Quality of Earnings: The Big Obstacle to Healthcare Deal Success

Volume 11, Issue 8, April 23, 2024

By: Anna Elliott, CM&AA

A lot of merger and acquisition (M+A) deals fail. That's been the case for a long time. The M+A failure rate that's frequently cited puts the percentage between 70 percent and 90 percent. A Harvard Business Review column largely blames failure on unexpected problems that pop up during the transaction process, which makes the process drag on and eventually motivates the involved parties to go their separate ways.

While unexpected problems contribute to deal failure, I would argue that a growing contributing factor is that buyers are scrutinizing deals more closely with prolonged intentions. That's apparent when we look at how buyers are approaching their quality of earnings (QofE) evaluations.

The Oversized Impact of the Q of E Process

The assessment of a company's value and the facilitation of deal negotiations are significantly influenced by the QofE evaluation. Recent trends in the healthcare industry indicate that the QofE process has become more prolonged due to heightened buyer scrutiny of a company's financials during the due diligence phase, which is creating a challenging and time-consuming process.

As due diligence firms delve even deeper into scrutinizing QofE, as if the small middle-market companies they're evaluating are publicly traded and require such an intense amount of analysis, the duration of the due diligence process extends. Failure to properly oversee this aspect of a transaction may result in disagreements about a variety of transaction issues and lead to prolonged negotiations, highlighting the importance for M+A advisors to adhere to the established protocols and remain open to considering alternative buyers for their clients. This mindset is crucial in accurately capturing the true value of the transaction and preventing wasted time, as extensive delays can jeopardize the success of the deal.

In today's competitive M+A landscape, it has become increasingly common for buyers to unintentionally disrupt a seller's process by moving at a sluggish pace. This can be frustrating for sellers who are eager to close a deal and move on to what's next in their career or begin to enjoy retirement.

Buyers must understand the importance of moving quickly in the M+A process to keep up with the fast-paced nature of the market. If they are unable to do so, they risk losing out on valuable opportunities and potentially hindering the success of the deal. As it is said, "Time kills all deals."

Improving the Likelihood of Deal Success

It is imperative for sellers to be well-prepared before putting their business on the market and initiating the M+A process. This includes getting financials in order, from cash basis to accrual, and we highly recommend sellers complete a QofE on their own company and have this report ready before launching the sale process. Such an initiative can significantly expedite the transaction process and eliminate or at least greatly reduce the level of scrutiny from a buyer's accounting firm.

Pulling off M+A deals, where the rate of success is well under 50 percent, requires extensive careful planning and due diligence, managing risks, and making smart decisions to increase the likelihood of sealing the deal and doing so in a manner that is fair for both parties. In this context, having a proficient healthcare M+A advisor to oversee the process is crucial for sellers, and collaboration with the advisor around preparation is key. Sellers have much at stake and more emotional involvement than buyers. The M+A advisor should prepare them for what's to come and help navigate the seller through the complexities of the deal.

It's worth noting that buyers occasionally attempt to disrupt a seller's process by submitting pre-offers prior to the designated submission date. The rapid acceptance of a preemptive bid by sellers may result in a missed opportunity to gain valuable market insights and enhance bargaining power, which can ultimately lead to a more favorable deal. Insufficient evaluation could potentially embolden buyers to dictate terms during negotiations, thereby endangering the success of the transaction. The M+A advisor must ensure compatibility and diligently adhere to the offer terms, or, alternatively, swiftly transition to the next prospective buyer if necessary. 

It's also important for sellers to understand how to best respond to preliminary offers. An offer provided to a seller prior to the company being brought to the market can potentially lead to a protracted negotiation process and limit the number of potential buyers. In other words, a preliminary offer that's accepted by a seller can essentially become a trap if the buyer submitting the offer then takes advantage of a QofE analysis to decrease the value of the offer now that the seller has begun to move forward with the transaction.

During a market sale, it is advisable for an M+A advisor to utilize any preliminary offers to effectively manage the transaction timeline and better achieve the objectives of obtaining the best value, fit, and terms for the seller's company.

In addition to the importance of thorough preparation and clear communication, it is also essential for all parties involved in healthcare transactions to maintain transparency throughout the process. By being open and honest about expectations, goals, and concerns, potential pitfalls can be addressed and mitigated early on. Such a level of transparency can build trust and collaboration, make the transaction process less daunting, and lead to a smoother transaction and more successful outcome for the parties.

Anna Elliott CM&AA

With over 15 years of experience in healthcare technology, post-acute care, hospice, and urgent care, I am a highly experienced healthcare executive. I have successfully supported numerous private equity roll-ups and exits in the home healthcare sector. My extensive knowledge of the healthcare industry and my leadership in the M&A community, as a certified M&A Advisor (CM&AA) and member of the Executive Committee of the Chapter of the Association for Mergers & Acquisitions Advisors (AM&AA), distinguish me from others in the field.

Throughout my career, I have specialized in healthcare and have excelled in attracting healthcare technology firms and industries that are growing through Mergers + Acquisitions. I have a strong ability to target specific needs and opportunities in the business supply and demand process, resulting in over $150 million in value delivered to organizations.

As a co-founder of M&A Finders, a boutique Merger and Acquisition advisory firm in Pittsburgh, I have been able to pursue my passion for advocating on behalf of buyers and sellers in achieving their M&A goals. I am excited to bring my skills and network to VERTESS, where I have access to the necessary resources to further expand my impact in the healthcare industry.

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Email Anna Elliott or Call: (724)900.1377