Determining the value of your CLIA, Lab Equipment, Contracts, and More.
By: Jon Harol
As the old saying goes, “Something is worth exactly how much someone is willing to pay for it”. This still reigns true, but how much someone is willing to pay can vary depending on how it is marketed, timing, and a slew of other factors. In times when the value of cryptocurrency, NFTs, real estate, and gasoline can change drastically in only a few hours, the concept of “value” is becoming an elusive idea. Fortunately, the clinical lab industry is a bit less volatile, and valuations have remained fairly steady. Below I will lay out some guiding principles for determining the value of a lab.
First, let me define what I mean when I say “laboratory.” There are many types of labs, but in this article, I am referring exclusively to clinical diagnostic labs. These are labs regulated by CLIA, COLA, CAP, and other healthcare regulatory authorities. These labs perform diagnostic testing on human samples and report patient results. The valuation principles below do not apply to biotech, pharmaceutical, or industrial labs.
Now, let’s break a laboratory down into the key parts that drive its overall value. Since there are several components, I have developed a simple acronym to help lab owners better understand their lab’s value. The acronym is CLIA SELF:
Contracts; Licensure; Infrastructure; Assays;
Science; Employees; Location; Financials;
“Contracts” refers to a laboratory’s status with commercial payers, Medicare, and various state Medicaid programs. This is one of the most difficult to quantify factors regarding a lab’s valuation. Getting in-network status on good payment terms with a major commercial insurance provider can be challenging, and many networks are closed or capitated, making it nearly impossible for an independent lab to get paid. As a result, for a laboratory that is not getting reimbursed for a significant portion of business, it may make sense to acquire a laboratory that already holds an in-network status with the desired commercial payer. The more difficult it is to obtain the contract, and the more lives the payor covers, the more valuable the contract is to a potential buyer.
I have seen transactions where a small lab is acquired by a larger lab and one insurance contract accounts for a majority of the transaction value. This may seem silly, but if you are not getting paid on $200K worth of lab testing per month and you can solve that problem with a $2M acquisition of a small lab, you will get your money back in less than a year. Plus, you now own two labs! There is an additional time component involved as well. It can take years to obtain commercial contracts, Medicare, and Medicaid in multiple states, so when a group is contemplating starting a new lab there is an appeal to being able to get paid months or even years faster via the acquisition of a lab with established contracts. It is important that the lab’s contracts are in good standing, as there will be a discount expected if there are pending clawbacks, active claim disputes, or improper billing allegations. The transferability of the contracts should also be contemplated and can be affected by whether the transaction is an equity purchase or asset purchase.
“Licensure” refers to the licenses, permits, and other paperwork that are needed to compliantly operate a clinical lab. The most fundamental of these is the CLIA License, which is obtained via the submittal of a CMS 116 Form. One factor that affects the value of your “Licensure” includes the complexity level of your CLIA. There are three CLIA complexity categories, Waived, Moderate and High, and the value of the CLIA License increases with the complexity. The number and type of approved subspecialties on your CLIA license also affect value.
All clinical diagnostic labs are required to have a CLIA license, but labs can get accredited from additional organizations such as COLA, CAP, SAMSHA, JCAHO, etc. These additional accreditations can add value for the right buyer. The lab’s CLIA certificate type reflects the status of the license. Once a lab’s initial application is approved, they receive a “Certificate of Registration”, which allows them to begin testing in most states. However, the “Certificate of Registration” is later converted to a “Certificate of Compliance” or “Certificate of Accreditation” once the lab passes its first inspection. The lab will be reinspected every 2 years on average, but it can be more frequent as additions to the test menu and random inspections can occur. A lab that has successfully passed an inspection is worth more than one that has not yet been inspected. Buyers will often want to see the lab’s last inspection report and they typically prefer a lab that has been inspected recently and has had few deficiencies.
Additionally, there are six states that require that your lab hold an approved Out of State Processing License to process samples from their states. NY and CA are probably the most difficult to obtain this license and the most sought after, so labs holding Out of State Processing licenses for these states will almost always see a bump in value. Many buyers want a lab that is licensed to process samples from all 50 states, even though most labs in the country are not approved for this. Labs that hold licenses to process samples from all 50 states will see a premium from the right buyer.
“Infrastructure” refers to the laboratory upfit, including instrumentation and ancillary equipment, furniture, cabinetry, and supplies. Clinical labs often have specific requirements for flooring, temperature control, ventilation, division of workspaces, etc., so space that is already upfit for medical lab use has value. Relocating a clinical lab triggers the refiling of paperwork and revalidation of equipment, so the actual size of the lab is important to many buyers. The lease term (rent) is also a factor, but not as important as you may think in my experience. Buyers would rather pay a bit more in rent than squeeze into a small lab that doesn’t provide room for growth. When listing your lab, you should investigate whether any adjacent space is available should the new buyer want more room. It is important that this space is contiguous or can be made contiguous through the addition of a door or removal of a wall, otherwise a separate CLIA license will be required. An important factor affecting the valuation of your infrastructure is how it presents during a showing. A cluttered, unkempt lab will scare a buyer away quicker than a Medicare investigation.
The lab instrumentation and supporting equipment are an important part of the infrastructure evaluation. Don’t get caught in the trap of thinking that you can add up the purchase price for all the equipment and space modifications and pass this along to the buyer at full value. Whether fair or not, in my experience the buyer typically values the equipment closer to 50% of the purchase price. This may be reasonable, since the lab often contains some equipment the buyers don’t need or want and the life expectancy of most lab instruments is only six years, so even though it may not seem old to you its value depreciates quickly. In fact, much like a new car, lab instrumentation loses much of its value as soon as it becomes used, since many manufacturers refuse to service equipment sold on the third-party market. Service contracts, warranties and well-documented maintenance logs can help to make the case for higher valuations on equipment. Signed clinical validations, including SOPs for any LDTs (Laboratory Developed Tests) being run on the instrumentation, are also important.
The number and type of “assays” that your lab has validated on your test menu affect value by determining the size of your buyer pool. Most buyers are looking to acquire a specific type of lab. Some of the most common labs that buyers are interested in include Molecular, Blood, Chemistry, Pathology, and Next-Generation Sequencing (NGS). The broader your test menu, the better your odds of attracting a potential buyer and getting the value you are seeking. There is some value in having an assay validated in your lab and included in your test menu, but the real value is derived from having regular sample volume associated with the assays on your test menu.
Proprietary “science” or any unique intellectual property (IP) that has been developed or commercialized in your lab can be a big driver of value for the right buyer. The exact value of the IP will vary greatly and can garner over a $1 billion valuation, as demonstrated by a recent lab black sheep and their alleged proprietary IP. This group was as an example of unproven science, but there are labs developing new and innovative tests that will change healthcare every day, and as you can imagine there are venture capitalists, private equity firms, and strategic players always on the lookout for the next big scientific breakthrough, and they are willing to pay top dollar for it. If the tests you have in your lab are not proprietary, you will not derive value from this category. However, if you do have unique IP, I recommend that you be careful about when you reveal this during the sales process and make sure you have an appropriate NDA in place first. Sometimes the proprietary science may not be a new lab test, but the ability to run an established lab test on a new sample type. As an example, I see many buyers that are interested in labs that can run common lab tests on Dried Blood Spot (DBS) cards, as this unlocks the home testing market. IP could also be unique technology or software that your lab uses. NGS labs with proprietary databases fall into this category. As an example, most of 23andMe’s value resides in their database and not their lab equipment.
Unless you are brand new to the lab industry, you realize that medical lab professionals are in short supply and building a good team is difficult and takes time. So, if you have a qualified staff of Certified Medical Lab Scientists and Medical Lab Technicians along with a Board-Certified High Complexity Lab Director there is value there. Having a team of successful W2 Lab Sales Reps that are compensated through an EKRA-compliant compensation plan is also valuable, especially if it is national in scope. This allows a potential buyer to quickly acquire the team they need to perform their test and reach a national audience. A buyer will want to see employment agreements, comp plans, and non-compete agreements. The more buttoned-up the paperwork is, the more valuable it is to a buyer.
The “Location” of the laboratory will influence its value. The address of the laboratory has a bigger impact than just determining where you get your mail. There are state regulations, shipping logistics, proximity to talent, insurance climate, and Medicare MAC implications to consider. Of these factors, the Medicare MAC where the lab is located in is probably the most important one to consider. Certain MACs are more favorable to various clinical lab test types and a buyer is going to want to establish themselves in the MAC that is the best match for their test offering. Proximity to an airport that is a hub for a major airline is also important to groups seeking to provide reference lab testing on a national scale with quick turnaround times (TAT). If you are in one of the 13 states that require lab staff to have a state license, this will probably have a negative impact on the lab’s value, as it makes recruitment difficult and drives up employment costs.
“Financials” may be the last letter in the CLIA SELF acronym, but it is almost always the biggest driver of value. Buyers like to purchase established, profitable, well-run companies. The most common approach used by sophisticated buyers is to value the lab based on a multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and then add or subtract from those numbers based on any findings outside the norm. Buyers will want to see at least three years of financials, if possible, but the EBITDA number will usually be based on the trailing twelve months (TTM). For small and medium-sized labs, I typically see a valuation in the 4 to 6 times EBITDA range (4-6X). Example: If ABC Labs does $1M in EBITDA per year they will be valued at between $4M and $6M. As the EBITDA number grows, so does the multiple. For example: If ABC Labs had an EBITDA of $5M I would anticipate a multiple in the 6 to 8 range for a total valuation of $30M to $40M. I have seen a few labs with unique IPs get multiples in the high teens. The EBITDA multiple valuation method only works on successful, well-run companies. There are many labs that are either unprofitable, breakeven, or only mildly profitable and this method doesn’t capture their value. As an example, a large lab with 100 employees and 1,000 samples a day that runs at breakeven on the year is not worth zero, as the EBITDA multiple method would suggest. In these situations, you sometimes see a valuation method that is 1x revenue or a customized offer based on the perceived value of the lab’s components. Often, the buyer feels these valuation methods do not capture the full value of their lab because they have a “pipeline full of great business” that is not reflected in the number. Sellers rarely trade on future potential, however, an earnout is a possible solution in these situations. This rewards sellers if their projections come to fruition and it protects buyers from overly optimistic sales projections. We are currently in a strange market state where buyers don’t want to pay full value for the trailing twelve months for labs that were heavily involved in Covid-19 testing, as this business is not viewed as stable and reoccurring in the future. A discounted valuation for Covid-19 profits is often given by most buyers.
The whole is often greater than the sum of its parts and a premium is paid for having everything wrapped up with a bow on it. In these situations, you can add up the value of C+L+I+A+S+E+L+F and apply a premium. However, that is not always the case. I often see buyers that only value a few of the lab’s components, maybe one insurance contract, a state license and the lab’s location, but they don’t value the other components at all. In these situations, I typically work with the seller to divide up the components among multiple buyers to ensure they are getting the best overall value for what they have built. Valuing a lab is more of an art than a science, and I recommend working with a professional who has experience with these transactions and can help provide sales comps, guide you with the best practices, and help you avoid common pitfalls.