Society Venture Investments is an investment and advisory firm. Our vision is a happier, healthier, wealthier life for a billion families worldwide by making healthcare investments whose impact strengthens communities and promotes long-term growth.

Introduction

• On September 19, the Federal Reserve lowered interest rates by 0.5%, a move that affects your healthcare practice more than you might expect.

• Interest rates play a crucial role in determining the financial health of your business, just as vital signs help assess a patient’s health.

• Common financial principles, like lower rates boosting valuations, don’t always work predictably—much like how a standard treatment plan can vary from patient to patient.

• Hidden opportunities, like lowering the cost of supplier contracts or financing, can arise from these changes if you know where to look.

How Lower Interest Rates Can Change the Game for Your Practice

In finance, interest rates play a role similar to vital signs in medicine—they provide key indicators of the overall economic environment that directly impact the health of your practice’s valuation. Lowering interest rates is like administering a drug that reduces systemic strain, improving outcomes—in this case, by lowering the cost of borrowing and raising your business’s perceived value.

Let’s explore how this works by focusing on the EV/EBITDA multiple valuation method, which is a widely used tool to measure the value of a healthcare business. If you think of the value of your practice like a patient’s overall prognosis, then the EV/EBITDA method is the diagnostic test that evaluates the underlying health of the business based on its operational performance, before considering factors like debt or taxes. Here's how the method works and how changes in interest rates affect it.

What is EV/EBITDA?

• Enterprise Value (EV) is like assessing the total health of a patient—it accounts for the entire value of your practice, including both equity and debt. EV is calculated as:

• EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is akin to measuring your practice’s core function—it reflects the earnings that come purely from your operational activities, like patient revenue and services, without factoring in costs that don't directly relate to operations (interest payments, taxes, etc.).

The EV/EBITDA multiple tells you how much investors are willing to pay for each dollar of your practice’s earnings before interest and taxes. Lower interest rates affect this valuation method in two key ways:

1. Lower Debt Costs Increase EBITDA: Just like a patient improves with the right treatment, your EBITDA (or core earnings) can benefit from reduced interest expenses. If you’re paying less interest due to lower rates, that boosts your earnings and makes your practice appear healthier.

2. Lower Rates Increase EV/EBITDA Multiples: Lower interest rates often lead to higher EV/EBITDA multiples because investors, like you, face fewer high-yield, low-risk investment options (like bonds). Much like how in a medical shortage, demand increases for any available resources, lower rates make equities (including your practice) more attractive, driving up valuations. Investors are willing to pay more for the same earnings, increasing your practice's EV/EBITDA multiple.

Impact of Rate Cuts on EV/EBITDA Valuation

Let’s say your practice has an EBITDA of $1 million per year, and investors are currently valuing your practice at a 7x EV/EBITDA multiple (i.e., they’re willing to pay 7 times your annual earnings to buy your practice). This means your current enterprise value is $7 million.

Now, the Fed’s interest rate cut lowers borrowing costs, making it cheaper for your practice to service debt. With this, investors start valuing similar businesses at higher multiples—say 8x EBITDA—because the lower rates improve the overall economic environment and reduce the cost of capital for potential buyers.

Example: How Rate Changes and EV/EBITDA Help You Expand Into an Ambulatory Surgery Center

Imagine you’re considering expanding your practice by investing in an ambulatory surgery center (ASC). You know this move could significantly increase your revenue by allowing you to perform outpatient procedures, but financing the ASC has always felt like a heavy lift.

Let’s walk through how the rate cut could boost your practice’s value, using the EV/EBITDA multiple approach.

Before the Rate Cut: Limited Options for Expansion

Before the Fed’s recent rate cut, your practice generates $1 million in EBITDA annually, and it’s valued at a 7x EV/EBITDA multiple. This puts your enterprise value at $7 million. However, securing financing for the ASC still feels too expensive due to higher interest rates—like diagnosing a patient who needs a procedure but is unlikely to qualify for insurance coverage.

After the Rate Cut: Improved Valuation Opens New Doors

With the Fed lowering rates, your borrowing costs drop, improving your EBITDA by reducing interest expenses. At the same time, investors are now willing to pay a higher multiple—8x EBITDA instead of 7x—because lower interest rates make healthcare investments more attractive. This bumps your enterprise value up from $7 million to $8 million, significantly improving your financial position.

That’s a $1 million increase in your practice’s valuation simply because of the rate cut. This higher valuation allows you to either leverage more financing for the ASC at a lower interest rate or attract equity investors who are now more willing to pay a premium for a stake in your practice. It’s like a patient suddenly qualifying for a less invasive, more affordable surgery that dramatically improves their health outcomes.

Lower borrowing costs and a higher valuation work together to make your ASC expansion more feasible. The reduced interest payments improve your cash flow, allowing you to allocate funds more efficiently toward the project.

Wrinkles in the Theory: Why the Rate Cut Might Not Be Enough

Just like a patient’s response to treatment can vary, the benefits of a lower interest rate on your valuation can be limited by broader economic conditions. For example:

• Patient Volume and Revenue Risks: A rate cut may signal broader economic concerns, like a potential slowdown. If the economy worsens, you might see fewer elective procedures or tighter reimbursement from insurers, reducing your practice’s future EBITDA. This could negate the benefits of a higher EV/EBITDA multiple.

• Capital Constraints: If your expansion plans rely heavily on external financing, even a slight economic downturn could make lenders more cautious, limiting access to funds despite lower rates.

It’s like a patient improving in one area (such as blood pressure) but experiencing complications elsewhere. You’ll need to weigh the broader economic context to ensure the rate cut delivers real long-term benefits for your practice.

Hidden Feature: Supplier Contracts and Lower Interest Rates

An often-overlooked benefit of lower interest rates for your practice lies in your supplier contracts. Just as reviewing a patient’s history can uncover hidden risk factors, combing through the fine print of your contracts might reveal cost-saving opportunities. Many equipment leases or pharmaceutical supply agreements contain clauses that tie payments to interest rates.

If interest rates fall, your ongoing payments could decrease, freeing up cash flow—just like a patient requiring fewer expensive treatments after their condition stabilizes. This additional liquidity could further improve your EBITDA and make expansions, like the ASC, even more affordable.

Conclusion: The Fed’s Rate Cut Can Boost Your Practice’s Value—If You Time It Right

The recent 0.5% Fed rate cut could significantly increase the value of your healthcare practice by improving your EV/EBITDA multiple. This opens up opportunities for growth, like building an ambulatory surgery center, while making debt more manageable. However, as with any medical treatment, the long-term benefits depend on broader factors. If the economic environment deteriorates, you may face challenges that offset these short-term gains.

By understanding how interest rate cuts affect your practice’s financial health through methods like EV/EBITDA, you can make more informed decisions about expansion and investment opportunities.