10 Reasons Why Healthcare Mergers Fail (and How to Avoid Them)

Volume 11, Issue 11, June 18th, 2024

By: Bradley Smith

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At least seven out of 10. That's at the low end of how many mergers and acquisitions (M+As) are likely to fail. The high end? Nine out of 10.

These are not misprints. They are conclusions of research, as referenced by Harvard Business Review and other publications. They tell us that 30% of M+As at most succeed, while only 10% are essentially assured to succeed.

These M+A failure and success figures were determined via examination of a large pool of deals in every business sector. Common reasons frequently cited for such a high failure rate include an uninvolved seller, culture shock at the time of the integration, and poor communications from the beginning to the end of the M+A process.

With the odds seemingly stacked against healthcare business owners, why would you consider selling your company, especially if you expect to be invested (financially and/or personally) in the future of the business after a transaction?

At VERTESS, we have found that the M+A process can be navigated and lead to a higher success rate when have the right information and team to work with. It also helps to understand what can go wrong and how to avoid making these mistakes. I personally have a closing rate of about 82%.

Here are 10 of the factors that can lead to failed mergers and what is necessary to overcome the shortcomings.

1. Not knowing the motivations of buyers and sellers

There are essentially two kinds of sellers: one that looks for the most money for their business and one that needs to find the perfect buyer for the individuals, families, staff, and community related to the business. Buyers, on the other hand, come in all shapes and sizes, from strategic buyers that are looking for growth to financial buyers (private equity) looking to build and flip — and many shades in between.

If a transaction has any hope of being a success, it is important to determine the motivations for both parties. At VERTESS, we always discuss what is most important to sellers well before bringing their business to market. We also carefully screen all buyers to understand their intention and assess if there is a good fit.

These steps help with winnowing down what could be a lengthy list of prospective buyers to those that align well — at least on paper — with a seller. If there isn't good alignment, there is likely no reason to continue conversations with a prospective buyer.

2. Unrealistic expectations

It's not unusual for sellers to believe they should receive a certain amount of money — usually a particularly high amount — for their business because that's what they believed the company was worth. Sellers often estimate what their company is worth after hearing about transactions for other companies in their market, reading articles and columns that discuss multiples and prices paid, or being approached by a prospective buyer that casually threw out some figures.

The numbers sellers envision are often unreasonable. That doesn't mean they don't have a good company that should do well on the market. Rather, it means that most people naturally believe that something they value is valuable — and often more valuable than the market would believe. A financial analysis and valuation can reveal figures that are objective and in line with similar transactions. Most buyers are unwilling to cross certain thresholds, regardless of how amazing a business may be (or seem to be to a seller).

Ultimately, a company is worth what someone is willing to pay for it. The only way to maximize a valuation of a company is to run a process that brings in all the buyers and has them make offers simultaneously. Anything less will likely result in selling your company for less.

A seasoned healthcare M+A professional can help prepare a seller ahead of time for the selling experience, including what offers to anticipate. Both parties should reach an understanding of the expectations of the sale before going to market.

3. Hidden debt and financial instability

Buyers understand sellers sell for many reasons, including the fear of losing the company because of debt or money stresses. However, no one wants to be halfway through a transaction due diligence process only to learn about the numbers trailing downward or worse: the posting of foreclosure notices. This tension for a seller will often lead to poor decisions. Any buyer will be aggressive and take advantage of the situation.

Be forthcoming with your healthcare M+A advisor. Paint the complete, honest picture of your business — its successes and especially the struggles and how you overcame them. Transparency is essential. With a clear understanding of your business, the advisor may have some immediate suggestions to stabilize the situation until the right buyer is found or can help fast-track the process to maximize value.

4. Inaccurate financials

The first step of our process here at VERTESS is to present to sellers a financial picture of their business the way that buyers will assess it. We help formalize even the most difficult financial (e.g., QuickBooks) records. We also complete a proforma that projects future earnings and opportunities.

Despite our best efforts, there are ways these processes can lead to the presenting of incorrect information. How? The numbers we use are provided by the sellers. If the data shared with us is incorrect, we will then be working with incorrect data, and we may not be able to identify all the errors. In addition, most buyers will convert the financials to an accrual basis and expect them to be compliant with generally accepted accounting principles (GAAP). This exercise will compromise a weak set of books and lead to inaccuracies.

We have seen sellers overinflate growth for future years, underestimate the cost of their services, or book revenue incorrectly. We can often secure a great offer with these numbers. However, once under a letter of intent (LOI), the buyer will conduct a quality of earnings (QofE) review. That's often when we learn that the numbers provided to us are not accurate. The result? The buyer either adjusts the purchase price accordingly or pulls the offer.

5. Quality of earnings

Speaking of quality of earnings, in today's healthcare M+A environment, buyers are highly reliant on the QofE report to the point of weaponizing the report to gain leverage on a transaction and ultimately reduce the purchase price. Given these unusual times, I highly recommend completing a seller's QofE prior to going to market.

In my column, "'The Deal Killer': What to Know About Quality of Earnings," I explain that the benefits for a seller that takes this initiative and makes this investment are significant. I further state that it has become a "gamechanger" for sellers. Why?

The buyer will still conduct a seller's QofE at the buyer's expense. However, this QofE will go by quicker and with less disruptions to the transaction process if the seller has completed its own QofE. A seller that completes the QofE can use the insight into its company's financial shortcomings to address any accounting issues identified that could be leveraged against the seller during transaction negotiations. A seller's M+A advisor should be able to help their client avoid most of the challenges and frustrations that can come from a QofE.

6. Change of ownership

It's very easy to change the name of a company owner. For one reason or another, you might decide to put your spouse or child as the owner. No big deal, right? Depends on your plans to sell the company and the regulatory standards of your payers.

In the eyes of many licensing agencies, such as the Centers for Medicare & Medicaid Services (CMS), any "change of ownership" (CHOW) must be reported to these agencies. That's straightforward.

What you may not know is that CMS, as an example, has a rule preventing organizations from undergoing a CHOW more than once every 36 months. If you reported a CHOW 24 months ago, the sale of your company to a new owner would have to wait 12 months.

States often have their own set of regulations around the sale of an organization that could greatly affect how a healthcare transaction should be structured. In addition, every payor will have its own set of rules around the change of ownership, with most payors having preclosing notifications.

To better ensure a smooth sale, know what guidelines exist before you start the process. Your M+A advisor should help you understand the rules that will affect your business and its potential sale.

7. Inflated "add-backs"

During the financial valuation process, we at VERTESS calculate a seller's earnings before interest, taxes, depreciation, and amortization (EBITDA) as well as the adjusted EBITDA. Adjusted EBITDA removes expenses the seller has incurred as a business owner that the next owner will not likely incur, which are referred to as "add-backs." These might be a car payment, executive development coach, or membership at a business club. Adjusted EBITDA is often the basis for valuing the company.

Most buyers will agree with such standard add-backs, but if a seller adds items of a questionable nature that the buyer does not agree with, the purchase price can experience a substantial adjustment. It's important to understand each add-back that you list and be ready and able to support why it is an expense the future owner will not need to incur.

A seller might receive an initial offer that appears generous, but once add-backs are discredited, the price may not be what was anticipated.

8. Lack of communication

The M+A process is lengthy and can take many months — sometimes even a year or more. Effective communication is critical throughout a healthcare transaction, with the communication starting with how your company is represented to prospective buyers during introductions. It becomes more intense when negotiating an LOI and finally during closing. Breakdowns in communication can jeopardize a deal at any stage of a transaction.

Maintaining consistent, transparent communication throughout the due diligence process supports a smoother experience. Expectations should be made clear between the buyer and seller, better ensuring that their post-transaction priorities are aligned. This can help avoid future culture and transition shocks.

Enlisting the expertise of a knowledgeable healthcare M+A advisor to communicate the good, bad, and ugly between buyer and seller can help avoid or at least greatly reduce discomfort and allow each party to work comfortably together following the closing. It is important to know that one person is overseeing each step of the process, from introduction to integration.

9. Poor representation

We have worked with clients that have used their trusted lawyer/friend to represent them during the selling stage. What many of them found was doing so resulted in making the process painfully confusing, time-consuming, and frustrating, often causing the deal to fail.

Let's face it: Buyers are typically experienced and have gone through the M+A process multiple times. Sellers, most likely, have not, which is why they need a lawyer with experience in their area. The details and language involved in a healthcare M+A transaction are often complex. There is often common language and terms that an experienced healthcare M+A lawyer will know to look for. This helps ensure a seller's best interests are represented in the deal.

A knowledgeable lawyer will also not waste time on other common protections for the buyer. If your lawyer is arguing over language or points that are typically standard in a deal, not only are you wasting your time and money, but you may be frustrating and insulting the buyer.

Have someone in your corner who knows the legal pitfalls and vulnerabilities you will encounter during the final stages of a deal. This will help you receive the most protection while making sure you understand the nuances of the legal jargon that will affect the sale of your business.

10. All eggs in one basket

When it comes time to sell your company, you may be tempted to jump at the first prospective buyer that approaches you with a reasonable offer and good fit from a culture perspective. After all, doing so will seemingly reduce the length and stress of the selling process.

This approach can work well, but we have also seen it go south very quickly. The reason: If the buyer knows or believes it's in the driver's seat, it may pay what it thinks is a price likely to get a seller to bite and not necessarily what is fair and appropriate.

Without competition, a seller loses critical leverage and may be pressured into compromises. For example, we worked with a client approached by a buyer directly. This buyer offered an amazing multiple for his company. It was the first offer he received. On paper, the offer looked like a great deal. Unfortunately, once the LOI was signed, the buyer quickly pulled apart the financials and discounted so many items that the multiple was no longer desirable.

Fortunately, the seller was knowledgeable about what he deserved to receive for his company and pulled out of the deal. Unfortunately, he had not engaged in discussions with other prospective buyers, so he lacked alternative avenues to explore. He then needed to start over with us. Had we started the process together, we could have quickly pivoted to other interested buyers when the initial deal fell through.

Making the Best of the Challenging Healthcare Merger Process

The M+A statistics shared at the beginning of this column were not intended to discourage you from selling your company. Rather, these stats help paint a realistic picture of the marketplace. The good news is that with the proper preparation, open communication, knowledge of the transaction process, and support by a team of competent, skilled healthcare M+A advisors, you will greatly increase the likelihood of being in the minority of companies that achieve a successful merger.

To learn how the expert VERTESS healthcare M+A advisors can help you get to the transaction finish line, contact us today!

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Bradley Smith ATP, CM&AA

For over 20 years I have held a number of significant executive positions including founding Lone Star Scooters, which offered medical equipment and franchise opportunities across the country, Lone Star Bio Medical, a diversified DME, pharmacy, health IT and home health care company, and BMS Consulting, where I have provided strategic analysis and M+A intermediary services to executives in the healthcare industry. In addition, I am a regular columnist for HomeCare magazine and HME News, where I focus on healthcare marketplace trends and innovative business strategies for the principals of healthcare companies.

At VERTESS, I am a Managing Director and Partner with considerable expertise in Private Equity Recapitalizations, HME/DME, Home Health Care, Hospice, Medical Devices, Health IT/Digital Health, Lab Services and related healthcare verticals in the US and internationally.

We can help you with more information on this and related topics. Contact us today!

Email Bradley Smith or Call: (817) 793-3773.