DUE DILIGENCE IN HEALTHCARE PRACTICE ACQUISITIONS (Part 1)

[Part 1 of a 2-part series]

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Today we examine why you need to do Due Diligence, who should do it, and how to do it for tangible Practice assets.

• CONFLICTS OF INTEREST ARE RAMPANT among practice appraisers and brokers. ?All healthcare practice Appraisers are also Brokers whose income derives from commissions on the sales of practices they have appraised.? As a result, the Appraiser's independence and impartiality may be impaired, and Appraisals should be taken with a grain of salt.
• USE A DUE DILIGENCE PROFESSIONAL ?Due Diligence is a blend of art and science. ?It can only be successfully achieved by a business professional who has an appropriate mixture of industry knowledge and experience.
• ?ALWAYS PROTECT YOURSELF ?Do your Due Diligence first hand.? Personally inspect the Practice and kick the tires.? Don`t let unresolved issues go unresolved!? This is your only escape hatch on the deal without losing your deposit, so TAKE THIS VERY SERIOUSLY!

Due Diligence is the most important, but often the most neglected, part of a healthcare practice acquisition.

You, as the Purchaser, are at constant risk in an acquisition. You're at risk due to misrepresentations by the vendor (intentional or negligent), incomplete or poor quality records in the business (management problems?), inaccurate financial statements (read the accountant's disclaimer!), distorted valuation by the appraiser (read the appraiser's disclaimer!), misleading statements by the broker (their legal duty is to the vendor, not to you),? etc., etc., etc.

Everyone else in the deal is motivated to take advantage of you.? The vendor wants your money.? The Appraiser is employed and paid a handsome fee by the Vendor to convince you that the business is worth buying (even if it really is not!).? The Broker is employed and paid a substantial fee by the Vendor to extract the maximum possible amount of money from you in the sale.

Due Diligence is your prime protective mechanism in an acquisition.? It confirms that the substance of the practice is as advertised in the Appraisal and that your Offer price is justified.

Many Purchasers only do superficial Due Diligence in a healthcare practice acquisition.? They look at the appointment book on the computer, they walk through the premises, they look at the equipment.....and that's about it.? They do so because they assume that the Appraisal contains all the information that they need to know about the practice, that the information in the Appraisal is complete and accurate, and that the analysis of the information and the calculation of the valuation by the Appraiser is objective and complete and correct.

Unfortunately, all of these assumptions are frequently incorrect.? The Appraiser is neither independent nor impartial.? The Appraiser who decides what information to include in the Appraisal, how it is presented and the valuation methodology that is applied to it, is also the Broker who is employed and paid a substantial amount of money (7%-10% of the sale price) by the Vendor to extract the maximum amount of money from you, the Purchaser.

All Appraisers of healthcare practices are also Brokers (or employed by Brokers) whose main source of income is commissions from the sales of practices they have appraised.? Thus, the Appraiser/Broker has a fundamental conflict of interest that may cause the Appraisal to not be objective, to emphasize the positives, to minimize the negatives, or to omit material information.

As a result, the Appraiser's independence and impartiality in determining what information to disclose, how to present it and in calculating the opinion of value may be impaired and should be viewed with a grain of salt by a Purchaser.

Independent verification of the Appraisal through complete, quantitative Due Diligence is the most critical part of the acquisition process.? Without professional Due Diligence, you are 'flying blind' – taking on significant financial risk and legal obligations that will extend for many years into the future, ultimately determining the success or failure of your professional career.

DUE DILIGENCE is a blend of ART and SCIENCE.

The ART of Due Diligence is knowing where and how to find the relevant information.? This comes from experience in doing acquisitions:? knowing what doesn't 'smell right' or 'feel right', and knowing how to read between the lines of practice records and financial statements because what isn't said is often more important than what is said.

The SCIENCE of Due Diligence is knowing how to quantify and correctly interpret information in a way that yields actionable results relevant to the Practice. ?This is based on a mixture of professional knowledge and industry experience encompassing practice and patient management software, standard operational and financial metrics, statistical analysis, data sampling methodologies and probability-based decision-making models.

Have your Due Diligence done by an acquisition professional.? He/she will provide you with a Due Diligence Report that identifies and focuses your attention on the strengths and weaknesses of the Practice.? That is not just valuable for determining whether you are comfortable proceeding with the acquisition, you can also use it as the foundation for your Business Plan for future growth and improvement of the business.

The purpose of in-practice Due Diligence is to investigate and verify the existence, quantity and quality of the operational assets that generate the revenue in the business.? The first and most fundamental thing to do is to confirm the existence of the assets advertised in the Appraisal on which the valuation of the Practice is based, then verify their quantity and finally determine their quality.

Confirming the existence of tangible assets such as furnishings, fixtures and equipment that you can see and touch is straightforward.? Start with the list in the Appraisal, do a careful room-by-room inspection of the Practice, identify and check off each item on the list, make sure descriptions and product/serial numbers are consistent with the Appraisal, and confirm that equipment inspections required for regulatory purposes (like x-ray machines or sedation equipment) are up to date. ?There should be tags/stickers on equipment and a central regulatory inspection register for the Practice.

Then do a thorough inventory count of general supplies.? Clinical supplies should be checked to ensure that all perishable items are within their expiry dates.? Count all multi-part packages to ensure they contain the proper number of items.? Carefully check the drugs inventory against the Practice's Controlled Substance Register!? If the drugs inventory doesn't match the Controlled Substance Register, if the drugs aren't stored in a locked facility, or if the Register isn't up to date – proceed with caution!

Do your Due Diligence first hand.?

Don't rely on pictures...........or comments from the Broker!

Personally inspect the Practice and kick the tires.? Document any discrepancies between what's listed in the Appraisal versus what's actually in the Practice. ?Raise any issues with the Broker in writing. ?Set a timeline for the Broker to respond within your overall time frame for completing your Due Diligence because, when you get to the end of the time period allowed under your LOI for Due Diligence, you have to make a final decision as to whether the results of your investigations are satisfactory to you or not.

If your Due Diligence results are satisfactory, then you`ll waive your Due Diligence condition and proceed toward closing the acquisition.? But if they`re not satisfactory – including if the Broker has conveniently not responded to any issues that you have previously raised – then you will have to formally notify the Vendor that your Due Diligence condition has not been satisfied and you do not intend to proceed with the deal.?

Don`t let?unresolved issues go unresolved!? This is your only escape hatch on the deal without losing your deposit, so TAKE THIS VERY SERIOUSLY !?

In Part 2 of this Series we'll take an in-depth look at the most difficult parts of due diligence:

in-practice inspection of intangible assets and remote review of practice records/documents.