Due Diligence Does What?
What is due diligence? Simply stated, due diligence is the examination and review of a business by the buyer before the business is purchased. During the due diligence phase of a dialysis clinic acquisition, the buyer will perform a detailed review in the following areas: financial, clinical, operational, corporate structure, litigation and human resources. Depending on the due diligence results, the purchase price may be adjusted downward.
Before we get into the issues that may impact the purchase price, let’s discuss the various items that fall under each of the due diligence categories mentioned above. Below is a summary list highlighting the more significant items.
Financial – financial statements, tax returns, revenue reports, payroll registers and related party transactions.
Clinical – state surveys, policy and procedures manuals, medical staff by-laws, QA minutes and patient outcome data.
Operational – staffing ratios, operational metrics and stats, vendor and payor agreements, lease agreements and permits and licenses.
Corporate Structure – certificates of organization, by-laws and listing of shareholders, directors and officers.
Legal – complaints filed and any pending or threatened litigation.
Human Resources – organizational chart, census and employee benefits and policies.
Although this is not an all-inclusive list, it should give the seller a better understanding of what is requested and reviewed by the buyer during due diligence. Now let’s move on to the more important issue. What if the buyer says they need to reduce the purchase price? The seller’s perspective is “Why is My Purchase Price Being Reduced? We Agreed on a Price and Now You Want to Pay Me Less.” The purchase price is discussed in the Letter of Intent (LOI) but remember that this price is based upon satisfactory due diligence results.
There are certain things Sellers can do to prevent Due Diligence from reducing their purchase price.
- Prepare Financial Statements on an Accrual Basis: many clinics have financials prepared on a cash basis. As such, not all clinic expenses are captured and properly recorded in accordance with Generally Accepted Accounting Principles (GAAP).
- Record Bad Debt Expense for Medicare Patients with No Co-Insurance: Medicare only pays 80% of the allowable reimbursement. Bad debt needs to be recorded for the uncollectible 20%.
- Record a Reserve for Paid Time Off (PTO): clinic personnel have paid time off for vacation, holidays, illness and personal days. PTO should be recorded on a monthly basis and reconciled at year end for any earned but unused hours that carryforward to the following calendar year.
- Comply with Quality Incentive Programs (QIP): compliance with the QIP needs to be closely monitored because CMS will reduce payments to clinics who are not meeting the established quality metrics thus decreasing clinic cash inflows.
- Review Volume Commitments: volume commitments should be reviewed with vendors on an annual basis. Any shortfalls should be recorded as a liability on the financial statements.
Clearly, for the sale to take place, both parties need to feel that it is a fair deal. The moral of this story is that if you want to get paid what a buyer originally offers you, then make sure financial information is in order from the get go.