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How to avoid transactional risk in hospital mergers and acquisitions

As healthcare providers band together to enter new markets and expand their capabilities, hospital mergers and acquisitions are likely to continue at a steady, if less sizzling, pace in 2023.

Amid economic uncertainties, it is more important than ever for buyers, sellers and investors to understand the key forces driving this activity and some of the key risks behind closing healthcare deals, particularly in the context of distressed systems.

economic pressure

Government spending and subsidies linked to Covid-19 are falling, energy and utility costs are rising and interest rates are stabilizing after a 30-year peak.

As a result, once-profitable target companies find themselves on the distressed side of their balance sheets or face significant financial and operational challenges.

In healthcare in particular, falling or falling reimbursement pressures, challenges in recruiting physicians and the transition to new payment models are also creating economic strains that are eroding revenues and affecting access to capital.

Labor issues are another growing problem. The strike by more than 7,000 nurses at two New York City hospitals this month underscores the challenges facing healthcare employers.

In 2021, as found in a study published in health matters1.8% of nurses — more than 100,000 nurses, the majority of whom were under the age of 35, according to McKinsey & Company — left the profession, a trend expected to accelerate in 2022 and beyond.

For many providers, these and other staffing issues lead to their own flight to safety or greatness.

What was once a relatively balanced environment dominated by dealmakers looking for quick wins is pivoting to a market where troubled assets — and options to turn around such businesses and service lines — are the focus of many deals.

Businesses with distressed systems

While acquiring distressed assets can bring benefits to both buyers and sellers, both parties should ensure that such transactions do not create stumbling blocks down the road.

Buyers and investors should always conduct thorough due diligence. These analyzes should go beyond clarifying the capital, financial and operational structure of the target company. They should also include a clear assessment of whether the acquirer can resolve the challenges faced by the seller.

Buyers and investors should also consider completing transactions under the Chapter 11 process. When properly administered, court proceedings can allow the buyer to emerge with the asset but without the debt.

In addition, deals settled through bankruptcy may allow buyers to meet the terms of collective bargaining agreements and acquire assets without assuming the debtor’s litigation liability.

A review of important contracts or leases that may reduce a target company’s presence but also strengthen the acquiring entity is also required. Chapter 11 may provide buyers and investors with the ability to terminate the seller’s contracts, leases, and other anti-monetary obligations.

Situations in which buyers and sellers face similar challenges are also tricky. For example, if both companies are facing high labor costs, it may be better to back out of a deal than to exacerbate an existing problem.

And finally, deals that lead to a loss in value should be avoided. Bringing a hospital into bankruptcy can provoke negative reactions from affected communities, physicians, patients and other stakeholders. Buyers should clearly communicate that filing for bankruptcy is understood as part of a rebuilding process that will lead to a positive outcome.

Positioning for acquisition

While high-performing hospitals and healthcare systems can impact the terms of the deal, struggling organizations need to be creative and think big. Sellers should consider the following to better position their businesses for a potential sale or to attract investors.

It is crucial for sellers to clarify their missions and strategize accordingly. Depending on the hospital’s goals, a new owner may enable it to move forward on its current path or provide the tools, assets and funds needed for a complete re-visualization of its competitive strengths and service offerings.

You also need to determine what exactly is for sale. These decisions must be based on what potential investors and buyers deem valuable.

For example, as healthcare systems seek to increase revenue from outpatient care departments and shift losses out of hospital facilities, providers may explore options that allow them to monetize service line assets.

Sellers should also start to think outside the box of the regular buyer. Retail and tech companies continue to push into the healthcare space, and private equity investors may offer terms that allow for some level of independence. Non-profit organizations can offer interesting – sometimes challenging – terms and conditions.

You may also explore alternatives such as outsourcing back office and technology support functions, sale-leasebacks, joint ventures, and other collaborations. This can provide the selling or target company with the capital it needs to continue operations while reallocating resources to its core strengths and mission.

It is also necessary to address potential community resistance. Patients, local governments and federal antitrust authorities alike express concerns that the consolidation of hospitals and healthcare systems is negatively affecting the availability, quality and affordability of healthcare services.

Before putting a company or business unit up for sale, executives should develop clear plans to identify and address obstacles that could gain momentum enough to destroy a deal.

Ultimately, the guidance that applies to any business transaction – knowing your goals, doing your due diligence, keeping your options open – will increase the likelihood of a successful close.

This article does not necessarily represent the opinion of the Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Information about the author

James (Jim) F. Owens is Counsel at McDermott, Will & Emery, serving a variety of not-for-profit and for-profit healthcare companies with a focus on transactional and regulatory advice.

Felicia Gerber Perlman is the global head of McDermott, Will & Emery’s corporate restructuring practice. Her practice focuses on complex corporate restructuring, debt restructuring and bankruptcy matters.

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