Accounting for health care M&A: What to know before a merger
With impactful reforms rolling out on a consistent basis, many small to midsized health care organizations are struggling to remain profitable as they survive reimbursement cuts, while larger organizations seek to grow their market share and achieve economies of scale, and as a result, the industry has experienced a major uptick in mergers and acquisitions.
However, before a business can be acquired, the seller must position and prepare their business for a high valuation from a potential buyer.
The following points should be taken into consideration by financial and accounting groups, and individuals at companies seeking to position themselves as an attractive acquisition target.
Crack the books
In order to provide an accurate valuation of a health care business, buyers will review different aspects of sales and operations. Sellers should be prepared with their current net worth by properly analyzing each of their elements of value. It may help to bring in a CPA to evaluate company sales, assets, performance and staff.
They will need to provide following information:
- Income statements provide high-level insight into collection rate, gross margins and net margins. These details related to operating expenses will help potential buyers understand the efficiency of the company and possible synergies. It is also critical to keep in mind that end-of-year income statements must tie directly to tax filings.
- A clean balance sheet is highly attractive to buyers, so businesses should satisfy their accounts payable and collect all accounts receivable. They should clear as much debt as possible because through certain types of capital structure (such as a stock purchase), the buyer assumes those liabilities and the company valuation could be negatively affected. Plus, slow AR collections reflect a slow turn of revenue and, again, could negatively affect the valuation.
- Organizations should evaluate inventory to see if it’s all saleable. If buyers find a large amount of obsolete inventory in a warehouse, they may negotiate for a decreased price based on the lowered value of the physical assets.
- Eliminate all unnecessary expenses to increase margins and EBITDA. Valuations are commonly calculated as a multiple of a company’s EBITDA, so reductions in operational costs can significantly increase the purchase price.
Construct attractive but accurate P&Ls
The profit and loss statement (or income statement) will paint the true picture of the company. This report is necessary to show total gross and net revenue. Sales can be reported on a cash or accrual basis.
Under cash reporting, the company will account for write-offs related to non-payment from insurance companies. Accrual-based reporting involves allocating a fixed amount to write-offs, using historical collections data.
Cost of goods total is often viewed as a percentage of net revenue to calculate a seller’s gross margin. Operating expenses are viewed the same way, and reductions in operating expenses will prove the business can run on a lean budget to generate higher net profits.
Discover the company's market value
Brand and reputation will also be taken into consideration to determine the correct value range for the business. Having the company's marketing and PR team build its voice and story to gain credibility among other businesses within the industry can help.
Speaking to active buyers and brokers will be helpful in assessing the current market value for different lines of business. Value fluctuates relative to payer reimbursement, risks and legislative changes.
Payer mix and product mix have the weightiest impact on a company’s valuation. Growth potential and synergies are important, but a company’s value will largely be based on its past performance.
Move forward with the business
Companies must not get distracted by the prospect of a potential sale. They should maintain their daily routine and normal business operations to prevent the business from experiencing attrition pre-close. In fact, it can be beneficial to try to grow the business, as subsequent payment(s) following closing are often tied to transition and performance.
Companies should also show discretion with regard to employees. Employees are unpredictable in how they process this information, and it is important to have the business operating strongly up to and through closing. This is crucial for preventing leaders and other staff from getting spooked and jumping ship when they are a necessary resource in finalizing the transaction and assisting with the transition.
Within the company, keep the potential sale under wraps to prevent the rumor wheel from spinning. Whispers heard by employees can be very concerning and can cause them to search for other immediate opportunities. Sellers need to maintain their talent to keep the business on track. Plus, the buyer may consider retaining existing employees if their particular skill set is valuable to the acquisition’s long-term success.
Patients are notified at the closing of the transition and, with respect to patient choice, are provided with an appropriate amount of time to select a different provider if they so choose. It is also best to notify employees after closing. Deals can fail to close for a number of reasons, and premature transparency could lead to employee attrition.
Before blindly jumping into a sale, it’s important to first determine the owner's personal reasons for selling the business. From simply wanting to exit the industry to passing the business along to more capable hands to grow their dream, the owner's individual incentives play a major role in determining the value for buyers.