Importance of Sellers Helping Buyers Reduce Healthcare Acquisition Integration Costs

Volume 11, Issue 12, July 2nd, 2024

By: David E. Coit, Jr., DBA, CVA, CVGA, CM&AA, CBEC, CAIM

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Why should a buyer's costs of integrating an acquired company be of interest to the seller? The most important reason is that sellers often pay part or all the integration costs of the buyer. According to McKinsey & Co., the average cost of integration is between 15% and 20% of an acquisition's purchase price.

How do buyers' integration costs become a concern for sellers? Buyers typically determine the offering price based on expected future cash flows received from the acquired company. When buyers estimate future cash flows, they often include the anticipated costs of integrating the acquired company. Thus, the purchase price is often net of the buyer's expected integration costs.

If you're considering a sale of your healthcare company, you might be wondering: What can I do to influence the buyer's cost of integration?

That's a great question! There are several actions sellers can take before going to market that can reduce the buyer's integration costs. Moreover, those cost savings may allow potential buyers to increase their offering price because of a perceived increase in first-year cash flows from the acquisition.

How to Cut Healthcare Acquisition Integration Costs

Let's discuss eight areas where sellers may want to take steps before selling their company that can reduce a buyer's integration costs and potentially increase offers and the final sale price.

1. IT software applications

Buyers typically migrate the information technology (IT) used by an acquired company to match the applications the buyer uses. Software migration can be a costly and time-consuming process, especially if the seller is using legacy systems and outdated technology, in-house developed software, and/or has inaccurate or incomplete data. On the other hand, using widely used, industry-specific applications and having clean and current data will considerably ease the migration process.

In addition, providing buyers with a listing of IT applications used, the methodology of data collection and data verification, and a scheduled IT software maintenance program will allow buyers to better determine the estimated time and expense of IT integration.

2. Repair and maintenance

Believe it or not, some sellers defer routine repair and maintenance in the months leading up to the sale of their business. While this may seem like a good way to increase the seller's cash flow before selling their business, buyers will likely discover such deferred expenses during due diligence and predictably take a dim view of such actions. Moreover, buyers will estimate their costs of remedying or mitigating the deferral.

It's better to keep up with scheduled repairs and maintenance as though the business wasn't being sold than having buyers decrease their offering price to account for these necessary expenses.  However, sellers should not needlessly incur excess repair and maintenance costs before going to market.  Keep in mind that companies sell for a multiple of cash flow.  As such, every dollar increase in cash flow returns a greater dollar amount in the price of the company.

3. Turnover

Buyers usually expect a post-acquisition drop in the acquired companies' revenue due to employee turnover, client/patient turnover, or referral source turnover. A key aspect of integration is the retention of essential employees, clients/patients, or referral sources.

If the seller can show buyers that they've taken and will continue to take actions to mitigate turnover, buyers will be less concerned about revenue loss and the associated costs of retention. In addition, sellers who demonstrate a commitment to work after the sale to address possible retention issues show good faith to prospective buyers.

4. Capital expenditures

Buyers often expect that sellers have underinvested in capital expenditures (Capex) leading up to the sale of their healthcare businesses. Appropriate investment versus underinvestment is a difficult issue to address. On the one hand, replacing older equipment does not necessarily increase the offering price from buyers. On the other hand, buyers may adjust their offering price after due diligence once they've determined the estimated costs associated with underinvestment.

A good rule of thumb is to continue Capex dollars based on historical needs. In other words, consider keeping up with maintenance Capex but limit the amount spent on long-term growth Capex. The most typical underinvestment in Capex is new computers for employees. Beware of acquiring new computers that may not meet the buyer's IT specifications.  In other words, be smart and frugal with CapEx dollars before going to market.  

5. Facilities

Before interacting with potential buyers, a seller won't know the facility needs of buyers. Many buyers don't want to own real estate. Others may have operations with excess capacity near the seller's location(s).

Perhaps the best way to address the issue of facilities is (1) the seller should not undertake any leasehold improvements before going to market, (2) sellers should avoid long-term lease extensions or related commitments, and (3) if the facility(ies) is/are owned, consider looking into alternative options should the buyer chose not to acquire real estate. Sellers don't want to be in a position where the buyer decreases the offering price because the seller needs to unwind facility(ies) commitments.

6. Open staff positions

It's commonplace for sellers to avoid filling open staff positions before selling their business. Such situations can be a two-edged sword. The buyer will discover unfilled positions during due diligence and factor in the cost of filling the positions by repricing their offer. On the other hand, the seller may be able to fill open positions at a wage rate or salary lower than the buyer's estimated compensation. Conversely, the buyer may be able to fill certain open positions where the buyer has existing staff to fill open positions.

I recommend the seller discuss this matter with their healthcare M+A advisor or potential buyers before the buyers make an offer to acquire the business. One other consideration is the potential to outsource open positions with independent contractors. For example, contracting with a fractional chief financial officer rather than hiring a full-time CFO.

7. Contracts, licensing, certifications, and subscriptions

Buyers will discover any past-due, expired, or soon-to-expire contracts, licensing, certifications, or subscriptions (CLCS). Sellers should keep essential CLCS' up to date. However, before going to market, sellers should evaluate each CLCS to determine the value of reviewing or extending the CLCS. For example, older certifications may be of little value because of changes in the industry. Similarly, certain subscriptions may not be of value to buyers and thus an unnecessary waste of funds.

For example, some physicians elect to be members of various associations like the American Medical Association, Medical Group Management Association, and/or state medical societies. If these CLCS do not drive revenue or business value, consider not renewing the CLCS.

8. Accounting/financial reporting

We regularly advise our clients whose financial reporting is on a cash basis to convert to an accrual basis before going to market. Accrual basis accounting is a more accurate method of financial reporting than cash basis accounting. We also recommend that their accrual basis accounting conform with generally accepted accounting principles (GAAP).

One way to ensure that a company's financial statements are GAAP compliant is to have a CPA firm perform an audit. Audited financial statements can provide buyers with confidence in the reliability of the financial reporting.

An alternative to having audited financial statements is to have an accounting firm prepare a seller's quality of earnings (QofE) examination. A QofE is an assessment of a company's performance that removes anomalies and poor accounting or bookkeeping methodologies, and more accurately reports a company's true performance.

Many buyers will undertake a QofE as part of their due diligence process. When sellers provide buyers with a seller's QofE report, as my colleague Bradley Smith discussed in this column, buyers gain confidence in the accuracy of the seller's financial reporting.

Moreover, buyers may either accept the seller's QofE rather than having a third party perform a QofE or hire a CPA firm to review the seller's QofE report. In either case, the buyer saves time and money and will be able to quickly determine the riskiness of the seller's company.

Impact on a Potential Healthcare Acquisition

Imagine you are looking at acquiring one of two healthcare companies in your industry. One of the companies uses similar IT software applications as you; keeps current on routine repairs and maintenance; has a sound record of low employee turnover; has no underinvestment in Capex; has the option to renew their facility's lease (which is now month-to-month); has no unfilled staff positions; is current with all contracts, licensing, and certifications; only has necessary subscriptions; and has accurate and verified financial reporting.

The other company is using proprietary or in-house developed IT software applications, is significantly delinquent in routine repair and maintenance; has higher than usual employee turnover; is underinvested in Capex; has a long-term facility lease contract on an undesirable property; has several unfilled open staff positions; is past-due on renewing contracts, licensing, and certifications; has many unnecessary contractual subscriptions; and has numerous accounting errors in their cash basis financial statements. Which company would you be willing to offer a higher purchase price? Which company would you perceive as a risky investment? Which company would you expect to spend less money on during integration?

It's easy to see how putting in some work to reduce acquisition integration costs can lead to more offers and higher offers while increasing the likelihood of a successful sale. If you are thinking about selling your healthcare company and would like to discuss ways to decrease acquisition integration costs and make your business more appealing to prospective buyers, reach out to me or any other member of the VERTESS team. We would welcome the opportunity to speak with you!

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David Coit DBA, CVA, CVGA, CM&AA, CBEC, CAIM

I am a seasoned commercial and corporate finance professional with over 30 years of experience. As part of the VERTESS team, I provide clients with valuation, financial analysis, and consulting support. I have completed over 400 business valuations. Most of the valuation work I do at VERTESS is for healthcare companies such as behavioral healthcare, home healthcare, hospice care, substance use disorder treatment providers, physical therapy, physician practices, durable medical equipment companies, outpatient surgical centers, dental offices, and home sleep testing providers.

I hold certifications as a Certified Valuation Analyst (CVA), issued by the National Association of Certified Valuators and Analysts, Certified Value Growth Advisor (CVGA), issued by Corporate Value Metrics, Certified Merger & Acquisition Advisor (CM&AA), issued by the Alliance of Merger & Acquisition Advisors, and Certified Business Exit Consultant (CBEC), issued by Pinnacle Equity Solutions, and Certified Acquisition Integration Manager (CAIM), issued by Intista.  Moreover, the topic of my doctoral dissertation was business valuation.

I earned a Doctorate in Business Administration from Walden University with a specialization in Corporate Finance (4.0 GPA), an MBA from Keller Graduate School of Management, and a BS in Economics from Northern Illinois University. I am a member of the Golden Key International Honor Society and Delta Mu Delta Honor Society.

Before joining VERTESS, I spent approximately 20 years in commercial finance, having worked in senior-level management positions at two Fortune 500 companies. During my commercial finance career, I analyzed the financial condition of thousands of companies and successfully sold over $2 billion in corporate debt to institutional buyers.

I am a former adjunct professor with 15 years of experience teaching corporate finance, securities analysis, business economics, and business planning to MBA candidates at two nationally recognized universities.

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