Financial Due Diligence Is Super Important
Obviously. While there are many aspects to due diligence, a practice’s finances are the biggest thing to put under a magnifying glass.
You’re putting yourself on the line to buy a practice. This is not something to mess around with.
The Importance of Being Realistic in Financial Due Diligence
Unfortunately, you can’t just ask the seller to give you access to their bank account and other critical accounts.
I once worked with a very jumpy buyer in California who was looking to purchase a dental practice. The buyer wanted to be sure that everything was on the up and up. Certainly understandable, I think we can all agree. But the buyer crashed his own deal.
He took his role in due diligence too far, wanting every possible bit of information, including bank statements, to review himself. At one point in the deal, the buyer wanted the seller’s bank login information because “the seller could alter the bank statements.” Specifically, he wanted to see if the cash income figures matched what the seller was claiming.
Before you ask, no, it’s not normal for a buyer to request a seller’s bank statements. And it’s definitely not normal to ask for login credentials. The deal fell apart, and the buyer ended up wasting everyone’s time and money, including his own.
Why was this buyer so jumpy? It may have been because of the seller’s pushy broker. Or maybe he had experienced fraud in the past. Perhaps he fancied himself a moonlight accountant. Who knows?
What I do know is that it’s normal to have a lot of questions during the purchase process. And most of those questions will be answered during the due diligence phase.
You Don’t Need to Do Due Diligence Alone
You’ll be involved in the due diligence process, but luckily so will the financial experts. And you don’t have to count on altruism here to trust those experts’ conclusions—for purely mercenary reasons, you can be sure your accountant and especially your banker will be as thorough as possible, for their own sakes. Here are the three major parts of due diligence and who’s involved:
- You will get to do the in-person due diligence yourself, where you walk the premises, check out the equipment and building, and ask the seller important questions.
- Your accountant (you hired an accountant, right?) will handle the financial due diligence, going through the practice’s records, looking at accounts payable and all the rest.
- But the most thorough of all is the bank due diligence. The bank does the deepest dive of all, checking bank records, pulling credit reports, and checking everything against IRS records. It’s the bank’s money on the line, after all, and they’re going to protect their investment.
The Asset Purchase Agreement Protects You
When it comes to the small stuff, as the buyer you’re going to have to take some information on faith. Is every patient in the system a real person? Are any records fabricated? Did the seller, even in the face of taxes, penalties, and jail time, submit inaccurate information to the IRS?
Am I making you nervous yet? So many unanswerable questions! But don’t worry. Smart lawyers built the ultimate protection into the standard purchase contract, the Asset Purchase Agreement. The APA has a section called “Representations and Warranties,” which essentially says that if you discover any fraud after the purchase, you can sue the seller for the loss plus damages.
Trust, but verify. Due diligence is a thing—and a thorough one—for a reason. If you’re not sure what’s normal, well, that’s where a dental practice transition advisor (like me) comes in.
What Does Financial Due Diligence Involve, Anyway?
Financial due diligence gets pretty deep in the weeds, but you’re not doing it all yourself. Your bank will do a lot of it, and we can help (we can also help you in the valuation, negotiation, and other stages of purchasing a practice).
Here are some of the items under scrutiny in financial due diligence:
- Review 3+ years of tax returns and financial statements. Analyze revenue, expenses, profitability, cash flow, and growth trends over time.
- Understand the revenue mix, services provided, associated billing rates/reimbursement rates, and payor mix (private, insurance, Medicaid etc.).
- Examine compensation structure (owner and employee salaries, bonuses, benefits).
- Review expenses (supplies, equipment, labor, rent/mortgage, facility expenses, insurance, etc.) over time. Look for trends and patterns.
- Review profitability by service line, provider, and insurance and patient type.
- Assess accounts receivable aging and collectibility.
- Evaluate employee benefits structure.
- Review depreciation schedules for equipment and assets.
- Analyze debt/leverage levels and ability to service loans.
- Project future revenue, expenses, profitability based on findings.
- Compare financial audit report vs. tax return for discrepancies.
We told you it’s a lot, but it’s manageable with the right help. This is what we do, all day, every day. Contact us for a free consultation.
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