7 buy-side considerations for Healthcare M&A in 2023

The shift to value-based care and an abundance of cash in the market are some of the drivers impacting healthcare mergers and acquisitions. These and other trends have been strong over the past few months and are expected to continue, impacting transaction planning for buyers.

If you are considering acquiring a healthcare business in 2023, here are seven things you need to know.

1. Value-based care is becoming a key driver in healthcare M&A

Value-based care compensation models, a healthcare delivery model in which healthcare providers are paid based on patient healthcare outcomes, require more complex tracking of patients, procedures and payments. To be profitable, value-based care requires more sophisticated financial management and back-office operations than traditional fee-for-service requires.

This payment-model shift represents a disruption in the healthcare market that has opened opportunities for buyers. You can inject new knowledge into practices’ operations and workflows, identify further opportunities to bring smaller practices into your existing platform, and, sometimes, optimize per-member-per-month profit levels. For sellers, as healthcare reimbursement models become more complex, it’s increasingly appealing to have someone else deal with the business back-end so the selling clinician can focus on providing patient care.

This trend is likely to continue for the foreseeable future as Medicare Advantage plans increasingly move to value-based models. While this trend has been experienced in primary care for years now and continues to grow there, payers are now experimenting with other specialties such as gastroenterology and nephrology.

Value-based care is becoming more prevalent, and many in the industry expect it to become the norm in the years to come.

2. Deal competition and rising interest rates are impacting deal multiples

In addition to value-based compensation, cash in the market – largely from more private equity firms entering the space – is also driving M&A in healthcare. This competition is pushing purchase prices higher in certain situations, however other factors have created contradictory impacts.

Thus far, we have yet to experience rising interest rates affecting the volume or velocity of deals; however, the higher cost of financing may put downward pressure on deal multiples going forward as some buyers push these increased costs onto the seller. Inflation – which has increased costs for everything from supplies to labor – is also placing downward pressure on deal multiples as costs of labor, supplies, etc. are being underwritten with more precaution.

3. Many buyers competing for smaller practices

Smaller practices with solid patient bases in densely populated areas are one of the most sought-after types of acquisition targets. Private equity firms, management services organizations (MSOs) and other strategic buyers see benefits in the ability to close these deals quickly, rapidly integrating the practices into their operations and improving earnings for a solid return on investment.

But these deals aren’t always driven by profitability, as evidenced in cases where contracting entities have a strong affiliate base, organizations will engage in M&A to increase their market share ahead of other acquisitive competitors. This includes MSOs, which oftentimes include right of first refusal clauses within their agreements with affiliate practices, and will subsequently exercise the right to acquire the respective practice so another competing group cannot.

Because demand for many of these smaller practices is high, anything that slows down a deal – even if only by a few days – can potentially cause a buyer to miss out. Sellers are quick to move on to the next offer, which means buyers need to be ready to act. Working with a third-party advisor can give you an edge by having a team ready to perform buy-side due diligence and provide guidance throughout the transaction quickly and efficiently.

4. Understand seller’s desires to win deals

Buyers can gain an advantage in this competitive market by treating the acquisition process as more of a partnership than the simple purchase of a business. It’s important to communicate often with sellers and encourage them to also be transparent.

You should take the time to understand each seller’s desired outcomes. Talk with sellers to understand expectations after a transaction closes, including hours, productivity, compensation, day-to-day managerial input, etc. Remember that each partner may want different personal outcomes from a deal, especially if they’re in various stages of their careers.

Each partner may also be open to various payout structures. For example, some partners may be interested in receiving rollover equity in the buyer’s organization or the newly formed go-forward entity,but those who want to reduce their hours or retire may be more interested in receiving the majority of their payout upfront.

5. Inflationary pressures affecting financial projections, deal multiples, and go-forward compensation

Financial projections built based on historical financials may fail buyers in this time of rapid inflation. While higher costs for medical equipment, supplies and rent may sometimes already be reflected in the current financials, pay raises needed to retain employees may not be. For every deal, consider whether you need to project for wage increases. It also makes sense to review the selling company from an operational perspective to confirm they are fully staffed.

Wage inflation, in particular, is sometimes leading to lower offers from buyers. While sellers never like lower multiples, they’ve likely been dealing with inflation-related issues for the past year. Being transparent with the seller about inflation’s effects on the practice and your offer can serve two purposes: helping a seller better understand your deal value and facilitating more accurate projected financials post-deal – prior to any partnership, it is recommended to achieve alignment on expected post-deal partner compensation.

6. Plan compensation structure that keeps clinicians motivated after deal closes

One of the biggest buy-side challenges is maintaining a practice’s patient volume and quality of care after it has been purchased. The right post-deal compensation structure is a key tool to help maintain historical levels and quality.

Buyers may want to set key performance indicators and benchmarks, especially around quality metrics,that clinicians must meet to earn their paychecks or bonuses. In other cases, it may work better to create a structure that allows clinicians to share in the practice’s profits after the partnership or acquisition to encourage managerial support and operating expense controls.

7. Consider risk tolerance around seller’s financial data

While it’s generally preferable for buyers to have access to solid pre-purchase data (e.g., each clinician’s productivity, revenues and care quality) before finalizing a merger or acquisition, that may not always be possible.

Obtaining accurate data can sometimes be challenging, especially when acquiring smaller practices that may not have the sophisticated financial or reporting infrastructures needed to fully understand their productivity or profitability. In addition, revenue can look different on a cash versus accrual basis, and many smaller healthcare practices may have only maintained their financial statements on the cashbasis method of accounting.

It’s important to understand your organization’s risk tolerance around the completeness and accuracy of the seller’s financial data. Some buyers may be willing to proceed with a deal despite incomplete or potentially inaccurate information, while others may not feel comfortable moving ahead.

Regardless of your risk tolerance, buyers can benefit from buy-side due diligence performed by an advisor who understands the unique challenges in the healthcare space.

If you are considering acquiring a healthcare business, reach out to a qualified advisor for assistance with mitigating risk and maximizing value in healthcare M&A deals.

Read the full article on HIT Consultant.