Exercising Due Diligence Before Talk of a Sale or Merger

With mergers and acquisitions more prevalent than ever in the long-term care space, advance due diligence can seal the deal for operators considering potential partners, affiliations or mergers.

Due diligence has become a priority and even a competitive advantage from the seller’s side. In long-term care, due diligence is frequently seen as purely a financial and compliance function, but increasingly buyers are focused on operational issues and control diligence through internal audit.

To help sellers avoid due diligence surprises and delays that can quickly derail a deal, long-term care operators should consider investing time in the process upfront—before a possible transaction. Consider these due diligence steps that sellers can take prior to entering the market for a potential merger, sale or strategic alignment.

Five Steps to Take Before Entering the Market

1. Prepare for due diligence well before talk of a sale or merger to identify and uncover potential deal killers.
    
2. Work with your compliance and internal audit team to ensure compliance with federal and state regulations, including Medicare and Medicaid payment regulations, contract compliance, environmental laws and employment law.
    
3. Standardize your internal definitions to make them consistent, particularly for occupancy and census figures.
    
4. Evaluate the business office processes and controls at your facility.
    
5. Look at your facility through a buyer’s eyes and anticipate their questions and concerns.
    

The benefits of preparing for the due diligence process of a potential transaction are numerous—most important is that it saves time during the due diligence phase itself. By organizing in advance, a facility should be better prepared to provide details once merger talks begin.

From the buyer side, they will want the most accurate picture of a facility when it comes to financials, health and safety and more general process-related items, such as the types of contracts signed with residents. It’s also important for buyers to understand what they are purchasing by identifying risk areas and potential liabilities.

Possible Setbacks

A due diligence period can be as brief as 30 days from start to finish, but this time frame can vary wildly. It is critical that sellers are ready before due diligence begins because there are multiple ways the process can be set back. These challenges include:

Timing.

The buyer often needs time to get comfortable with a deal. Assuming the seller has already provided a pitch book, the buyer will provide a list of additional requests and diligence activities to complete. Because the information and activities frequently build on each other, if one step can’t be done in a timely fashion, everything else falls behind.

From the other perspective, the seller may be hesitant to allow a buyer’s team on premises for fear of tipping off employees or residents that the facility is for sale. While auditors are not necessarily uncommon at these facilities, there’s an advantage to bringing in an independent, third party auditor who is less likely to raise a red flag or cause a disruption by providing the business card of a competitor.

Access.

The seller needs to gather and organize solid financial, legal and regulatory information about the facility. This information is then made available to potential buyers upon request, through what’s known as a data room, which is basically escrow for files.

Availability of data.

Maybe an operator only has financials for a portfolio of facilities instead of standalone financials for each facility. Documentation can be difficult with multiple facilities, and it can be challenging to find true numbers for just one building. Debt agreements for a single facility can be particularly tricky when you consider the bank might negotiate removing the best-performing facility from a portfolio.

Transferring licensure or a certification number.

There are often restrictions that require creative thinking to make this process work for both parties, which can result in interim management agreements, shared processing, revenue sharing or claw back features and possible shifted transfer dates.

Risk Areas

While due diligence can be fairly all-encompassing, understanding some of the key risk areas before the transaction begins can help your facility be better prepared. Knowing where deal killers may lurk before transaction talks are underway will ultimately save your organization time, money and headaches. Because financial and compliance issues are well known, here’s a sample of other critical focus areas during the due diligence process.

Definitions

One of the most prevalent issues tied to the financials is how a facility defines occupancy. If the buyer is told an assisted living or long-term care facility has 90 percent occupancy, a buyer needs to know if that figure is based on the number of beds built, designed, licensed or available. For example, if a facility is designed for 100 rooms but two rooms are used as a staff lounge and a demo room for prospective clients, is the occupancy percentage based on 100 designed rooms or 98 functional rooms? Occupancy discrepancies will affect a buyer’s calculations for financial projections and models.

Another complication: If you have one person in a room, is it 100 percent occupied? Room type must be determined as single or double occupancy. Once defined, occupancy is not complicated, but a definition needs to be established upfront. If occupancy looks good, a buyer will also look at a facility’s revenue cycle to see if it has reduced rates to keep occupancy numbers up.

Resident Contracts

Of particular interest is whether a facility has life-care contracts, which are unique to continuing care retirement communities (CCRCs). These contracts can last for the duration of a resident’s life after an entrance fee is paid in advance, or month-to-month, so having an accurate inventory of them can dramatically impact a facility’s projected cash flow. Life-care contracts can be overlooked, especially if the buyer is unaccustomed to the world of CCRCs.

A buyer will also send auditors to review resident agreements because the current template agreement may be much different from the previous ones executed. Review will include evaluating free rent, annual rate increases and other revenue details.

Integration

The integration of processes can often be a challenge for buyers when they acquire new facilities. It’s important for a buyer to think ahead and consider the integration of a facility and how processes align. Some points that a buyer can be prepared to discuss at the beginning include:

• Centralized or decentralized model. When a new resident arrives, the paperwork may be filled out locally but is processed by the corporate office. It’s important to understand staff capabilities and knowledge of internal processes.
   
• Purchasing. When a long-term care operator has several facilities, is purchasing done at each facility or from one central location?
   
• Other services and providers. Some facilities have leases or service contracts attached to them, such as an onsite hair salon, a physical therapist or a fleet of vans.
   

Be Prepared

We have seen buyers cancel deals because of surprise deal-killer information that is uncovered during the due diligence process. While compliance issues are where acquisition deals often fail, most other items can be negotiated during the process. Preparation is key for both sellers and buyers in order to keep the due diligence process moving in the right direction—toward a successful deal.