9 Strategies for Robust Healthcare Due Diligence
Due diligence is a necessary step in any transaction. Whether it is a clinical affiliation or a full sale, due diligence is conducted so both parties fully understand the other. Often times, the best due diligence process is one that is robust, involving substantial interaction and discussion between the parties, and most likely resulting in a detailed understanding of the operational performance of each party.
According to Bill Baker, partner and head of transaction services for healthcare at KPMG, due diligence is similar to dating before marriage. During due diligence, each party prefers to put its best foot forward, refraining from revealing any negatives, just as in dating. It is usually after the marriage or the deal — when it is impossible or extremely difficult to undo a transaction — that negatives come to light.
"If a hospital relies solely on the other party to fully disclose without a robust due diligence process, it will find only positives, which could be misleading," says Mr. Baker.
Due diligence is a very complicated process because a lot of factors and issues must be covered, even more so with organizations that are as complex and regulated as hospitals and health systems. Here are eight strategies that could prove useful to executives and board members hoping to ensure a robust due diligence process for their organization.
1. Address due diligence as early as possible, ideally before governance negotiations. Mr. Baker recommends addressing due diligence as one of the first steps in a transaction process — before the governance of a deal is negotiated — because fully understanding a potential partner is beneficial in realizing the true benefits of a transaction. However, Mr. Baker does acknowledge that due diligence is not always easy to conclude prior to governance discussions.
"It is not unusual to agree on governance before initiating due diligence because not every potential partner will want to lay all their cards on the table. [For this reason], many parties allow due diligence caveats — transaction terms are not locked in until due diligence concludes," says Mr. Baker.
According to Dale Van Demark, JD, partner at EpsteinBeckerGreen, due diligence can be conducted even as a definitive agreement is signed. "In a perfect world, due diligence is conducted before and after a letter of intent. In those instances, the due diligence is utilized to modify terms of the letter of intent," says Mr. Van Demark.
2. Hold a call or meeting with senior leadership. According to Scott Becker, JD, CPA, partner at McGuireWoods, a call with the potential partner's senior leadership should be done as soon as possible. During the call, questions should be asked to give each party a feel for what the key issues are.
"In a pretty short period of time, you are going to have to do a ton of detailed follow-up to close the loop, but you can get a good sense of the key and challenging issues [from a call with senior leadership]," says Mr. Becker. "From there, you figure out further due diligence. You want to make sure the individuals reviewing the documents and information are focused on the key areas, the ones likely to be trouble. This way the process is not an endless waste of time, but a focused process."
3. Develop a game plan or strategy. Since due diligence is complicated by nature and many factors are involved, healthcare executives need to think through a strategy for due diligence before the process begins.
"The best sort of due diligence process begins with a game plan [or strategy], and it proceeds along that game plan, only changing as dynamics of the due diligence changes or as [new issues] are discovered," says Mr. Van Demark.
While sticking with the strategy is crucial, Mr. Van Demark recommends flexibility. "You have to be able to modify plans in order to react to changes," he says.
4. Use a checklist. According to Michael Daray, lead attorney in the healthcare practice at Law Weathers in Grand Rapids, Mich., a checklist of issues to cover during due diligence should be created as soon as possible.
"It is more of an organizational issue. It helps clarify the important items that the respective parties need to focus on. If you don't have some sort of checklist, it's easy to get bogged down on certain issues while neglecting others. From an organizational standpoint [the checklist] puts everyone on the same page as for what needs to be done," says Mr. Daray.
Ten key topics should be included on the due diligence checklist :
• Legal matters
• Financial matters
• Regulatory matters
• Environmental matters
• Employee matters
5. Prepare for anything and know the deal breakers. It is likely that a variety of issues will surface during a due diligence procedure, so hospital executives and board members need to be ready to deal with due diligence that veers off course.
"You have to be ready to contend with issues that come up out of the due diligence process and recognize that as a part of what due diligence is for. Due diligence gives each party the opportunity to assess and, in many instances, modify aspects of an agreement to deal with issues," says Mr. Van Demark.
For this reason, a hospital also needs to understand and determine its deal breakers in advance, so that when problems arise, no member of the board or executive team is caught off-guard or unprepared to make decisions. "Hospitals conduct their business in a highly regulated industry where there is a lot of risk. Organizations need to understand their risk tolerance in respect to diligence, because once an agreement is final, you can't get rid of that risk," says Mr. Van Demark.
6. Encourage full investment from all parties. Mr. Van Demark believes that the most successful due diligence occurs between two or more parties that really embrace and understand the process, especially the time and resource commitment that is necessary.
"Due diligence needs to be conducted in a deliberate manner so that vast amounts of information and numerous issues can be identified at both a technical and managerial level, at the appropriate time, so appropriate decisions can be made," says Mr. Van Demark.
According to Craig Garner, JD, former CEO of Coast Plaza Hospital in Norwalk, Calif., cooperation from both sides helped to streamline due diligence when he was negotiating the sale of Coast Plaza to Avanti Hospitals in El Segundo, Calif. Mr. Garner's willingness to respond to all of the requests for information about Coast Plaza — during multiple phases of diligence — helped the deal conclude successfully.
"I wanted to make sure that we made all disclosures. I wanted to do this only once, and do it right," says Mr. Garner.
Without full effort and participation from both parties, an issue may fall through the cracks, or certain information will not come to light at the appropriate time.
7. Don't lose sight of the purpose of due diligence. Due diligence itself can take a very long time and it is common for organizations to forget why they are doing due diligence, says Mr. Van Demark. Most organizations never lost sight of the business perspective of the process — how it provides a financial perspective to operations — but they forget that due diligence should inform modifications to the transaction agreement.
"When organizations forget to review or modify the rights and obligations of the parties in respect to each other, depending on what is revealed in due diligence, than the process was not fully useful. Hospital executives need to remember not to get caught up in closing the deal," says Mr. Van Demark.
8. Enlist advisors and legal counsel for assistance through the process. As mentioned before, due diligence covers many complex areas within a hospital's operations — financial, legal, compliance and so on. Due to the complexity of healthcare organizations as well as the complexity of topics, Mr. Baker advises that hospitals involve financial and legal advisors who have experience performing due diligence in a healthcare setting.
"Individuals with experience know what to look for, what areas to prioritize, the questions to ask and what risks to address," says Mr. Baker.
While advisors and legal counsel are not necessary in order to conduct due diligence, the experience they often bring is a good indicator of success for the deal. According to Brian Kerby, CPA, director of transaction services group for Crowe Horwath, some hospitals or health systems have experience in transactions so they may be more familiar with due diligence — they may have more experienced executives and/or in-house legal counsel.
"The hospital board or executives need to ask themselves: Are we experienced in [due diligence]? Have we done this historically? The answers to these questions are good indicators of whether or not advisors are necessary and to what extent," says Mr. Kerby.
9. Prepare to navigate politics. Due diligence can stir up some sensitive or controversial issues, adding the dynamic of politics to the already complicated process. According to Mr. Baker, it is possible for politics in discussion to cloud what should be appropriate, standard due diligence procedures. Typically the politics arise around the closing of the transaction when the parties begin to visualize the changes and operations post-closing.
"Typically [politics become a factor] during the lengthy discussions and negotiation around what a merged board or executive team looks like immediately post close as well as how it may evolve over some predetermined period of time," says Mr. Baker.
Unfortunately, politics can distract and/or delay the due diligence. This is why professionals suggest covering governance and post-closing structures early on. "[It is] an instance where experienced advisors play a key role. They may be better at probing for information amid sensitivity and tension," says Mr. Baker.
When participating in a healthcare transaction — a merger, acquisition, full sale or affiliation — there is no way to avoid due diligence. The above strategies will help hospital executives and board members conduct robust due diligence to satisfy their needs, state and regulatory officials and any other parties with a stake or interest in the deal or its outcomes. Overall, robust due diligence is pivotal because the more one partner knows about another and vice versa, the better — in a transaction or a marriage.
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