Mergers & Acquisitions – Is Your Business Ready?

No matter where you turn, you hear or read about another acquisition in the healthcare sector. The merger and acquisition market is red hot right now, especially with the activity from private equity funds. Perhaps it is time for you to consider whether it is time to sell. Many of you may think that you are prepared because you already have an audit of your financial statements. Think again. The due diligence process is far more intrusive than an audit. The due diligence firm hired by the buyer will be reviewing the financial statements for at least the past two years and looking for items that are not part of a standard audit, which may reduce the value of your business. If you are not ready for the due diligence process, you could be leaving significant dollars on the table.

Here are some areas where issues/problems typically surface. If you are planning to acquire a healthcare company or if you are planning to sell your healthcare organization, you should be mindful of these six areas.

Billing & Coding

It is important to gain a deep understanding of the entity’s processes for billing and coding of healthcare services, as there are many issues that arise: (1) it is very common to see an overstatement of revenues as a result of an organization’s billing practices; (2) many organizations have a general ledger system that is independent of the billing system, and the risk is that the organization does not reconcile the two systems regularly and/or properly; (3) how old is the billing software, and have the updates been regularly performed? (4) what is the organization’s process and practice for adjusting for contractual allowances? and (5) are services properly coded?

Generally, a buyer will request a coding audit as part of the due diligence process. It is important that you evaluate your own billing and coding process and perhaps conduct an internal coding audit to be sure that your organization is in compliance. Furthermore, violations of regulations such as the False Claims Act could impose significant fines and penalties and ultimately reduce the amount that you can realize from the sale of the business.

Collectability of Accounts Receivable

The collectability of accounts receivable goes hand-in-hand with gaining an understanding of the billing and coding process. Adjustments related to the collectability of accounts receivable are the most common adjustment. Purchasers are looking at (1) the aging of receivables, (2) the estimation process for bad debt, (3) how often the organization trues-up its bad debt expense, and (4) which payors make-up the older accounts receivable. Many organizations are reluctant to adjust their accounts receivable to the true net realizable value for various reasons. Any buyer will focus on this in the due diligence process, and if there are any suspect receivables, rest assured an adjustment will be proposed by the buyer.

Payor Mix

The contracts that an organization has with the various payors and the reimbursement rates received could be a significant aspect of the acquisition and could create value for the company. As part of the due diligence process, a buyer will evaluate the payor mix to understand the expected revenue realization from the types of patients served. Depending on payor trends, this could add or potentially reduce the value of the company. It is important for both the buyer and seller to understand the existing trends and why the company would be trending in one direction or the other.

Census/Utilization

This is a measurement all healthcare organizations track. The key take away here is to understand utilization trends by location and where these trends could be heading, as this will be an important aspect of the negotiation.

Hidden Liabilities

These are the liabilities not recorded on the balance sheet and which may or may not be known by the seller. Examples include pension or benefit liabilities, deferred rent obligations, liabilities related to HIPAA violations, or deferred compensation. However, the most common hidden liabilities are generally around taxes, including payroll, federal corporate, and state and local taxes related to nexus issues. Other hidden liabilities may be discovered through the normal financial due diligence procedures. However, with respect to taxes, the normal financial due diligence procedures are not sufficient by themselves. Specific tax due diligence procedures are necessary, as they are focused on tax-specific issues that are the genesis of hidden liabilities such as tax positions taken (or not taken) on federal and state tax returns and state and local nexus issues.

Typical Management Adjustments

The most common management adjustments seen in due diligence engagements are as follows:

Reduction of Accounts Receivable and Revenue – Generally, companies are not reconciling their accounts receivables regularly or accurately. Hence, providers are generally hesitant to reduce accounts receivables to net realizable value, but a buyer is only willing to pay for what it believes is truly collectible.

Deferred Rent Obligation – Many organizations do not properly straight-line their annual rent expenses based on the provisions of the lease agreements, or they are not recording the adjustments at all, and we typically see an adjustment for rent as a result.

Accrued PTO – Every company has its own policy with respect to paid time off. However, some companies are not properly accruing the liability each period or not accruing at all. Therefore, it is not uncommon for an adjustment related to PTO to be included as part of the due diligence process.

Other Compensation Adjustments – These would include adjustments for unusual bonus arrangements that are not typical for the organization, or adding back the salary of the owner because it is not consistent with what the market will bear; however, the adjustment used for a “typical” salary is also not consistent with market rate.

If you are contemplating purchasing or selling a business, you want to be mindful of the issues addressed above. If you are thinking of selling, it may be beneficial to undergo sell-side due diligence, as this process will uncover those skeletons that you will want to correct before going to market, as well as items that may enhance the value of the business.

If you need any assistance in this process, Marcum is ready to help.