Priming Your Healthcare Practice for Private Equity Purchase: Part I

Private equity deals have increased in recent years as baby boomers seek exit strategies for their privately-held companies in lieu of succession planning.  Healthcare is one area that has recently been at the forefront of private equity transactions, and this trend is expected to continue.

Sax’s Healthcare Practice has seen our clients enticed by the anticipated multiples and the volume of recent transactions.  However, whether or not their practices are ready to undertake the due diligence process necessary to bring a successful transaction to a close must be seriously considered.

Doing Your Due Diligence

Across all industries, not just Healthcare, the purpose of the due diligence process is to evaluate all aspects of the company prior to the acquisition. It is a precautionary measure whereby company records are reviewed in great length providing the purchaser with a level of comfort as to the viability of the entity and the predictive future of the organization’s EBITDA and cash flow.

The due diligence process begins after the letter of intent and a non-disclosure agreement has been signed by both parties, and prior to the preparation of the purchase agreements. While the company owner may look to hurry the process of due diligence, it is inevitably a long, arduous journey that requires much time and attention to detail.

There are various aspects of the due diligence process:

  1. Financial Due Diligence
  2. Legal Due Diligence
  3. Operational Due Diligence
  4. Intellectual Property Due Diligence
  5. Commercial Due Diligence
  6. Information Technology Due Diligence
  7. Human Resource Due Diligence

This article will focus on preparing for the financial due diligence process.

Preparing for the Financial Due Diligence Process

If the plan is to sell to private equity, processes should be put in place a long time before a transaction is considered to ensure that the financial information will be accessible and that the records provided are complete.  Much consideration should also be given to accounts with lingering differences in need of adjustment. Time and attention to these matters will be well served in advance of the planning phase of selling.

This will require a potential seller to assess the various processes within their organization along with the assistance of a trusted advisor.  This assessment will undoubtedly uncover weaknesses which can be remedied prior to the selling of a business.

Reviewing accounts receivable will help gain a better understanding of the collection process and identify issues such as an increase in the days receivables are outstanding It is important to inquire regarding credit limitation for new customers and sales cut-offs. It is also an opportunity to reveal any underlying process which needs correction. Understanding the revenue cycle of a healthcare entity is of critical importance to the success of the due diligence process.

In addition, it is important to review the respective accounts payable aging schedule. Are there proper monthly cut-off’s and are the months invoices recorded? Are vendors’ statements compared to the aging schedule and are noted discrepancies followed up with the vendor?  This might sound simplistic, but for companies who do not have controllers overseeing their accounting process, inconsistencies will become visible when reviewing comparative monthly financial information. This will then become a hindrance to moving the due diligence process along. In addition, a review of all leasing arrangements will prove invaluable to the proper recording of financial data.

While focusing on financial data, the process of identifying potential red flags needs to be implemented in all aspects of an organization. The more that can be addressed prior to the due diligence process of a transaction, the smoother the process will go while sustaining minimal adjustments to the overall value of the business.

Maximizing Your Practice’s Value

It is important that healthcare entities are equipped to identify any issues that might impede or devalue the sale of the practice.  When performing due diligence for our clients, we act as if we are the purchaser and analyze all data that would be meaningful to a buyer, so we are proactively addressing any and all issues, and are ready with an explanation or course of action to remedy.

A potential purchaser will look back several years at a healthcare entity’s financial history to identify key trends and performance indicators that help to tell the story of past operations and areas for future improvement. Incomplete data and/or poor quality of data leads to a breakdown of the due diligence process, resulting in a delayed closing or the impediment of the transaction. The seller needs to provide data for the roll forward period and consistent monthly financial data that enables the purchaser to analyze trends.  This reporting needs to include detailed reconciliations and explanations for any discrepancies.  The significant accounts that should be reviewed include:

  • Accounts Receivable
  • Inventory
  • Accounts Payable
  • Accrued Expenses
  • Fixed Assets
  • Revenue and Various Expense Categories
  • Leasing Arrangements
  • Accounts with Significant Account Balances

The Importance of Compliance

It is vital that you are complaint.  The Healthcare industry is fraught with many regulatory compliance matters.  A company’s financial presentation may be stellar but if internal practices are found noncompliant during the assessment, this can seriously impede progress with the transaction. Parties in healthcare transactions will have a separate healthcare regulatory due diligence performed.  Regulatory considerations during the due diligence for healthcare entities include:

  • Stark Law Compliance
  • Anti-Kickback Statute Compliance
  • The False Claims Act
  • HIPAA Compliance

In addition, the parties should consider any potential successor liability or pending litigation, and a review of the current payor contracts in place.  The purchaser will have their own consultants analyzing regulatory matters for the respective state that the company does business in to ensure the adherence to the rules governing their state.

Sax’s Transaction Advisory

At Sax, our advisors recognize the delicate balance between deal makers and deal breakers when it comes to M&As and transactions.  With the unique needs of the Healthcare industry and private equity, our advisors have a deep understanding of what it takes to bring a successful deal to a close in both arenas.

Be sure to stay tuned for Part II of “Priming Your Healthcare Practice for Private Equity Purchase” when we address post-close transaction considerations such as tax planning, the roll over equity in a recapitalized company and the circumstances regarding the disposition of the additional equity.

Please reach out to Sax’s Healthcare Practice with any questions or needs with regards to private equity transactions, or the healthcare industry overall.


About the Author:

Deborah Nappi, CPA, MST is a Director at Sax and a vital member of the firm’s Healthcare Practice.  She specializes in conducting due diligence for private equity, analyzes Healthcare related transactions on the buy and sell side, reviews practice evaluations and manages post-close transactions.  She also serves as interim CFO during healthcare M&A deals, mitigating risk and ensuring a smooth and successful transaction.  She can be reached at [email protected].