The med spa and aesthetics industry exhibited robust growth in customer demand in 2024, driving continued interest from private equity investment. A key driver behind this interest stems from the increased demand for treatments like neurotoxins, skin rejuvenation, and weight loss procedures and strategies, such as Semaglutides and CoolSculpting. When acquiring med spa practices, private equity firms routinely conduct financial due diligence to better understand the economic performance of the target company and ensure alignment on strategic objectives. Financial due diligence is pivotal for determining a fair and accurate valuation of the target because it proactively identifies potential risks and opportunities.  

During financial due diligence, the provider typically adjusts a company’s EBITDA to provide a fair and accurate representation of its run-rate earnings. In the med spa industry, the most notable considerations include proper revenue and expense recognition on an accrual basis, discretionary shareholder spending, determination of assets and services that will convey, and changes in service mix and pricing.  

Revenue & Expense Recognition 

Proper revenue and expense recognition is one of the most important factors when evaluating a target company because it enhances financial transparency. Historical margin analysis is paramount for private equity firms and other buyer groups when evaluating med spa practices for acquisition, and they are only useful with proper revenue and expense recognition policies. Med spas are generally cash-pay businesses, which may result in misleading financial statements, as earnings may seem more volatile than the underlying business’ true performance. This volatility stems from the use of prepaid and packaged services, membership offerings, and gift card sales, each necessitating adjustments to accurately reflect revenue generation within a given period. 

For example, a company might run a holiday sale in December on prepaid neurotoxin injection packages for treatments that will be provided the following year. Cash-basis accounting would show a material increase in revenue in December by recording this transaction at the time of purchase, whereas accrual accounting would normalize this scenario by recording the revenue when the services are rendered over the subsequent months.

Other common revenue reporting issues include improper recognition of revenue from prepaid packages, where the subsequent usage of services is booked as write-offs or discounts rather than the amortization of said prepaid balances. Another issue is the mismanagement of cash payments, where collected funds may not be recorded in the billing system, driving financial discrepancies. These industry-specific challenges highlight the critical need for thorough financial due diligence to uncover and address potential risks, ensuring more accurate financial reporting and informed decision-making. VMG Health’s team of experts conduct a comprehensive analysis of revenues and revenue-related liabilities, leveraging the med spa’s billing and sales data, engaging in detailed discussions with management, and reviewing unearned revenue reports along with package and membership details. This process ensures accurate revenue recognition under ASC 606 as we transition from cash to accrual accounting.  

Similarly, expenses recorded on a cash basis can be misleading due to varying inventory and cash management practices. For instance, a med spa practice may buy injection drugs and supplies in bulk one month to take advantage of rebate arrangements with suppliers, creating misleading gross margins and other profitability metrics when evaluating the cash-basis income statement. For further detail on cash-to-accrual conversions, see VMG Health’s previous article: Quality of Earnings Analysis: Navigating the Cash-to-Accrual Conversion. 

Changes in Service Offerings & Pricing Strategies

To keep up with the dynamic nature of its consumers and evolving cost pressures, med spas must continuously update pricing matrices and offer new services. VMG Health understands med spa pricing and service mix through our in-depth analysis of billing data reports and price-volume trends.  

Financial due diligence procedures focus on adjusting revenues based on historical volumes and new pricing considerations to give a more accurate representation of the revenue streams an investor would be acquiring. Through our comprehensive revenue analysis, VMG Health’s industry experts provide our clients with clarity regarding historical service line trends and production centers. Through our deep industry connections, we have noted service-offering expansion in the sector to include hormone replacement therapy (HRT) and regenerative medicine to improve same-store sales growth. 

Understanding the drivers behind the price and service mix shifts is critical; it deeply informs the run-rate adjustments that may be warranted. Through Q1 2025, increasing supply and personnel costs continue to pressure gross margins, while increased competition limits operators’ ability to raise prices to offset expense inflations. Med spa practices must pay particular attention to the revenue contribution attributable to weight-loss drugs, given the change in their status on the FDA-shortage list.   

Non-Recurring, One-Time, & Shareholder Discretionary Expenses 

Often, shareholders of any small business—not just med spa practices—pay for certain eligible personal expenses, such as automobile and travel costs, through the business. It is critical to understand what expenses and cash outflows are truly used to operate the business versus the items more closely aligned to the benefits of ownership. These expenses are unlikely to continue after the transaction, so removing them from adjusted EBITDA helps reflect the company’s true expense profile.  

Moreover, the med spa industry has seen tremendous growth in technological advancement. As new technologies have come to market, practices are purchasing improved equipment to enhance their service offerings. Given the industry’s cash-basis accounting nature, these equipment purchases are recorded as expenses on the income statement at the time of payment rather than being capitalized on the balance sheet and depreciated over time. In financial due diligence, it is imperative to identify and exclude one-time equipment purchases from EBITDA calculations to provide a clearer distinction between operational profitability and cash requirements to operate the business.  

In addition to removing one-time large equipment purchases, VMG Health works with practice management and uses financial and industry insights to determine whether the practice will need to replace or purchase new equipment in the future. Maintenance and growth capital expenditures can have a material impact on a practice’s future cash flows and should be brought to the attention of any potential investor.  

Shared Resources 

Finally, shared resources such as exam rooms, personnel, and equipment partnerships introduce complexities that must be carefully evaluated. Revenue and expense allocations become critical, as shared assets can obscure true profitability by inflating or deflating costs based on informal agreements or non-standardized accounting practices.  

In one recent engagement, a target practice shared treatment rooms with another entity under favorable terms to the other entity, which overstated facility rent expenses relative to what would convey post-close. Similarly, shared personnel, such as aestheticians, nurses, or administrative staff, may be compensated through different entities or cost-sharing arrangements, requiring verification that wages and benefits are properly allocated.  

Equipment partnerships—where expensive devices are leased or shared between businesses—can pose risks tied to contractual obligations and revenue-sharing terms that may be missed without financial due diligence. A thorough analysis assesses whether financial records accurately reflect the med spa’s standalone earnings potential, ensuring shared resource arrangements do not mask operational inefficiencies or create hidden liabilities. Through document investigation and in-depth discussions with management, VMG Health informs clients on shared resource considerations that may impact the target’s future EBITDA contribution. 

Contributor:

Jacob Mullen