In today’s highly competitive healthcare environment, investors may find themselves in an auction process where they must conduct due diligence pre-exclusivity. With limited time and mounting pressure, it can be difficult to know what issues to prioritize. Here are some practical tips for focusing your due diligence efforts strategically in a pre-exclusivity setting:
- Quality of Earnings: Against the backdrop of high valuations, quality of earnings should be a key diligence focus, particularly in the context of high-complexity transactions such as corporate carve-outs, partnerships with corporates and public-private pairings. For example, it is critical to examine the pro forma EBITDA to see if it excludes costs or includes questionable adjustments or add-backs.
- Timeline: How competitive is the auction process and when are bids due? Does the buyer plan to conduct a full due diligence review pre-exclusivity, or instead look for big ticket liabilities that have a potential to impact valuation or derail the transaction?
- Legal Showstoppers: Keep an eye out for legal showstoppers—issues that go to the core of the business, are not isolated incidents and are not fixable through purchase price adjustments, indemnification, escrow or enhanced compliance measures. For example, referral relationships that are based on illegal arrangements, systemic upcoding, quality of care issues, tenuous relationships with hospital partners, untenable and promised salary increases, a culture of non-compliance, or a retiring physician workforce without adequate succession planning.
As you plan your due diligence, keep in mind these additional factors that can inform how you structure your efforts:
- The size and the sophistication of the target. Is it a $100 million business or is it a mom-and-pop shop? If the target is a larger more mature business, then diligence issues may have a smaller impact when viewed in the context of the larger business. For example, if the target operates 200 surgery centers, a license issue at a single surgery center is likely not material. A larger business will also have a more sophisticated compliance infrastructure and management team in place, which should give buyers additional comfort in the diligence process.
- The structure of the transaction and transition issues. Is it an asset purchase, such that historic liabilities are left behind, or is the transaction an equity purchase such that historic liabilities will be assumed by the buyer going forwards? Will the target transition on to the buyer’s benefit plan, billing system, IT and compliance infrastructure?
- The specialty involved. Every specialty has different risk areas and risk profiles and your advisors should have significant experience in that industry to be most effective. For example, pediatric dental is an area where a targeted billing and coding audit is a must before closing. Similarly, taking a careful look at how ophthalmology practices compensate physicians for visual field tests is critical in ophthalmology transactions. Addressing anesthesia arrangements for surgical groups is also an area of concern, given recently regulatory activity in that arena. Finally, managing the expectations of ASC management company partners or any option holders is a critical step to be addressed early in the transaction process.
Striking a balance between speed and attention to detail is crucial for success in the healthcare dealmaking landscape. Companies that prioritize and seize control of the due diligence process position themselves to build partnerships that will deliver excellence in both care delivery and profitability.