A Guide to Strategic Due Diligence for Physician Practice Mergers
By: Nick Hernandez, MBA, FACHE
Medically reviewed by Patricia Salber MD, MBA (@docweighsin)
Applying a systematic and thorough approach to strategic due diligence can yield huge returns to practices considering mergers.
If you are considering a physician practice merger, this guide will provide you with essential information about the key elements and strategic considerations of a well-done due diligence process.
While mergers and acquisitions can be an exciting part of physician practice transformation, however, it’s important not to get too far ahead of yourself as the next step in the process can be a lengthy one. That is due diligence.
The decision to buy, sell, or merge a medical practice is more complicated than ever. There are so many more elements than simply determining a medical practice’s worth.
For those considering merging with another private practice entity, there are many things to strategize about as a part of the due diligence process. Therefore, applying a systematic approach to strategic due diligence can yield huge returns to practices considering mergers. Let’s dive in.
What is due diligence in physician practice mergers and acquisitions?
Due diligence is an important part of the acquisition process. It represents the orderly investigation of any matter pertaining to business dealings. Essentially, it’s about understanding how a business really works.
Since no two medical practices are the same, it’s important that a diligent effort is made in order to obtain any information that would be relevant in the sale or purchase of a physician practice and its assets.
In mergers and acquisitions, due diligence helps clients recognize any financial, legal, or operational risks that may not be noticeable from outside perspectives. A key aspect of due diligence is to examine the strategic positioning of the “target” medical practice.
Why does due diligence matter?
While due diligence may seem like it only benefits one party, the fact is that due diligence helps both the buyer and the seller in the acquisition of a physician practice.
It is the seller’s responsibility to provide buyers, investors, and potential business partners with the information needed to make an informed decision. Yes, it means turning over extremely sensitive corporate documents such as profit and loss statements, business plans, payroll records, payer contracts, lease agreements, and so on.
From a buyer’s perspective, due diligence gives them peace of mind that they’re making the right deal and have all the information they need to make a good purchasing decision.
This information can include learning more about the practice’s existing patient base and referral relationships. It can either validate positive assumptions or warn of potential irregularities.
From a seller’s perspective, due diligence helps physician owners take a deeper dive into the financial integrity of their business and can also help them uncover the fair market value of their practice.
As valuations and acquisition prices are intertwined, it’s essential that physician owners, private equity firms, and management services organizations invest in quality due diligence reporting and services.
What’s included in due diligence reporting?
First of all, it is important to note that non-disclosure agreements (NDAs) are standard. If you are a potential seller and you are not offered an NDA by the potential buyer then this is a red flag right from the start. This is true whether or not you have chosen to work with a broker.
Every detail matters when during the due diligence process, including such things as,
- patient volumes and catchment areas
- existing relationships with referring physicians
- the practice’s workforce
- the competitive environment of the practice
Good due diligence may validate your assumptions. More importantly, it can help alert you to any irregularities or possible issues in a business that may bring the value of a “target” medical practice down.
Ideally, any issues would be surfaced before the due diligence stage, but sometimes things slip through the cracks, or may not be fully considered in the right context.
More Content from this Author:
Buying or Selling a Medical Practice? Read This First.
Physician Practice Valuation: What You Need to Know
Key elements of due diligence
* Financial Information
Most buyers spend the majority of their due diligence looking at and confirming financial reporting. All documentation and accounting information should be up to date and accurately portray numbers that were disclosed during the deal-making stage.
* Legal
Understanding if the business being acquired has any potential liabilities is another important consideration in due diligence. This includes looking into current partnerships and contracts in place to ensure there are no irregularities before moving forward.
* Business sustainability
Cash flow management and long-term business sustainability are important aspects of due diligence. Careful analysis and previous years of data (e.g. patient volumes, procedures, billings, and collections, etc.) will help potential buyers diagnose trends and decide if their investment is worthwhile.
* Assets
Buyers will want to validate what assets are in place and if they are in good working order. If not, they will have to make investments after closing. This may impact the value of the deal.
Be sure to review service agreements as well as any lease arrangements. Additionally, real estate (owned or leased) needs to be evaluated and discussed strategically with the seller.
Contracts with physicians and any other employees may need to be redone. The buyer will often have sensitive discussions with the seller during due diligence as it relates to those.
All other employee-related items (e.g. benefits plans, 401(k), COBRA continuations, etc.) should be readily accessible as these can take time to review and make determinations on post-transaction changes.
Finally, it is important to note that not all due diligence investigations are the same. Expect surprises. This can greatly impact the length of the due diligence process as well as the time invested by all parties. And, if due diligence drags on for too long, one or both parties can lose interest in the potential transaction at stake.
Strategic considerations for the due diligence process
* Seek validation
Is the strategic vision for the agreement valid? Physician owners must have a clear rationale for a transaction or truly understand a deal’s impact on their practice’s long-term financial future.
Too often, however, there’s a misguided sense of why the merger should take place at all. Often there’s far too little time spent defining how the merger will enable them to beat competitors and increase organizational value. Those that fail to take this into account contribute to the failure rate of physician group mergers.
Unfortunately, the link between strategy and a transaction is often broken during the due diligence process. By focusing strictly on financial, legal, tax, and operations issues, the typical due diligence around a proposed merger fails to test whether the strategic vision for the deal is valid.
To do so, physician groups should bolster the usual financial due diligence with strategic due diligence. They should test the conceptual rationale for a deal against more detailed information available to them after signing the letter of intent. They should also see if their vision of the future operating model is actually achievable.
* Seek confirmation
When analyzing a practice, looking at historic and current performance is relatively easy. But what about looking further into the future? What are the strategic issues ahead?
A strategic due diligence process should explicitly confirm the assets, capabilities, and relationships that make a buyer the best owner of a specific target acquisition. It should bolster the physician owners’ confidence that they are truly an “advantaged buyer” of an asset.
Advantaged buyers are typically better than others at applying their established skills to a target’s clinical and business operations. They also employ their privileged assets or management skillset to build on things such as
- a target’s practice reputation
- patient experience
- relationships with referring physicians
Naturally, they also turn to their special or unique relationships with vendors and the community to improve performance, leading to advanced synergies that go beyond what’s normal.
When change comes suddenly, it can turn strengths into weaknesses and sweep away dreams of success. The aim of a merger should be to achieve mutually reinforcing advantages.
* Seek mutually reinforcing advantages
Michael Porter wrote in his classic Harvard Business Review article, “What is Strategy,” (subscription required) competitive advantages stem from how
“activities fit and reinforce one another…creating a chain that is as strong as its strongest link.”
By undertaking strategic diligence, physician owners will be able to not only define their main objectives but also gain greater control over the desired direction of the new entity after the merger is consummated. Some of the strategic diligence issues to understand include:
- The strengths of each practice
- What the practice could be doing better
- What opportunities exist as a result of this merger?
- Are there threats that we face by completing this merger?
- The current culture of each practice
As part of the process, you should also consider the scope for further growth, efficiency, improvement, and so forth. It is critical for physician owners to be honest and thorough when assessing their advantages.
Ideally, they develop a fact-based point of view on their beliefs-testing them with anyone responsible for delivering value from the deal, including
- physicians
- physician extenders
- clinical staff, and front
- back-office personnel.
Above all, when it comes to the merger of two physician groups, culture is a key decision criterion. It must be meticulously examined as part of any due diligence process. Further, it should be completed prior to any financial considerations. In my experience, this is of paramount importance for practice-to-practice mergers.
Final thoughts
The results from the strategic due diligence process provide the acquiring practice with the strategic information it will need to manage the target practice. Often, the seller knows more about the practice and its patients than the buyer. This asymmetrical knowledge can have long-lasting negative effects post-merger.
Strategic due diligence accelerates this learning process and expedites the achievement of the long-term goals. Of course, nothing in the future is certain but using a strategic and diligent approach provides a far greater understanding of the issues ahead.
The due diligence process is a must, however, it is inherently filled with conflict. This conflict usually arises in the following circumstances:
- A first-time seller is hesitant to turn over sensitive information.
- The seller is untrusting of because the buyer is a competitor
- The transaction was unsolicited by the potential seller.
These are keen reasons why it may be of interest for the seller to engage the services of an independent consultant.
I have assisted many entities (including physicians themselves, private equity firms, and management services organizations) with due diligence of physician practices. So, I can attest to the highly structured process of due diligence.
There are myriad items to review and question. These go beyond having a mere rough idea of what equipment is in the practice. Or whether there are any malpractice claims.
Due diligence is a critical part of mergers and acquisitions, particularly as the deal comes to a close. It’s important to understand what to expect from the process. That way, you’ll be able to provide accurate and timely reporting that increases the value of your medical practice. It can also help you identify and address irregularities ahead of time.
Nick Hernandez, MBA, FACHE is the CEO and founder of ABISA, a consultancy specializing in strategic healthcare initiatives.
Since founding ABISA in 2007, his emphasis has been on developing and maintaining a strong relationship with physicians and identifying areas for business opportunity and support. The company’s client list includes physician groups, hospital systems, healthcare IT organizations, venture capitalists, private equity firms, and hedge fund managers.
Nick is a graduate of the United States Naval Academy and a former Captain in the U.S. Marine Corps. He holds MBA degrees in both Operations Management and Information Technology & E-Business Management from Wake Forest University. He is Board Certified in Healthcare Management and has been named a Fellow of the American College of Healthcare Executives.
He is a frequent guest lecturer and is often quoted in the national media. He has consulted with clients in multiple countries and has over 20 years of leadership and operations experience. Nick is a Subject Matter Expert in business strategy, practice management, telemedicine, health IT, and oncology.
Originally published at https://thedoctorweighsin.com on September 25, 2020.
