Nine Due Diligence Best Practices for Healthcare M&A

By Brian W. Kerby, CPA; Brian P. Murray, CPA; and Ronald L. Ralph, CPA
| 4/4/2017
Nine Healthcare Due Diligence Best Practices

The healthcare environment remains ripe for mergers and acquisitions (M&A), with many organizations across various sectors continuing to consider these transactions among their financial and growth strategies. When contemplating a business combination, healthcare executives must take a well-planned, coordinated approach to avoid unwanted surprises during or after the transaction.

The following nine due diligence best practices can aid buyers in executing successful healthcare merger and acquisition transactions.

1. Create a Deal Execution Plan

Planning is an essential first step in facilitating smooth transactions. Taking time to thoroughly research and understand potential partners will assist the buyer in uncovering and assessing possible problems and issues before meeting with and considering target partners.

First, the buyer should develop a schedule and systematic process for the transaction, which will help in working toward desired outcomes. A systematic approach also helps remove any emotion that may be associated with the transaction.

Next, a strategy or game plan for the transaction should be created. An important part of creating a strategy is determining the criteria the buyer is looking for in a partner. Setting criteria based on the buyer’s objectives helps the buyer to have a thorough understanding of its needs, including what it’s looking for in a potential partner and the financial impact of the transaction on employees, the community, and stakeholders.

In addition, buyers should have conversations with a target partner about what deal and operating structures are acceptable to the target. Developing an acquisition criteria sheet will help with this process, as it allows the buy-side team to stay focused and disciplined.

Buyers interested in a merger or acquisition also should consider developing a core diligence team. Because due diligence covers many complex areas – such as finance, legal, compliance, regulatory, quality, human resources, and IT – including team members from all essential organizational departments will help identify risks and opportunities associated with a potential transaction. And to lead the team, some buyers find it beneficial to hire an external third party or designate an internal core diligence team leader to help spearhead the transaction process and add expertise as the deal progresses.

2. Commit Time to Partner Selection

When looking for a potential partner, the buyer organization should spend ample time evaluating whether the partner would be a strategic fit and would help meet the goals the organization wants to achieve. Sourcing of potential partners can be achieved in several ways, including directly reaching out to the potential partner, being introduced to a potential partner through other business contacts, and receiving an invitation from the potential partner.

3. Perform Preliminary Due Diligence

Once the buyer chooses a potential partner, it should perform preliminary due diligence to better understand the target partner and to ultimately determine if it wants to move forward with the transaction. This step involves gathering and evaluating information in areas such as financial performance, structure of the transaction, significant risks, cultural fit, and legal and tax issues. Performing preliminary due diligence will assist the buyer in setting a preliminary value for the targeted partner.

4. Write and Issue a Letter of Intent

After conducting preliminary due diligence, if the buyer determines it wants to move forward with making a formal offer, it will submit a nonbinding letter of intent (LOI). The letter should include a preliminary valuation and also may mention the buyer’s ability to pay the purchase price, propose a target closing date, touch on tax consequences for both the buyer and the seller, request a period of exclusivity to complete due diligence and execute the deal, explain the anticipated transaction structure, and summarize the buyer’s intentions about the retention of key management.

5. Perform Confirmatory Due Diligence

If the seller accepts the LOI and if the buyer decides to move forwarded with the transaction, it will want to perform extensive confirmatory due diligence. The goal of this step is to confirm the information and representations that were provided to the buyer from the target partner during the preliminary due diligence process.

During confirmatory due diligence, the buyer should:

  • Determine whether it should go through with the deal
  • Confirm the purchase price based on identified risks and the quality of financial statements provided by the potential partner
  • Confirm the transaction’s structure
  • Address how it will handle any post-closing issues that arise
  • Begin to plan for an integration strategy with the seller

At this point, the buyer also should form the rest of its transaction advisory team, which should include members from organizational areas such as legal, accounting, regulatory, operations, reimbursement, quality, insurance, human resources, benefits, and tax.

6. Arrange and Secure Financing

If the buyer is moving forward with the purchase, it will need to secure a financing commitment to support the acquisition. In general, the seller will want to see proof of financing before closing the transaction. Depending on the transaction structure, financing can be raised based on the borrowing ability of both the target partner and the buyer.

7. Deliver a Definitive Agreement

If the transaction continues to move forward, the buyer will submit a legally binding definitive agreement to acquire the target company. This agreement will include the purchase price, target working capital, and all details about the transaction. It also will state whether the transaction is being structured as an asset purchase agreement or as a stock purchase agreement.

8. Design an Integration Strategy

Multiple objectives exist for designing the integration strategy. The first is to take advantage of any complementary strengths that will enhance services or operations of the newly merged organization. The second is to develop an implementation plan for expected cost efficiencies and elimination of redundant work processes. The third is to establish clearly identified transition plans and timelines for addressing such things as cultural differences, operating policies, and benefit plans. Employees are the most precious asset of any company, and overlooking their needs could undermine the future success of the merger. Successful integration often is one of the primary determinants of a transaction’s success, so this important step should not be overlooked and should be started early in the due diligence process.

9. Anticipate Questions From Regulators

If regulatory approval is needed for a transaction, buyers should anticipate detailed questions from regulators and plan appropriate answers. Common questions asked by regulatory bodies include:

  • Why did the buyer select this specific target company?
  • What is the transaction’s structure?
  • Is the buyer paying fair market value?
  • Are there market share issues that could be in conflict with the Federal Trade Commission?

A Well-Thought-Out Approach

Conducting thorough due diligence is essential for buyers to see to it that merger or acquisition activities run smoothly and result in successful transactions. A well-thought-out approach can uncover potential issues and help the buyer avoid regrets after a deal is closed.

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