Becker's Hospital Review

Transactions & Valuation Issues 40 9 Strategies for Robust Healthcare Due Diligence By Kathleen Roney D ue 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, 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 • Indebtedness • Assets • Regulatory matters • Environmental matters • Contracts • Employee matters • Insurance • Litigation 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 dealbreakers 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.

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