M&A Basics: How to Avoid a Broken Deal
Every M&A transaction is complicated. Following the appropriate steps to pursuing the transaction helps ensure compliance with regulatory concerns.
In this age of healthcare reform, the amount of merger and acquisition (M&A) activity is increasing dramatically. Providers and systems are aligning to develop accountable care organizations (ACOs), broaden their patient base, improve their managed care contracting, achieve economies of scale, and acquire greater access to capital, among other reasons.
Leaders of stand-alone community hospitals are often involved in these M&A discussions, and there are some fundamentals they must understand about transactions if a deal is to be consummated successfully.
Standard Transaction Steps
Some steps are common to all transactions, including the following:
- Develop confidentiality agreements with prospective partners so the other party can have the data needed to make an informed decision and offer while keeping the data protected
- Name a transaction team that includes experienced attorneys and consultants plus key internal staff, as appropriate
- Agree upon a timeline for the transaction to keep the process moving forward
- Sign a letter of intent with potential partners, including exclusivity or “stay steady” agreements as necessary
- Conduct internal audits and compliance checks to address any areas of organizational or operational weakness and regulatory risk
- Sign a definitive agreement that binds the parties to move forward but will still be subject to conditions prior to closing (e.g., new hospital license, provider agreement, financing), where the definitive agreement will include closing and post-closing obligations
- Never announce the deal until due diligence is complete and all closing conditions have been satisfied; an untimely announcement can do significant harm to the reputation of the facility
Pre-transaction considerations apply regardless of the structure of the undertaking; they will generally lay the foundation for a successful deal and include:
- Solidifying key constituencies to make sure important individuals are in agreement
- Conducting pre-market due diligence
- Understanding the process to select the right partner
Each of these is discussed in greater detail below.
Although there are challenges from outside the organization to any M&A deal, some of the toughest obstacles often come from within the organization and at the level of the governing board. It is, therefore, important to present the strongest justification for a deal to one’s internal constituency. This will help ensure that a united front is presented when a potential partner is chosen.
Board of directors. The board of directors must be given a strategic plan that addresses the following questions:
- What are the current weaknesses and threats to the organization, and how would a potential partner help mitigate these?
- What are the potential opportunities that a partner could bring to the deal?
- Who are the right potential partners that can help the organization achieve its goals, and what are their track records in similar transactions?
- What issues might arise during the course of the deal and how might these be mitigated?
Key managers. Employees, particularly the organization’s management team, will need to be “on board” with the proposed transaction. Because some positions may be eliminated as a result of the deal, some key individuals may be placing their own positions at jeopardy. It may be necessary to obtain non-disclosure agreements from these people and to construct retention plans or other incentives tied to the success of the transaction.
For example, the organization could consider entering into “stay steady” agreements with key managers to enable or even require them to stay in their current positions for a certain amount of time after the deal closes. These efforts may allow for greater efficiency and limited distractions while the transaction is pending and for some time afterward.
Medical staff. The medical staff, whether employed or independent, must also be engaged during the process. This is generally done through the medical staff’s executive leadership, and it may be appropriate to establish ad-hoc advisory committees that provide a “voice” for the medical staff, especially if the relationship with the medical staff is strong and their input will be helpful. Regardless of the type of transaction, keeping the medical staff informed and involved during process generally results in quicker integration and greater acceptance.
Pre-Market Due Diligence
Due diligence involves review of various aspects of an organization’s operations, including compliance with legal and regulatory matters and requires focusing on the highest risk areas. One’s compliance officer, internal audit team, and legal counsel should be among the key players in the due diligence process.
Depending on the composition of the market, antitrust can be simply one of many factors to review, or it may be the most important consideration. No party wants to be involved in a protracted fight with antitrust regulators, thus due diligence must include identification of any antitrust risks relating to each potential partner.
The parties should also adopt an antitrust protocol to ensure that sensitive, non-public information is not shared with competitors. An effective antitrust protocol contains guideposts to the board and management on how to avoid any implication of such key antitrust pitfalls as price fixing, division of markets, and attempts at monopolization. The antitrust protocol would provide evidence that the parties made a good faith effort to comply with the antitrust laws and to avoid pitfalls.
Moreover, a tax-exempt entity should also take the following steps:
- Review organizational documents to ensure they are in compliance with the requirements of the Internal Revenue Code
- Review and test debt covenants
- Review ad valorem tax considerations
Once a partner is chosen, any presentation to the board must include an explanation of the benefits to the partnership including:
- The reputation of the partner
- The ability of the partner to mitigate weaknesses and threats and build on strengths and opportunities.
Transaction Team Structure
A transaction committee of the board may be formed to deal directly with management’s transaction team. The transaction team comprises key members of management plus consultants and others who can help bridge the competing interests within the organization, such as those of the medical staff. The transaction team should include a small core group responsible for negotiating the details of the transaction. Because the board of directors has ultimate responsibility over the transaction, the transaction team and top management must keep the board fully informed so that the directors can evaluate the transaction in relation to the best interests of the organization.
The Right Partner and Right Structure
The purpose of the affiliation may be clinical or operational, but the type of affiliation and the choice of an appropriate partner to pursue it depend on the needs of the organization. It may also depend on such factors as whether one or more parties is affiliated with a religious organization, is a public entity, or is for-profit versus not-for-profit. In addition, there are numerous options within the rubric of M&A— a full merger (consolidation) or outright purchase (acquisition) may not be the best solution. A joint operating agreement is an alternative that allows for allocation of resources and sharing of risk.
Ultimately, the organization must understand the purpose of any affiliation in relation to its short-term and long-term goals.
Curtis H. Bernstein, CHFP, CPA/ABV, is managing director, The Valuation and Transactions Group, Altegra Health, Miami Lakes, Fla., and a member of HFMA’s Colorado Chapter.
Ethan E. Rii is a partner, Katten Muchin Rosenman, Chicago.
Thomas J. McFadden is a partner, Katten Muchin Rosenman, Chicago.
Forum members: What do you think? Please share your thoughts in the comments section below.
- What important steps are often overlooked during the M&A process?
- What steps have you taken during past M&As that have helped ensure success?