Due diligence is the formal investigation a prospective buyer conducts on your practice after you’ve agreed on the general terms of a sale in a Letter of Intent (LOI). Think of it as a complete pre-operative workup on your business. The buyer’s team of specialists will examine every aspect of your practice’s health—financial, operational, and legal—to confirm its value and uncover any hidden risks before finalizing the acquisition.
This isn’t a simple check of your accounting books. It’s an in-depth review of your billing and coding practices, physician employment agreements, payer contracts, IT systems, and compliance with healthcare laws like the Stark Law and Anti-Kickback Statute.
Why This Matters to Healthcare Providers
The due diligence phase is where a potential sale of your practice becomes real—and where it is most likely to face challenges. Any negative findings, from inconsistent financial reporting to potential compliance violations, can give a buyer leverage to lower their offer, demand that you set aside more money in escrow, or even walk away from the deal entirely. Being thoroughly prepared for this intense scrutiny is one of the most important factors in a successful transaction.
Example in Healthcare M&A
Scenario: A private equity group signs a Letter of Intent to acquire a successful five-physician gastroenterology practice. The initial valuation is based on the practice’s strong reported EBITDA. The buyer then begins formal due diligence.
Application: The buyer’s accounting team performs a Quality of Earnings (QoE) analysis and discovers that a significant portion of the profits in the last year came from a single, highly favorable contract with a local insurer that is set to expire in six months. Simultaneously, their legal team finds that the practice’s anesthesia service referrals may present a Stark Law issue.
Outcome: The buyer no longer sees the practice’s historical earnings as sustainable or risk-free. They return to the physicians with a revised offer. The new terms include a lower purchase price and a large indemnification escrow account to protect the buyer from any future government fines related to the referral patterns. The deal is now at risk unless the sellers agree to the new, less favorable terms.
Related Terms
- Quality of Earnings (QoE): The deep financial analysis that forms the core of financial due diligence, designed to verify the sustainability of your practice’s earnings.
- Stark Law: A key federal regulation governing physician self-referral, making it a primary focus area during regulatory due diligence to avoid massive inherited liabilities.
- Representations and Warranties: The set of factual statements you make about your practice in the purchase agreement, which the buyer’s due diligence process is designed to verify.
Preparing properly for buyer due diligence can prevent unexpected issues. Request a Due Diligence Preparation Session →
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Frequently Asked Questions
What is due diligence in the context of healthcare practice sales?
Due diligence is the formal investigation a prospective buyer conducts on a healthcare practice after agreeing on the general terms of a sale. It involves a comprehensive review of the practice’s financial, operational, and legal health to confirm its value and uncover any hidden risks before finalizing the acquisition.
Why is the due diligence phase critical for healthcare providers selling their practice?
The due diligence phase is critical because it is where the potential sale becomes real and where challenges often arise. Negative findings during this phase can lead to a buyer lowering their offer, demanding escrow funds, or walking away from the deal, making thorough preparation essential for a successful transaction.
What aspects of a healthcare practice are reviewed during due diligence?
During due diligence, the buyer reviews billing and coding practices, physician employment agreements, payer contracts, IT systems, and compliance with healthcare laws such as the Stark Law and Anti-Kickback Statute to ensure the practice’s operations and financials are legitimate and sustainable.
Can you provide an example of how due diligence can affect a healthcare practice sale?
In an example of a gastroenterology practice, during due diligence, the buyer found that a large portion of profits came from a single contract set to expire soon, and identified a potential Stark Law issue with anesthesia referrals. This led the buyer to lower the purchase price and require a large escrow for indemnification, putting the deal at risk unless the sellers accepted new terms.
What related terms are important to understand when preparing for due diligence in healthcare M&A?
Important related terms include Quality of Earnings (QoE), which verifies the sustainability of earnings; Stark Law, which governs physician self-referral and compliance risks; and Representations and Warranties, which are factual statements made by the seller about the practice that are verified during due diligence.