Due Diligence (Part 1): Basic Elements

The term “due diligence” first came into common usage after the stock market crash of 1929.  Prior to that time, many sellers of equities marketed stock without investigating the economic soundness of the companies involved.  The Securities Act of 1933 required that brokers conduct a “due diligence” of their future offerings and that they disclose all findings.  The term has morphed into one that is widely applied in other markets, including acquisitions and mergers.

In the healthcare mergers and acquisitions area, the due diligence process is the inspection of a business by a prospective buyer.  This is an in depth examination of all aspects of the business and typically occurs after a Letter of Intent (LOI) has been signed.  Occasionally, prospective buyers will initiate a hybrid of the due diligence prior to submitting an LOI as a way to determine if an LOI is justified or not.

There are some due diligence items that will almost always be considered across the range of healthcare companies, whether an independent pharmacy or a residential program for people with disabilities.  They include:

  • Financials – P&Ls, balance sheets, cash flow statements, A/R aging schedules, and other financial documents for a two to three year period, including year-to-date (YTD) results.
  • Projections – all budgets, business/strategic plans, projected capital expenditures, and related assumptions.
  • Ownership Structure – corporate structure, ownership shares, debt instruments, any unique liabilities or liens, and records of ownership actions, including all corporate documents and meeting minutes/notes.
  • Organizational Structure – organizational charts, total FTEs, segregation of employees per service area, turnover data, unique compensation agreements, and backgrounds on key employees.
  • Customer Information – revenue by customer/payment source, revenue by service site, copies of all key funding contracts, opportunities and threats in the current and new marketplaces.
  • Marketing/Referrals – current marketing efforts, customer referral sources, documented impact of marketing, new marketing initiatives and referral development strategies.
  • Legal Issues – pending litigation involving the company, current insurance coverage/contracts, intellectual property, and regulatory-related concerns.
  • Real Estate/Facilities – nature of the facilities, ownership of related property, terms of leases including equipment leases and future use options.
  • Personal Matters – current benefits and related expenses, leave policies and related accruals per employee, and current issues that may pose a longer term risk for the buyer.
  • Marketplace Trends – recent and evolving trends in the current marketplace, known changes that will affect future revenue/profitability, competitors, and actions currently being taken to address future changes.

While this list does not cover every unique issue (e.g., size of inventory at a durable medical equipment (DME) company), it provides an overview of the depth of required preparation.