Practice Acquisition: Due Diligence Checklist for MSOs

“You don’t want to buy a lawsuit.”  

That’s what seasoned investors tell eager MSOs hot to add the next specialty practice to their portfolio. 

The great minds at the University of California, San Francisco and Stanford University bought lawsuits when they decided to join forces. Hundreds of millions of dollars in legal fees later, they decided they weren’t a match after all. 

From 2022 to 2023, 12 hospital mergers, acquisitions, and partnerships unwound or failed. The Becker’s Hospital Review article that lists them doesn’t name the reasons behind these breakdowns, but given deal complexities as well as the governmental anti-trust legislation constraining them, it’s surprising more don’t disintegrate. 

As Sourabh Hajela of CIO Index explains, a new practice or group acquisition is exciting because it’s, “the start of a new era of growth and opportunity…[but] up to 70-90% of mergers and acquisitions fail to achieve their intended goals…” 

Due diligence conducted upfront helps ensure you’re in the 10 to 30 percent that grow together in a positive direction. 

As healthcare consolidates, management services organizations battle each other for the specialty practices with the most profit potential. Pulling the trigger too quickly, however, can lead to frustration and disruption on both sides. 

Performing a thorough pre-closure due diligence process when evaluating potential acquisitions may take additional time, but, given how healthcare is shifting away from independent practices so dramatically, targets abound. Taking the time to complete the due diligence checklist here ensures your portfolio is filled with ideal partners that will strengthen your enterprise rather than debilitate it. 

The healthcare M&A landscape today

Over the last 10 years, private-equity-backed management services organizations (MSO) firms have invested nearly $1 trillion in nearly 8,000 healthcare deals, with specialty physician groups their most common target. 

Healthcare is consolidating because, among other reasons, it has to. Supply and labor costs are skyrocketing while consumers are living longer and demanding the expensive and revolutionary procedures emerging every year, all while struggling to meet their surging healthcare payment responsibilities. 

Healthcare organizations struggle to recover adequate reimbursement from payers (which profits in the millions and billions every year) and from government entities like Medicare (which reimburses at 82 cents for every dollar spent delivering that care.) Physician groups and practices can only win fair fees and terms when they, too, become larger. Further, it takes a larger entity to select and integrate the automation, AI, and other technological advances that have become imperative to practice survival.  

Despite these opportunities, however, investors must roll-up and tuck-in carefully. 

Q1 2024 physician practice deals

M & A consulting firm LevinPro shares that, in the first quarter of 2024, healthcare investors made 127 deals, mostly with physician practices. This figure represents a decrease from the 143 deals in Q1 2023 but an increase from the 116 transacted in Q4 2023. Private equity investors accounted for 68 of the deals as of April 2, 2024. Overall, experts feel the total number of 2024 deals will match those of 2023. With the Federal Reserve holding off on lowering interest rates until the fall (if then), borrowing is still prohibitive. Still, some are picking up locations at discounted prices as the price / borrowing cost financial balance will shift once rates go down. 

What is pre-closure due diligence in the healthcare industry? 

Pre-closure due diligence in the healthcare industry, especially for management services organizations, is a critical phase in the mergers and acquisitions (M&A) process. Mostly, it involves the MSO reviewing the target's goals and plans for growth to determine compatibility. When an MSO conducts a due diligence process, it also examines the target's legal, operational, market positions and situations. This diligence ensures that the MSO understands all facets of the transaction, mitigating risks and aligning expectations before finalizing the deal.

Pre-closure due diligence for new practice acquisitions

It takes thorough diligence to achieve a profitable partnership. Execute each of the following steps with care: 

Initial Review

Review the target's market position, business model, and strategic fit within your portfolio. The majority of MSOs look to gain a dominant position in one specialty in one geographic market. This helps with price consistency. 

Review essential documents such as the certificate of incorporation, by-laws, and minutes of board meetings to understand the governance and operational framework.

Look for:  Potential synergies that can be achieved through the acquisition, such as cost savings, revenue growth opportunities, or market expansion. Evaluate how the two companies can create value greater than the sum of their individual parts.

Address by:  Documenting culture, market, specialty, and financial alignments between your MSO and the provider group. Share your perceptions with the physician group to get their insights. Be candid. 

Goal Alignment

 This involves identifying the primary reasons driving the merger, such as market expansion, synergy realization, or diversification. Read more about physician group versus investor goals on our recent blog post on optimizing provider group performance after acquisition. 

Look for:  hesitation regarding your turnaround plans. Most investors sell physician groups within three years. 

Address by:  being fully candid about your goals. Ask them to provide the same consideration. 

Financial Due Diligence

A thorough examination of the target’s financial statements, tax compliance, and financial projections is critical. This step involves checking past income statements, balance sheets, cash flow statements, and future financial forecasts to assess the financial health and sustainability of the business. Analyze financial ratios like profitability, liquidity, EBITDA, and leverage. Evaluate historical and projected financial performance, as well as any tax liabilities. 

Look for:  evidence of poor financial management like excessive debt, declining revenue trends,  irregularities in financial reporting

Address by: renegotiating financial terms or planning on cost-saving measures. 

Legal Due Diligence

Identify any legal risks that might not be visible through financial analysis alone This step covers the review of legal documents, including contracts, employment agreements, intellectual property rights, and compliance with relevant laws. Review the group’s compliance with laws and industry standards. Finally, review all licenses, clinician credentials, permits and certifications. 

Look for: pending lawsuits, regulatory violations or claims against the group.

Address by: using your legal experts to evaluate. Consider indemnification clauses or corrective action plans in cases of legal issues. 

Operational Due Diligence

Assess how efficient the group’s operational aspects are. Production capacity, supply chain management, and human resources policies could all be sources of potential liabilities that could impact business performance post-acquisition. 

Look for: prior authorization and claims backlogs, high denials rates, patient data security measures, HIPAA compliance measures

Address by: proposing new technology, addition or elimination of staff roles

Examine Technology Infrastructure and Integration Challenges

Scrutinize the IT systems, software, data management protocols, and cybersecurity defenses. Pinpoint any technological discrepancies, compatibility concerns, or hurdles that might complicate your integration phase. Assess the necessary effort and resources needed to merge the group’s tech systems with your existing setup. It's advisable to involve technology specialists to conduct a detailed assessment and devise a strategic plan for smooth integration.

Look for:  EHR mismatch, ways to harmonize data to achieve a unified view of their assets

Address by:  evaluating willingness to change EHR

Market and Commercial Due Diligence

 Analyzing the group’s market dynamics, competitive landscape, and customer base helps in understanding its market position and potential growth opportunities. Review marketing strategies, customer and supplier contracts, and market research reports. Evaluate its portfolio of services and the pricing of each. Look for growth opportunities and potential market risks.  identify key competitors, market trends, and potential threats

Look for: declining or increasing market share, competitors

Address by:  proposing market expansion initiatives or product differentiation strategies 

Human Resources Due Diligence

Examine employee contracts, benefits, corporate culture, and any potential labor issues. This step helps in planning the integration process post-acquisition and assesses any cultural or operational changes needed.

Look for: staff attrition, wrongful termination lawsuits, insufficient staffing

Address by: proposing technology or hiring/firing to balance staff

Dive into every one of these due diligence steps to ensure that you’re making an informed decision, understanding not only the financial valuation but also the strategic and operational alignment of the target company. The diligence process typically concludes with a final evaluation where all findings are reviewed to form the negotiation stance or adjust the acquisition strategy. 

Improve revenue for your current portfolio of physician groups

Your thorough due diligence process helps you understand all the weak and strong points of your target. With that data documented and agreed upon by both parties, tackling your next challenge – integration – has a better chance of success. 

As Carl Friedrich, managing director of Scale Healthcare cautions, 

“One of the biggest mistakes that MSOs make is that they need to follow a very basic formula post-integration, post-close. [This formula is:] stabilization, followed by optimization, followed by growth.” 

The due diligence you’ve performed accelerates your stabilization process. 

As you seek optimized revenue, keep in mind that optimizing revenue for the physician groups currently in your portfolio also can help you get the capital to grow your entity. 

Two ways to improve revenue are sweeping in the extent of your earned revenue via underpayment recovery and increasing upfront collections using accurate patient payment estimates. Underpayment recovery and patient payment estimates and eligibility are MD Clarity’s specialty. Our contract management and underpayments tool — RevFind – ingests, digitizes, and analyzes payer contracts. It compares every payment to payer contract terms and alerts staff to any discrepancies. Pursuing underpayments can result in millions of dollars in cash recovered and improved margins.

Patient payment estimate tool Clarity Flow automates eligibility verifications, generates accurate patient estimates, and sends a text or email to patients delineating their financial responsibility. It details deductibles, copays, and coinsurance. Patients appreciate knowing what they’ll owe providers and how much the insurance company will pay. The convenience of making a deposit right from the estimate also cuts down on confusion. The less confusion surrounding the payment experience, the more satisfied your patients will be and the more likely they will pay on time and in full.

Schedule a demo to see how RevFind empowers your underpayment recovery and/or Clarity Flow automates your upfront collections and builds estimates. Keep patients aware and connected to your organization. Keep payers honest in their reimbursements.

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