When selling a healthcare business, the due diligence stage is one of the final and most critical phases in an M&A process. It's the buyer's opportunity to verify every aspect of the business before proceeding to and finalizing a purchase agreement. In healthcare, this phase can be especially complex, given the regulatory landscape and sensitive patient data involved. Typically lasting between three to six months, confirmatory due diligence involves a deep dive into financial, clinical, human resources, and legal aspects of a business to ensure that everything presented during the courting period aligns with the reality of the business’ operational performance. Here's what to expect during this process and how to best prepare for it.
Confirmatory Due Diligence: Setting the Stage
Confirmatory due diligence starts once a Letter of Intent (LOI) is signed. At this point, a buyer has demonstrated legitimate interest but must take the step of confirming that the financials and other representations of the business are accurate. This phase often begins with a formal Quality of Earnings (QoE) review or amplified financial vetting. The goal is to verify the financial health and performance of your healthcare business, ensuring the revenue trends, profitability, and expenses align with what was originally presented.
A thorough QoE review evaluates:
- Income Statements and Balance Sheets: Typically, buyers request at least three years of income statements (P&Ls), balance sheets, and year-to-date financials.
- Adjusted EBITDA: Buyers assess your Adjusted EBITDA, which eliminates non-recurring or personal expenses to give a true picture of cash flow.
- Net Working Capital (NWC) involves understanding your current assets minus liabilities, affecting the deal structure.
- Long Term Debt & Other Liabilities: Reviews any debts or liabilities that are contributing to interest expense which can be of the main addbacks in EBITDA. Moreover, when a company sold, it will be without indebtedness. A seller should know how their cash proceeds will be affected by any relevant loan principals.
- Compliance Risks: Healthcare is a highly regulated industry, and compliance is a non-negotiable aspect of due diligence. A QoE lays the groundwork, confirming the company complies with healthcare regulations (e.g., Medicare, Medicaid) and identifies any legal or audit risks. The assessment of these risk may go beyond the scope the QoE, but the QoE can quantify the exposure.
If discrepancies arise during this financial vetting, buyers may adjust their offer or renegotiate the commercial or legal terms to accommodate any changes. Conversely, accurate and clean financials build trust from the start, ensuring a smoother negotiation and closing process.
Diving Deeper: Clinical, Human Resources, and Legal Due Diligence
Once the financials are vetted, buyers delve into other critical areas:
- Clinical Due Diligence: In healthcare, clinical operations play a pivotal role in sustaining revenue and patient trust. Buyers will examine:
- Quality of Care and Patient Outcomes: Ensuring compliance with healthcare standards and regulations.
- Licensure and Certifications: Verifying that all practitioners have the required credentials.
- Regulatory Compliance: Assessing adherence to HIPAA, OSHA, and other relevant healthcare regulations.
- Human Resources Due Diligence: The workforce is the backbone of any healthcare organization. Buyers will evaluate:
- Employee Contracts and Agreements: Ensuring all contractual obligations are documented and transferable.
- Organizational Structure: Understanding the hierarchy and key personnel roles.
- Retention and Transition Plans: Identifying strategies to retain key staff post-acquisition.
- Legal Due Diligence: This phase verifies that the business is free from legal encumbrances, including:
- Contracts and Agreements: Reviewing vendor contracts, payor agreements, and lease arrangements.
- Litigation History: Investigating any past or pending legal issues.
- Intellectual Property and Licensing: Ensuring compliance with licensing requirements and securing intellectual property rights.
Clinical, human resources, and legal diligence findings significantly impact the drafting of the Purchase Agreement (PSA). If discrepancies or risks are identified, the buyer may seek adjustments to the agreement's commercial or legal terms.
Navigating the Process: The Role of Virtual Data Rooms (VDR)
Maintaining confidentiality is crucial given the volume and sensitivity of information shared during due diligence. This is where Virtual Data Rooms (VDRs) come into play. VDRs are secure online repositories where all relevant documents are stored and accessed by authorized parties.
Why Use a VDR?
- Security and Confidentiality: Only formally invited and vetted parties can access the VDR, protecting sensitive patient and business information.
- Organization and Efficiency: Information is categorized for easy navigation, ensuring all required documents are available in one place.
What Goes into the VDR?
- Financial Documents: Income statements, balance sheets, and QoE reports.
- Clinical Records: Compliance documents, licensure details, and patient outcomes (with HIPAA compliance).
- Legal Contracts: Vendor agreements, employee contracts, and lease documents.
- Corporate Documents: Organizational structure, operational procedures, and intellectual property records.
Common Challenges and How to Overcome Them
Due diligence can be an arduous and time-consuming process stretching over several months. Here are some challenges sellers may face and strategies to navigate them:
- Volume of Information: The sheer amount of data required can be overwhelming. Organizing and categorizing documents prior to entering a formal sale process helps streamline the process.
- Inaccuracies in Financials: Any discrepancies can jeopardize a deal. Engaging in a sell-side QoE review before buyer diligence begins ensures accuracy and builds trust.
- Employee Disruptions: Prematurely revealing a prospective sale to employees can lead to anxiety and attrition. Keeping the sale confidential is advisable until the Purchase Agreement is signed and due diligence is complete.
Working with experienced intermediaries or M&A advisors can mitigate these challenges and guide you through the complexities of due diligence.
Concluding Due Diligence with a Purchase Agreement
As the main components of due diligence are nearing completion and all information has been verified, the buyer will begin drafting the Purchase Agreement (PSA). This document outlines the terms of the transaction, including the purchase price, payment terms, and any contingencies based on due diligence findings.
However, if inaccuracies are uncovered during due diligence, the buyer may seek to renegotiate:
- Purchase Price Adjustments: If financials are overstated, the buyer may reduce the offer pricing to accommodate an accurate reflection of the business.
- Legal or Commercial Terms: Buyers might include indemnities or contingencies to protect against potential risks.
On the other hand, if the presented information proves accurate and no red flags are found during diligence, a deal has a better chance of reaching a successful outcome and maintaining the terms originally proposed in the Letter of Intent.
Final Thoughts: Navigating Due Diligence with Confidence
Due diligence is a rigorous yet crucial part of the healthcare M&A process. It ensures buyers have a comprehensive understanding of what they're purchasing, while sellers gain credibility through transparency. The process can be daunting, but thorough preparation—starting with organized financials, verified clinical operations, and secure organization — can make all the difference.
If you're considering selling your healthcare business, start organizing your documents early, engage in a preliminary sell-side QoE review, and work with experienced M&A advisors to navigate the complexities of due diligence. With the right preparation, you'll be well-positioned for a successful and profitable exit.
By understanding and preparing for the due diligence process, you can minimize delays, build buyer trust, and maximize the value of your healthcare business. If you're ready to take the next step, contact us to learn more about how we can help you through this complex journey.
