Four Considerations When Selling to a Private Equity Fund

The benefits of selling to a private equity (PE) fund can extend well beyond the capital infusion. The right PE partner can equip an entrepreneurial medical product or device company with the expertise to expand into new markets and serve existing clients better. It can also help professionalize key corporate functions, such as finance and marketing, in order to take the company to the next level.

Companies considering selling to a PE fund should follow these four steps to help minimize surprises and secure better outcomes.

Step One: Conduct a Gap Analysis
Many entrepreneurial medical device companies considering a PE investment have top-notch technology and strong revenue streams. Their corporate functions and regulatory strategy, however, may be somewhat sparse. Therefore, it is advisable to conduct a gap analysis using both external auditors and self-assessments to identify areas of weakness and potential risks. Knowing in advance which aspects of the business may need further investment and improvement will reduce the chance of mid-transaction surprises and make negotiations with a buyer more productive.

The top priority for a gap analysis should be understanding exactly how the product or medical device is regulated, as potential enforcement exposure can be a major roadblock for a buyer. While a founder-entrepreneur may be comfortable with a certain degree of risk regarding regulatory grey areas, PE funds typically are not, since they are responsible to their institutional partners. An external regulatory consultant can help clarify the compliance obligations for a medical device or product. These consultants may have a long scheduling lead time, so plan well ahead.

For facilities that are regulated by the U.S. Food and Drug Administration (FDA), it is wise to have an independent auditor conduct an assessment of quality control and operations in advance of any sale process. Similarly, fraud and abuse should be an audit focus if the customer base is highly regulated or if the product is a reimbursed medical device.

Even if a company lacks the capital or lead time to rectify a regulatory or reimbursement problem prior to a sale, conversations with prospective buyers will be more productive if the issue can be competently discussed and a practical, financially sound solution identified. Understanding potential compliance weaknesses will also help avoid surprises regarding the purchase price, as expenses necessary to gain FDA clearance or obtain certifications may be taken out of the company’s valuation through add-backs.

Intellectual property (IP) is another important element of a gap analysis. The transaction due diligence process will examine the protocols and systems for protecting IP, including issues of data security, so it’s helpful to know in advance what the IP portfolio looks like and how it is being protected. Contract manufacturing firms that don’t actually own the IP for the relevant medical device or product they help produce must still ensure they are protecting that property on their customers’ behalf.

Step Two: Ensure Corporate Housekeeping Is in Good Order
Companies with cutting-edge technology may still need to review and refresh their back-office marketing, finance, and accounting processes to maximize their value to potential buyers. Medtech firms should take a close look at staffing and training procedures. Are the finance and accounting functions communicating effectively? Do the individuals responsible for training have the right experience and expertise?

Seemingly small housekeeping issues can have big consequences. An incomplete corporate reorganization or lack of communication between departments, for example, may lead to missed Internal Revenue Service filings and material tax exposure. While a PE fund can help professionalize corporate functions, it is far better to discover and resolve problems before the buyer is involved than to have them surface as an unpleasant surprise mid-transaction.

Step Three: Pick the Right Partner
When choosing a PE fund to which to sell, price is almost always the top factor. But other dynamics can help guide the decision as well. A partner that knows the sector well will not only be able to bring its own expertise to the table, but can engage experienced operating partners and outside directors to add value to a medtech company. The same goes for other external advisors: hire accountants, lawyers, and bankers that are deeply familiar with a particular industry and have experience with similar deals.

A potential PE investor should have the right regulatory experience to support a company, and should have the capital for additional investments for growth subsequent to the deal. Most indications of interest will include references from other entrepreneurs who have sold to the PE fund. Talking to these references about their experience with the fund can help medtech executives evaluate whether it is a good fit for their organizations and products.

Step Four: Set Expectations
Particularly in today’s sellers’ market, with high multiples attached, PE funds often need to move aggressively to grow and lever up the purchased company. For medical product and device entrepreneurs or company founders used to managing their own business solo, the transition to working with an equity partner and responding to a board of directors can be jarring.

Mentally preparing for this increased level of accountability and corporate cultural shift is an important step of the transaction process. Setting appropriate expectations in advance will help entrepreneurs transition smoothly into this next phase of their company’s growth and reap the benefits of a productive PE relationship for years to come. 

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Bill Hadler is a partner at McDermott Will & Emery. He counsels clients on mergers and acquisitions, private equity transactions, securities offerings and general corporate matters. Hadler has advised public and private companies, as well as private equity funds and their portfolio companies, in connection with mergers, acquisitions and divestitures across multiple industries, including healthcare, specialty retail, consumer products and financial services.

Anisa Mohanty advises medical device, biotech and pharmaceutical companies on U.S. Food and Drug Administration premarket strategy and post-market compliance issues, from advertising and promotion to disclosure and periodic reporting. She offers guidance to her clients on the regulatory requirements and industry standards for the development, creation and review of advertising and promotional materials for drugs and medical devices.