Selling Your Business: What to Know about the Due Diligence Process

Last month, we discussed the pressures of negotiating an employment offer. But perhaps you’re further along than that and have your own otolaryngology practice. Healthcare businesses are a hot commodity in the market today—there may even be interest in your healthcare business right now. This month, we’ll talk about a particular aspect of selling your business.

Whether or not you’ve gone down the road of selling a business before, the process and preparation that a seller must do can be stressful and time-consuming. A lot of the time and stress centers around one aspect of a transaction: due diligence. Due diligence is a complex process, and while it can certainly feel like a roadblock to both sides of a transaction and can create deal fatigue, it doesn’t have to be that way.

What Is Due Diligence?

Due diligence is a prospective buyer’s opportunity to “look under the hood” of the business that they’re interested in purchasing. Once a letter of intent is signed, the buyer will ask for a detailed list of documents and information to evaluate before finalizing the deal. (See the sidebar for more information on letters of intent.) Due diligence can encompass a wide range of information, including financial statements, copies of licenses or permits, corporate formation documents, employee information, policies and procedures, lists of services provided, leases, vendor and payor contracts, asset lists, litigation information, and anything else a buyer may request to evaluate the business.

Sellers aim to get the best price for their business. If you build preparation into your business culture, you will reap the rewards well before you ever put your practice up for sale. —Emily A. Johnson, JD

Buyers will want to know that the target business is in good working order. As a seller, you want to put your best foot forward to ensure a smooth process. The best time to get your business into shape is well before you take it to market, but it can be a real challenge to prepare for questions that haven’t yet been asked.

Not preparing for future due diligence, however, can put a potential deal at serious risk. This may be acceptable for some sellers who will go on to find another buyer. But imagine if you needed to sell the business. Perhaps your personal circumstances have suddenly changed, the geographical area you practice in has changed, or you find yourself at the perfect strategic moment to maximize the value of your business. Transactions can be time-sensitive affairs. Buyers will walk away from a deal if they feel a business’s due diligence materials reveal too many issues.

If the buyer in front of you is your best option, you cannot risk the transaction because of a lack of preparation. By turning in inadequate, inscrutable, or incorrect records for due diligence requests, you could scare a buyer away—one who might perhaps be your best, or only, buyer.

Wrapping Your Mind Around Due Diligence

With an almost endless number of documents a buyer could request during due diligence, it’s difficult to know where to start to prepare your business for an eventual transaction. If you don’t have a due diligence request list in front of you, look to other parties that are also evaluating you. For example, if you’ve been accredited, inspected, audited, or surveyed by any third party, use their evaluation process as an opportunity to stress-test your business to see where any gaps might be.

How your business works may make perfect sense to you, but in a transaction, it needs to make sense to someone else. Take notes during these third-party interactions. How easy was it for you to assemble the information they asked for? Did you find yourself having to find creative ways to present the information in the way they requested, or was it a straightforward procedure? Did the third party need to ask a lot of additional questions to get the information they needed? At the end of the evaluation, you may receive an updated license or certificate from them, but you will also have received your marching orders for improvements you can make to ensure any future transactions go smoothly.

When all is said and done with the third-party evaluation, sit down with any other stakeholders in your business to discuss how to make the next evaluation (or the sale of the business) better. If your filing system was disorganized, create a system that allows you to find the necessary files quickly. If certain information was missing entirely, make a plan to find that information and memorialize any changes you make to your processes. 

Running a Business Like It’s Always for Sale

But maybe you aren’t ready to sell your practice. Maybe your plan is to sell it in a couple of years, or perhaps not until you retire years from now. You may think that your business is doing just fine. Everyone gets their work done, the money comes in, and the bills get paid. Why worry about making all these disruptive changes for a hypothetical sale sometime in the future?

The six-year rule. First, due diligence requests often reach several years back. In the healthcare industry, it isn’t uncommon to receive requests for information from the previous six years, as that’s the look-back period covered by many federal healthcare laws. Depending on the structure of the transaction, the buyer may be inheriting issues your business has had in the past, so they’ll want to know everything they’re taking on.

The sooner you start fixing any issues, the better. If you recently made a procedure change to fix an issue, for example, a due diligence request asking for six years of information could still reveal that the practice went for several years without a fix in place.

Lowered costs. Second, the actual process of due diligence is expensive. During a sale, your lawyers must review your diligence materials for any issues they may need to address with opposing counsel. You and your employees will also need to spend valuable time compiling materials for diligence requests. If your records are orderly and accessible, this can significantly decrease the billable hours spent by lawyers and your staff. Additionally, if records are kept and presented to buyers in an organized manner, there will be fewer additional requests from potential buyers.

A better business. Finally, by always running your business like it’s up for sale, you create efficiencies, produce better output, and hone your and your staff’s expertise. Sellers aim to get the best price for their business. If you build preparation into your business culture, you will reap the rewards well before you ever put your practice up for sale.

The prospect of preparing for due diligence can be overwhelming, but you don’t have to do it alone. In addition to key stakeholders within your business, involving an attorney with preparation can be a smart move. Attorneys will be able to identify the types of materials that are frequently requested as part of due diligence and can help identify high-risk areas within your specific practice area. Armed with a plan and some strong partners, you could be well on your way to a successful sale.

Emily A. Johnson, JD, is a healthcare attorney with McDonald Hopkins LLC. Contact her at ejohnson@mcdonaldhopkins.com or through mcdonaldhopkins.com.

Reprinted with permission from the American College of Rheumatology.