Guide to closing a private equity transaction: Due diligence

Part 3 of the Series: Guide to closing a private equity transaction

The role of due diligence in the course of a private equity transaction is equally as important for both the buyer and the seller. Understandably, the buyer’s examination of the medical practice is comprehensive (going back several years) to ensure they understand the business they’re acquiring in terms of its profitability, operations, business relationships and potential liabilities. Unless the physician sellers are making a complete exit from the business, which is highly unusual for physician practice acquisitions, similar information from the buyer can be equally as valuable as the actual purchase price. 

What to consider

The selling physicians can use a similar process (often referred to as “reverse due diligence”) to evaluate compatibility with the buyer and the probability they deliver on their promises made during negotiations. While such a process requires time and resources, it saves far more time and money than finding out after the transaction closes that a new business partner’s style or strategy is incompatible. Physicians should consider inquiring:

• The buyer’s “culture” and how it’s consistent with the seller’s “culture”
• The experience of other physicians who entered similar transactions with the buyer
• Whether the buyer has been involved in regulatory investigations and/or litigation
• The buyer’s plan to reach their profitability and growth goals
• The buyer’s success to date with expansion, growth in value and other exits (in the same or similar industry sector)

The buyer’s formal due diligence process begins by sending the seller a written detailed due diligence request, and the process is largely executed by a team of experts to assist in the review of the materials, which may include healthcare regulatory lawyers, transactional lawyers, medical coders and auditors. 

Due diligence can be the most time-consuming and tedious aspect of a transaction. The more structured and organized the process, the smoother it goes, and the less risk of confusion, delays and spooked parties involved. To manage the process, the buyer establishes a secure data room where all responsive information is uploaded. This ensures the information shared is protected, tracked and easily accessed by all parties when needed. There’s a temptation to avoid the hassle of uploading documents to the data room and instead respond directly to individual requests for information from the buyer’s representatives. However, this makes it challenging later when they need to be referenced in schedules required for an ultimate purchase agreement.  

What to expect

Generally, the physician sellers can expect the following once the due diligence process starts:

• Most buyers begin the process focused on the financial information necessary to confirm the seller’s earnings. This involves reviewing the financial statements, coding audits, compensation methodologies and sources of revenue. 
• Material contracts are usually the next priority. These include payor agreements, employment agreements, leases, loan documents, software licensing agreements, other vendor agreements and insurance policies. The buyer looks to confirm the agreements have not terminated, the financial terms, how and when they can be terminated, whether there are exclusivity or non-compete provisions, and what is required in the event of a change of control.
• Next, the buyer focuses on any past and/or present investigations, disputes, settlements and current liabilities (such as loans, letters of credit and tax liabilities).
• Lastly, the buyer wants to understand how well the business is doing in the area of healthcare regulatory compliance.

Part of the process

The physician sellers should not be concerned with issues arising during the due diligence process. This occurs on every transaction, whether the seller is a large or small business. The buyer identifies areas of concern and  works together with the physician sellers to agree on how they will be resolved. This can include cleaning up corporate documents or agreements with third parties, adjusting the purchase price or amount placed in escrow, making a disclosure to a regulatory agency, or pushing back the date of closing. 

While due diligence can be time-consuming and anxiety-producing, it serves the important objective of ensuring the transaction is a successful investment for both parties.

Other articles in the series: 

• Part 1 - Guide to closing a private equity transaction: Preparing for a transaction
• Part 2 - Guide to closing a private equity transaction: Negotiating the letter of intent
• Part 4 - Guide to closing a private equity transaction: Healthcare regulatory issues
• Part 5 - Guide to closing a private equity transaction: Material terms to negotiate

Additional Resources

• "Mergers, acquisitions, and the dirty little secret of medical practice governance" (MGMA Podcast)
• "Four important factors to consider during mergers, acquisitions" (MGMA Stat)
• "Insights: Owning it! Strategic planning, navigating M&A and staying independent in healthcare today" (MGMA Podcast)