By Ian Goldberger

Market liquidity is beginning to open back up now that investors and banks are starting to rationalize the impact of COVID-19 on different business sectors, which means deal activity is also picking up again after a noticeable dip in the second quarter of the year.

There are many reasons why now, more than ever, larger physician practices, hospital systems and private equity funds may want to acquire or merge with other healthcare companies. Several trends are currently driving healthcare M&A, including the business impact on hospitals and physician practices, which may be seen by opportunistic investors as distressed assets; and the evolution of digital healthcare and the opportunities it presents for startups and investors alike.

However, in healthcare, it is sometimes more challenging than in other industries to ascertain whether an M&A transaction will be a net positive, as increasing earnings in healthcare is rarely as straightforward as simply increasing patient volume and/or decreasing costs. Acquiring an entity often includes considerations around areas such as insurance contract reimbursement rates, billing and coding practices, and realization of other potential operational synergies through company integration and change management.

As a result, due diligence and strategic planning initiatives for transactions are particularly important when considering acquiring a healthcare practice. Private equity firms, physician practices or healthcare organizations considering acquiring a healthcare organization should pay close attention to key areas during due diligence efforts, especially considering heightened risks resulting from impacts of the COVID-19 pandemic. This article outlines several critical areas that any potential buyer should evaluate to mitigate risks, including:

• Accounting methods
• Coding procedures
• Reimbursement rates
• Earning potential
• Post-deal integration
• Staffing changes
• and more

Accounting methods
It’s imperative to perform thorough financial due diligence for any potential healthcare transaction. As part of that process, it’s important to consider whether the target uses a cash-basis or accrual-basis method of accounting and what this might mean as you assess their financials, as there can be significant lag time between when medical services are performed and when an insurer reimburses the claim.

Financial statements calculated on a cash-basis may not give an accurate picture of whether a practice’s revenues and profits are growing or shrinking. Smaller practice groups – often the targets for acquisition – tend to use the cash-basis method of accounting. For buyers considering acquiring such a practice, it’s critical to understand the significance of the impact between cash-basis and accrual-basis income levels. As an example, this can be extremely problematic during the pandemic where accrual revenue may have begun to decrease in March, however cash-basis revenue may not have begun to trend downward until May, June or even later.

Coding procedures may need to change
Smaller companies generally have fewer resources available to understand and analyze how to properly document and code procedures for reimbursement from insurance companies. Furthermore, with government payors, such as Medicare or Medicaid, regulations exist that could create significant risks to a buyer for coding issues that existed prior to an acquisition. Therefore, it’s important to conduct a thorough coding compliance review prior to finalizing an acquisition.

Some coding practices may need to change when a practice becomes part of a larger organization. Coders/billers may errantly select CPT codes for procedures that reimburse practices as high as 35% more than the specific CPT codes that should have been selected. If this were going on for years prior to the acquisition, it could total hundreds of thousands of dollars in wrongful revenue payments, resulting in a very different perspective of the practice’s prior financial and operational performance.

While the above example addresses a potential significant issue, there are times where coding changes can positively impact revenues: improving coding and billing procedures at a smaller practice through further education and training may lead to increased reimbursement from payers. In both cases, performing a coding compliance review prior to an acquisition provides the buyer with the necessary knowledge to make informed decisions.

Now consider this: the practice may have adopted a telehealth solution to continue seeing patients while their offices were closed due to the pandemic. Organizations who do not have the appropriate resources to research the proper coding and documentation procedures for telehealth patients may create significant risk of incorrect billing. Furthermore, the inaccurate billing could yield higher revenues than what would otherwise be received and create potential risks of future complex remediation procedures to solve for the overpayments received from payors.

True earnings potential after the transaction
Sometimes, the strategy behind buying a physician group may be to gain access to an entity with favorable payor reimbursement rates in a specific geographic area. However, due to contractual terms with insurers, typically reimbursement rates are restricted from being shared between parties. As such, how would a buyer fully understand whose rates are better and/or what the true earnings potential of a merger or acquisition would be after closing a transaction? In these cases, the buyer would benefit from hiring an independent third-party advisor to perform a black box analysis, which could help provide transparency in this situation, while appropriately maintaining confidentiality.

To further assess future earning potential, pay close attention to financial key performance indicators (KPIs) and month-over-month reports. Was the practice shut down for a certain amount of time and if so, how long? Did the pandemic significantly impact patient volume, revenue, or possibly the mix of services provided? Are these effects likely to continue or was it a short-term dip? Many businesses are “omitting” the months of March and April altogether when analyzing their KPIs and projected revenue numbers. Focus on any identifiable trends in the more recent months when the company was fully operational, as well as for the same time period in the last couple of fiscal years. Understand the true financial impact of the pandemic and what projections may look like once the economy is fully up and running.

Finally, it’s important for buyers to include a thorough review of suppliers in their due diligence procedures. The COVID-19 pandemic created massive challenges in the global supply chain, and healthcare suppliers were forced to prioritize hospitals in order to serve patients affected by the coronavirus. Were any of the company’s key suppliers affected and how does that impact operations, timing of supplies and inventory, and vendor expenses going forward? Are new discounts or promotions available based on larger volume orders or paying within a specified time period?

Strategic fit and post-deal integration in healthcare M&A
As with any merger or acquisition, it’s important for buyers to determine how the acquisition of the target aligns with their strategic vision and goals, and to have an action plan from the beginning for post-deal integration initiatives. If the seller(s) understand and support the strategy, the deal is more likely to be successful.

An integration strategy should consider the following questions, among others:

• Does the buyer have the capability to fully integrate the new practice, including the time and investment required?
• How does the geographic reach of both, the buyer and acquisition target, overlap or complement each other?
• Will any new or ancillary services be offered to the existing patient base?
• Is growing the overall patient base part of the strategy; if so, how quickly is this expected to occur?
• How will the acquisition target be integrated into the acquiring company’s existing IT infrastructure, billing and other back-office functions?

Change management and staffing changes
Any integration strategy should also include a change management plan.

To get buy-in from employees, the buyer should place an emphasis on transparency and communicate the strategy, vision, and goals of the newly combined organization. A change management plan may also include communications about new policies and procedures, organizational hierarchy and training on new IT systems, among others.

Buyers should get to know the current owner(s) and assess how they will respond to key changes if they are staying on board. A common deal term negotiated by many buyers (especially more recently due to the economic downturn caused by the COVID-19 pandemic) includes incorporating part of the purchase price as an earn-out bonus after the transaction closing, based on the company’s meeting of certain desired financial and operational results. The earn-out bonus provides the seller with additional payments based on how the company performs after the acquisition, how he or she specifically performs, or a combination of both. This can help maintain productivity and motivation after an acquisition, as well as minimize certain risks and exposures for the buyer.

Seller financing may also be a beneficial way to structure a deal for a buyer. In this case, part of the acquisition price is “loaned” to the buyer. For example, in a $10 million acquisition, a buyer may pay the seller $6 million up-front and provide $3 million in earn-outs over a period of time. The remaining $1 million may then effectively act as a loan from the seller to the buyer, with a predetermined interest rate and payoff schedule. Seller financing is another solution to ensure that the seller remains “invested” in the company.

Increasing the odds of success in a healthcare M&A deal
Healthcare practice buyers need to evaluate a variety of factors for any potential M&A transaction. After all, many deals don’t live up to expectations. While it can be difficult to accurately predict how a merger or acquisition will ultimately play out, buyers can increase the odds of a favorable outcome by engaging an experienced, industry-specialized transaction advisory professional to help them prepare for a healthcare M&A transaction, identify the risks and exposures outlined above, and conduct thorough buy-side due diligence.

About the author: Ian Goldberger is a manager in the Business Consulting Services (BCS) practice for Kaufman Rossin and helps lead the firm’s Transaction Advisory practice. Ian advises companies through capital raise and merger and acquisition initiatives including strategic planning, financial modeling, business plan preparation, financial and operational due diligence and post-deal integration planning and execution.