Performing Extensive Diligence on the Buyer
It is textbook for the buyer in a healthcare M&A transaction to perform extensive diligence on the company that they are acquiring for their portfolio. Financials are checked, cash flow is double checked, and in the end, the overall cost of the business for the buyer will either most likely go up or down.
The Ambulatory M&A Advisor takes a look at some proactive actions that sellers can take in order to ensure that the buyer is the right person to take over the business, and to ensure that the business itself is prepared to take on a new owner for an appropriate price.
Steven Lawrence, shareholder at Milligan Lawless says that one thing that sellers need to look out for that could be the starting point of failure is a misalignment of goals to the extent that the parties are headed to a different result, or have a different mindset in terms of what the end goal is of the transaction.
These differences in end goals are obvious reasons that a transaction can fall off of the rails. Lawrence says that a subset of this problem would also be a financial difference or financial performance that does not meet buyer expectations. Another issue could be potential purchase price or return on investment that is offered by the buyer that does not meet the seller’s expectations that the believe the company might be worth. Really, it is a difference in valuations expectations where often transactions can fall off of the rails.
During the due diligence process, Lawrence says there are quite a few red flags that sellers need to pay attention to and catch on their own before they pop up and scare a buyer away from a potential transaction.
According to Lawrence, the starting point is when looking at the financial statements. If there are items that are discovered in due diligence that are not reported in the financial statements, or if the financial statements do not properly reflect the performance of the company, that can certainly be a red flag.
“I would say anything surrounding the financial performance or accounting methods of the company can be things that are considered red flags,” Lawrence says.
“Also, anything in the healthcare space from a compliance perspective that potentially creates risks for the purchaser can be a red flag in terms of diligence. Finally, I would say that matters in relation to intellectual property are other red flags. To the extent that there are potential risks associated with the company’s intellectual property where it has not been protected or may not be owned properly, those are all areas where diligence may turn up red flags that send the transaction off kilter.”
Julian “Bo” Bobbitt, a healthcare lawyer with Smith Anderson says that when it comes down to a seller performing diligence on a buyer, it is something that should absolutely be done. Bobbitt says this type of a move harkens back to the importance of the fundamentals of a good partnership in general.
“It is almost like a marriage; you are not just buying equipment and things like that. You are buying a culture, and acquiring some liabilities from both sides. In healthcare businesses, transactions are really for a long-term period and it is very important that both sides essentially do their homework. Any healthcare transaction needs to be well thought out,” Bobbitt says.
He adds that his goal is to have the parties be happy with the deal five years after it on both sides, otherwise, he does not predict the success of the proposed transaction.
Blayne Rush, Investment Banker, President of Ambulatory Alliances LLC says when performing due diligence on the buyer, the majority of the buyers are fairly known in the marketplace.
“They will have some sort of history, some sort of branding. In addition to what is known about the market and what their personal experience is, a potential seller can request contacts of other people that have sold their business to the buyer. For example, the physician up the road that has been in similar situations, that have similar types of practices or facilities and have sold to this buyer. You want to get multiple examples. You might even want to go to their website and examine all of their locations. You could pick out five locations then ask the potential buyer, of these five, which three are similar to your situation,” Rush says.
Another way Rush says diligence can be performed is through an interview of the buyer. According to Rush, sellers need to sit down with the buyer and be prepared to ask them questions to the extent that the buyer would ask a seller questions.
“A lot of sellers, of who I work with more than buyers say that the diligence process is similar to them having to get undressed in front of a room with a full audience. They have to bare it all of their business and the buyer is going to look at all that they have to offer in the deal. You don’t necessarily need to go that far with potential buyers, but you want to know where their money is coming from. Do they have cash? Are they going to borrow the money? If they are borrowing the money, meaning debt, do they already have that approval done? On top of that, what is their approval process?”
In an example, Rush says that the buyer could have corporate level debt that says it is on the parent company and filters down and there are liens on the practice level that dictate the criteria that a target must meet.
“Even during the preliminary due diligence, they have to turn around and see if the selling business fits in the criteria that they have agreed to from the lender. Typically they will put that package together, look at it, verify it with the lender and earn a rubber stamp of approval. If they are going to stack debt on it and they don’t already have the corporate level debt, then that is a challenge in the sense that you need to dig further because you don’t know where they are going to get their money,” Rush says.
A seller should also have a complete understanding of the long-term plan of the acquiring business. They need to understand what type of investor the buyer is, how long they have been investing.
“Say this platform is a potential buyer; they have a private equity group and they are four years into their investment. You have got to ask how long they are going to hold their investment. It is usually four to six years then depending on the buyer, they want to get out. You need to find out their plans and whether or not that is a problem for you. If you are still staying in the business, then you don’t know who the investor is going to be later. Most of the operational and other areas are going to remain consistent, but you want to find out who their EMR is….those types of things,” Rush says.
Bobbitt says that aside from recognizing a negative culture in a buyer, there are other red flags that a seller should watch out for.
“Obviously if the payments are delayed over time, you want to have some security for that or some recourse, escrow etc. A lot of times business liability and the leadership of the buying business are important. Are the adequately capitalized and do they have the proper technology and strategic plan for the rapidly changing healthcare industry,” he says.
“A lot of people are moving to a larger organization that is more sophisticated to help them cope with all of these changes that need to be made in order to succeed in the industry. Beyond the market puffering of the promises, you need to dig down and see that they can actually deliver. Quite often, those who have not done their due diligence and listened to the promises of the buyer are extraordinarily disappointed.”
When discussing the possibility of a company performing due diligence on itself before the buyer has a hand in the process, Bobbitt says that he tends to look back on the definition of marketing in healthcare where a seller had better have something worth marketing before they go out and try to make money off of it.
“You may get a contract or LOI, but it will fall through if you aren’t prepared. Make sure that you can back up what you say. Also, you may have representations and warranties in the transaction and if you aren’t properly prepared to follow through on those you are setting yourself up for breach, damages and other problems. If you can’t back up your representations and warranties, they would often go to due diligence where you should perform it based on your own ability to meet the binding requirements that you are agreeing to in your transaction.”
If you have an interest in learning more about the subject matter covered in this article, the M&A process or desire to discuss your current situation, please contact Blayne Rush, Investment Banker at 469-385-7792 or Blayne@AmbulatoryAlliances.com.