By Brian Hackman, MBA, MSIS, ASA, Manager, GE Healthcare Camden Group
Many, if not most, healthcare organizations have been involved in a transaction with another business entity within the past several years, whether with a physician practice, outpatient center, hospital, or health system.2014 and 2015 saw record numbers of healthcare M&A transactions, and the desire and pace of healthcare organizations to complete deals will likely remain strong even in light of the recent presidential election results.
Now more than ever, it’s important to reemphasize the fundamentals of a successful transaction. Below is a list of ten “do’s” and “don’ts” for a smart transaction as a healthcare provider. In the current environment, it is imperative that healthcare organizations properly prepare and execute a prudent transaction process. Otherwise, a lot of time, money, and attention can be diverted from managing core business operations.
- Identify a strategic vision for the transaction. A strategic vision lays the groundwork for the transaction. Be able to articulate and defend the vision of the transaction and the environmental factors and business rationale leading to it. Draft a post-transaction governance, transaction, and organizational structure and outline any preliminary terms and conditions. Finally, confirm the transaction is consistent with your strategic plan. Two questions to contemplate: (1) Does the transaction better position the organization for a value-based environment and (2) does the transaction add a competency or resource necessary to succeed?
- Seek an independent, third party to perform a business valuation and anti-trust assessment. Transactions in the healthcare industry involve a number of legal, regulatory, and tax considerations. By engaging with an independent third party, you gain a greater level of assurance that the purchase price is fair. It also limits your exposure to potential compliance and regulatory issues (i.e., Stark Law, Anti-Kickback Statute), and provides proper documentation if ever audited by a governing body, such as the Centers for Medicare and Medicaid Services, the Internal Revenue Service, or the Federal Trade Commission. Outside counsel to inform potential anti-trust or other regulatory risks is also crucial. A market assessment to determine the potential market impact, as well as potential consumer benefits of the transaction should be performed to assure that all parties are informed of the opportunities, requirements of the transaction, as well as potential risks.
- Complete thorough due diligence. The purpose of the due diligence phase of a transaction is to gain a greater understanding of your target company. Use this process to research and evaluate any potential issues, liabilities, or concerns. An analysis of the target company typically includes, but is not limited to, a review of its operations, such as revenue, expenses, volume/productivity, and coding and documentation; its finances, including the cash flow and strength of the target’s balance sheet; and any legal considerations, including pending litigation that could impact future profitability. In addition, pay keen attention to the cultural fit between the two organizations. If the cultures are too divergent, or the cultural integration is back-burnered until after the transaction, it is unlikely that a deal will work out. Depending on the findings of the due diligence, it may be necessary to renegotiate the proposed structure of the transaction. Don’t be afraid to walk away from the transaction if the risk profile of the target company exceeds the risk tolerance of your organization.
- Develop internal financial projections. Based on the information provided during the due diligence process, develop financial projections for the target company or combined entity. It is likely these internal financial projections will differ from those generated during the business valuation, as the projections will incorporate contract rates from your organization and any prospective synergies to be gained from the transaction, which the business valuation may not include. Depending on the type of transaction, a business plan of efficiencies (“BPOE”) can be a useful guideline to articulate where and how operational and structural efficiencies will be created. Use these financial projections to understand the impact of the transaction on your current financials and cash flow. These are also good ways to measure future performance versus targets. Calculate the return on investment to ensure it is consistent with your organization’s goals..
- Understand the impact of the transaction on your balance sheet. Take into account and plan for how the transaction will affect your balance sheet. Will the transaction be financed with cash, debt, or a combination of both, and what are the advantages and disadvantages of each? How will the purchase price be allocated on the balance sheet? Be sure to understand how or whether the transaction will impact any debt covenants or key balance sheet ratios, which can influence your credit rating.
- Be bewitched by the shiny rock. At some point, an opportunity may arise to pursue a transaction with a top organization in your market. At first glance, the concept of joining forces may be compelling. However, in this situation, it is particularly critical to follow the steps outlined above and evaluate the financial and operational merits with clarity and objectivity. Ensure it isn’t too good to be true and really is in the best interest of the organizations and their patients.
- Buy into overly optimistic integration synergies. Rosy projections can make any potential transaction seem like a no-brainer. Run various scenarios (e.g., expected, best case, and worst case) to test the primary assumptions or question the main drivers of the projections for reasonableness. It is advisable to hash out and understand the operational and financial risks during the due diligence process rather than after the transaction closes.
- Assume the integration process will be 100 percent seamless. While the transaction process can be long and time consuming, don’t assume that once the transaction closes, the hard work is over. In fact, the hard work is just beginning. The integration of two organizations can involve numerous operational and cultural hurdles, including blending corporate cultures, information technology systems, human resource systems, operating mechanisms, etc. Successful integration requires thorough pre-transaction planning and consistent ongoing communication. Consider employing change acceleration processes to facilitate the integration process.
- Lose focus on what you do well. Most organizations typically have a small number of core strengths. Acquiring business lines outside of this portfolio of expertise can sometimes dilute management’s ability to run each efficiently. In such situations, a higher level of due diligence may be required to ensure you have the internal capability to manage that business line. If not, consider bringing in outside expertise through a management services agreement or hire the required talent from outside. Alternatively, consider other types of transactions, such as joint ventures or joint operating agreements, where the day-to-day management can be handled by partners who specialize in that particular space.
- Engage in this process alone. Outside third party expertise can help ensure a higher probability of success. Form a team of advisors to create a sounding board for your thoughts and ideas. Legal, financial, and operational support can not only mitigate potential compliance and regulatory risks, but also assist in validating the rationale for the transaction to the various stakeholders in the respective organizations. Post-transaction, advisors can help navigate the inevitable challenges that will arise during the integration process.
Mr. Hackman is a manager with GE Healthcare Camden Group and specializes in healthcare finance. His focus includes fair market valuations and strategic planning for both nonprofit and for-profit healthcare organizations. He also has experience in reimbursement analysis, service line planning, and financial forecasting. He may be reached at [email protected].