peart is amanaging director at VERTESS, a national healthcare merger and acquisition (M+A) advisory firm. Blake has extensive and diverse career in healthcare spanning for more than 20 years. In the past 10 years, he has served as CEO for multiple hospitals of Fortune 500 companies and CEO for several large ambulatory surgery centers. In addition, his operations and business development knowledge has allowed him to experience the entire M+A process from start to finish focusing primarily on private equity transactions. He can be reached at bpeart@vertess.com.

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