Mergers and acquisitions

Part III: Due Diligence

This is the third article in our series on “Closing a Private Equity Transaction.” In Part I, the benefits of preparing for a transaction were explained, along with how best to prepare. In Part II, the letter of intent (LOI) was discussed, and key terms were identified and explained. Next, we walk through the due diligence process, which begins immediately after the parties execute the LOI.

Due diligence is used by both the buyer and seller to confirm the decision to proceed with an ultimate closing. Typically, the buyer’s examination of the seller’s business will be comprehensive and include information covering the past three to five years. This is necessary in order for buyer to understand what it will be purchasing, in terms of profitability, operations, business relationships, and potential liabilities. 
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Private equity buyers have become a significant player in the healthcare M&A space and they continue to focus on those types of healthcare services that have the greatest opportunities for aggregating. Traditional health system buyers have continued to focus on which physician specialties will assist most with alignment and care coordination strategies. While there are many similarities in transactions with these two types of buyers, there are often just as many differences. The following examples illustrate how those interests may vary:
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Recent press reports are speculating that CVS Health Corporation is seeking to acquire the health insurer Aetna.  The rumored transaction would create a new type of health care company that doesn’t currently exist:  one that combines a commercial health insurer with a retail pharmacy chain and a pharmacy benefit manager (PBM).  According to most reports, CVS would pay $66 – $70 billion to acquire Aetna (with Aetna stockholders receiving cash and CVS stock).  It’s said that the parties are trying to enter into a definitive agreement by year-end.    
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On May 9, 2016, the Middle District of Pennsylvania in FTC et al. v. Hershey Medical Center et al. (“Hershey”) denied a preliminary injunction request by the FTC to block a merger between Penn State Hershey Medical Center and PinnacleHealth System. The District Court rejected the FTC’s request based on its finding that the FTC’s geographic market definition was “unrealistically narrow and does not assume the commercial realities faced by consumers in the region.” The proper geographic market is one from which the defendant hospitals draw the bulk of their patients, with few patients entering in from outside that area to seek medical care and few patients within that area leaving to seek care from other hospitals. The District Court found the FTC’s proposed geographic market to be “starkly narrow,” particularly “given the realities of living in Central Pennsylvania, which is largely rural and requires driving distances for specific goods and services.” By failing to set forth a relevant geographic market, the District Court held that the FTC could not demonstrate a likelihood of success on the merits of its Clayton Act case against the merger and denied the preliminary injunction.
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ContractSignature_iStock_000013778118MediumAs with any transaction, a healthcare deal typically starts with a Letter of Intent (“LOI”) or Term Sheet to outline the base agreements on the business deal. The LOI or Term Sheet should include not only the purchase price (or range), purchase price adjustments, payment terms, closing conditions, confidentiality, exclusivity, and other common items, but also the transaction structure – for example, asset sale, stock/membership interest sale, merger, joint venture, affiliation, etc.
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