How to Conduct M&A Healthcare Due Diligence

Few areas of due diligence call for as much attention as that of healthcare.

A detailed understanding of exactly what’s being acquired is always important but the complexity of healthcare means that experienced hands in M&A won’t be enough to conduct the due diligence process.

It will take experts in the field with knowledge and experience of what’s being acquired. In the case of a diversified healthcare firm, it could take several different experts.

DealRoom has been involved in over 20 healthcare industry transactions, and played host to some remarkably complex due diligence processes.

In this article, we look at some of the most important aspects that anyone about to undertake a healthcare deal should consider.

For a more detailed look, check out the healthcare due diligence checklist that was put together by healthcare professionals working in M&A.

Trends in healthcare M&A

Merger and acquisition (M&A) activity across nearly all sectors settled back to more modest levels in 2022 with 1 notable exception. The mental health sector has remained hot, according to the Mertz Taggart report.

After the COVID pandemic, interest in health care took off from different sides. Not only M&A but also, health education and newly build startups and businesses in mental health education and businesses supporting students in passing exams like the psychiatry board exam and other became more popular.

New technology drives healthcare industry and raise interest to the companies to be acquired. At the same time the diligence process becomes more complex.

The importance of due diligence in healthcare

The scope, complexity, and innovative nature of modern healthcare create challenges for investors when deciding where to invest their capital.

The value generation potential of these investments is often tied up in the target company’s proprietary technology.

And to top it all off, getting healthcare wrong can have massive repercussions in terms of third-party liabilities. The combination of these factors means that due diligence in healthcare is of paramount importance.

6 Common Due Diligence Challenges in Healthcare

Dozens of healthcare companies conduct M&A with DealRoom and here we begin by formally outlining the process of healthcare due diligence in the M&A process. Here is a list of common due diligence challenges when it comes to healthcare entities:

1. Understand the target company’s market and where it fits

We can all be thankful that the world of healthcare makes such rapid advances.

But as beneficial as this is for the rest of us, it creates challenges in healthcare.

Questions to consider here include:

• “where is progress being made in this area?”,
• “is there a danger that what we’re paying for is going to be quickly superseded?” and
• “how do we protect our space, and advance further in this segment of the industry?”

The lines between healthcare and technology are increasingly blurred (hence, the term healthtech), and as a result, due diligence needs to take account of both. 

2. Review claims process and controls

Because of the thousands of  interactions that a healthcare company has with its end customers - patients of one form or another - it faces significant user risks for its products or services.

Some of the largest corporate settlements over the past two decades have involved pharmaceutical companies.

Examples include Johnson and Johnson’s $2.2 billion settlement for misbranding its antipsychotic drug, Risperdal, and Eli Lily’s $1.2 billion settlement for misbranding its antipsychotic drug, Zyprexa.

These are just the well-known cases. Companies operating in the healthcare space have to be constantly vigilant and have good processes and controls in place to mitigate these risks.

3. Review the target company’s compliance

Before most healthcare companies can even operate, they need to be compliant with a series of regulations.

It’s easy to assume that the company will be compliant because they’ve been operating in the market for several years.

But part of the issue when even global firms like Johnson and Johnson and Eli Lily have been caught on the compliance question, can you fully trust a company in the lower middle market which can far easily avoid regulatory scrutiny?

Examples of the sort of regulations that companies in the healthcare space should be compliant with include Federal Anti-Kickback Statute compliance, Stark Law compliance, Civil Monetary Penalty Law compliance, Corporate Practice of Medicine Law compliance, False Claims Act compliance, and of course, HIPAA compliance.

4. Review licenses and permits

Licenses and permits can be time consuming and costly - mainly in attorney’s fees - to obtain.

It’s important to understand where the target company has licenses and permits, and where it will need to obtain them if it is to fulfill the buying company’s corporate strategy.

Each country’s regulations are different. It could be that certain treatments aren’t allowed - or are more strictly regulated - in a different regulatory environment, reducing the company’s ability to operate there.

Understanding whether the target company is going to fit in its target markets is therefore an important issue to understand.

5. Review contracts with suppliers and distributors

Similar to operational due diligence, investigating the role of suppliers and distributors in the target company’s ability to conduct its operations is crucial.

Perhaps there’s a supplier of a certain additive which a drug depends on, a piece of technology that needs to be used in your healthtech, or just a relationship with a healthcare distributor which looks after over half of the company’s output, it’s crucial that you have a handle on the company’s value chain and how it operates.

6. Conduct HR review

Due diligence for healthcare is analogous to that for technology: understanding who generates value for the company is a key success factor for acquisitions.

For example, if the target company has developed several patentable drugs over the past decade, is that because of the process or because of a world class team of scientists working at their laboratories?

Are some of the managers fostering a culture of innovation that doesn’t exist at other pharmaceutical companies that doesn’t exist elsewhere?

A successful company depends on the people behind it as much, if not more, than any other kind of business.

Read also
HR Due Diligence: How to Do It Properly in M&A

Healthcare due diligence checklist

1. Legal

• Organizational Chart
• Joint Ventures
• Governing Documents
• Authorized Jurisdictions
• Board Minutes
• Past Transactions
• Related Party Transactions
• Management Bios
• Board Bios
• Capitalization Table
• Equity Issuances
• Options and Convertible Instruments
• Outstanding Debt
• Litigation
• Licenses and Permits
• Encumbrances
• Material Contracts - Termination
• Material Contracts - Restrictive Covenants

2. Commercial

• Customer List
• Customer Terminations
• Sales Channel List
• Sales Data
• Customer Contracts
• Sales Channel Contracts
• Commission Contracts
• Government Contracts
• Long Term Contracts
• Commercial Policies
• Pricing Policies
• Partnerships
• Strategic Plans
• Marketing/Advertising Plans
• Product Pipeline
• Advertising Materials
• Product Descriptions
• Marketing Assessment
• Vendor List
• Vendor Contracts
• Subcontractor Contracts
• Vendor/Supplier Onboarding Process

3. Financial

• Financial Statements - Audited
• Financial Statements - Unaudited
• Off-Balance Sheet Transactions
• Contingent Liabilities
• Prepaid Expenses
• Audit Letters
• Accounting Policies
• Changes to Accounting Policies
• Budgets
• Projections
• Cash Management
• Investmet Policies
• Accounts Receivable - Aging
• Bad Debts
• Reserves
• Credit Support Obligations
• Bank Statements
• Capital Expenditures - Past

4. HR

• Employment Agreements
• Consulting Agreements
• Compensation Arrangements
• Collective Bargaining Agreements
• Confidentiality and IP Agreements
• Severance Agreements
• Recruiting Arrangements
• Benefits Summary
• Benefit Plans
• Compensation Policy
• Bonus Plans
• Stock Option Plans
• Stock Option Awards
• Pension Plans
• Employee Litigation
• Judgements and Awards
• Disciplinary Proceedings

5. Industry

• Infrastructure (equipment, technology, capabilities)
• Location proximity to ancillary services and transportation (bus-line)
• Median household income, age, workforce opportunities
• Payer mix, CMI, and discharge data by county and diagnosis group
• Current methods for scheduling, documentation, coding and billing
• Adult and pediatric inpatient and ED incidence rates
• Transfer/referral frequency and receiving facilities
• Competing services
• Potential for growth
• Strategic fit
• Quantity and training of additional support staff (RNs, Mid-levels and other providers)
• Potential Key Performance Indicators (KPIs) expectations for number of visits, return on investment, etc.
• Insurance Claims and Risk Management • OSHA and workers compensation
• Environmental Compliance (Solid and hazardous waste, infectious medical waste, underground storage tanks, radioactive materials)
• Medical Staff and Physician Matters
• Admissions (inpatients)
• Number of inpatient days and growth of inpatient days, Length of stay

To find the whole healthcare due diligence checklist simply click below.

Tools for M&A healthcare due diligence

DealRoom’s competency in acting as a catalyst for M&A in the healthcare industry has been proven on over 50 deals.

From the earliest transactions, we worked closely with healthcare investors to establish what they required from a due diligence and project management package. The result that investors receive today is the result of that feedback.

The DealRoom due diligence package enables healthcare investors to:

• Identify the issues that need to be addressed, using our healthcare due diligence playbook based on experience gained on over 50 transactions.
• Create cloud-based environments where team members can gain a structured overview of the potential investment.
• Open channels of communication with third parties (e.g. IP lawyers and healthcare experts), enabling easy sharing of documents only with those that need to see them.
• Develop project management timelines, showing where everybody is in their work flows to ensure that the process stays on time and within budget.
• Begin the integration phase in tandem with the latter stages of due diligence.