Why Healthcare M&A Deals Succeed or Fail: Lessons from the Deal Table

Stewart Gandolf (Healthcare Success): Welcome to the Healthcare Success Podcast. Today, it is my pleasure to interview a partner from McGuire Woods, Kayla Marty. First of all, welcome, Kayla.

Kayla Marty (McGuireWoods): Thank you. Yes, thank you so much for having us.

Stewart Gandolf (Healthcare Success): Glad to have you. I'm glad to talk to you more after seeing you around your conferences from time to time. So the first thing I want to talk about is you have a unique perspective. You've worked on hundreds of transactions, and there are things that you see over and over again.

And that pattern recognition, and especially something we talked about a couple times, is the expectations. And like, how can you reach a goal when expectations have never been set? So I'd love you to talk about that to start, please.

Kayla Marty (McGuireWoods): Yeah, absolutely. So I think setting expectations is one of the most important parts of the transaction. Typically speaking, there's a couple different expectations we see. One is, what is the amount of time it's going to take? What is the schedule and resources it's going to take to complete a transaction?

The other is the substantive deal points, right? Like, what is expectation about pricing? What is expectation about risk allocation? What is expectation about integration and what impact the transaction is going to have on your company? And then the last thing is setting expectations about how is the integration going to work?

How is it going to trade over from a seller-run company, often founder-led, to a buyer-owned company that often has institutional capital, very formalized processes? So from my perspective, those are the major, major points.

Stewart Gandolf (Healthcare Success): So it's interesting. I was just at a, I was invited to a dinner recently by a private equity firm I know, and there was a lot of agencies there in this case, not healthcare companies.

But I thought it was really an interesting presentation because I've known this guy for a long time, and I thought it would be fun to hear him say his thing. Because I work in this space, I'm kind of familiar with the basics of it. But I thought it was really interesting that the private equity company and others that I've met on both sides of the equation really do want those expectations to be figured out up front.

Do you agree with that? Because you know, I always say problems don't necessarily kill deals, surprises do. So I'd love to hear some insights on that.

Kayla Marty (McGuireWoods): Yeah, I think that's right. I think that going into a transaction, it's really important, especially if you're a founder-owned business, to have a clear understanding about what you want from the outset and then communicating that clearly to a potential buyer or potential partner. I think it's also equally important for a buyer to do the same thing where they know what their pain points are and what's really important to them.

A lot of people have different philosophies about what level of detail is shared at what parts in the process, but from my perspective, if there is an item that will cause you to walk away from the transaction, whether you're on the buyer side or the sell side, it's really important to be upfront and transparent about that. For some people, that's price. For some people, that's risk, post-closing risk allocation. For some people, that's, are we going to keep all of our employees?

How are we going to operate the business post-closing? And so, there's absolutely no seller that's the same. There's no buyer that's the same. And so that's why I think it's so important that conversation has up front, because that is the number one thing, from my perspective, that kills deals.

Stewart Gandolf (Healthcare Success): So let's talk about, you just mentioned several different things there. And sort of Transaction 101 is like the price is only part of it. You need to think about terms, right? Because I'll give you a billion dollars if we have a payout of a dollar a year, right? So that's like kind of meaningless.

Is that, you know, I'm sure you deal with very sophisticated buyers and sellers sometimes, and sometimes not so much. Do you find that is a big issue about just understanding before they get started with this process? by the time they see you, you know, you would hope a lot of this stuff is sorted out, or at least, you know, along the path.

Help me understand how that works in the real world. And what do you see?

Kayla Marty (McGuireWoods): I think the core business terms tend to come down to total amount of price, right? Like, what is the total purchase price? Is it going to be paid in cash or equity? And over what period of time? And then what is the risk allocation?

So what responsibility does a founder or a seller have post-closing after the deal is done? Are they going to buy rep and warranty insurance so that it's a no indemnity, no responsibility deal? Or is the seller and founder going to hold that responsibility post-closing? Those things are material. The other components that we see that are also material are, am I going to be restricted from moving away?

Am I going to have to stay with the business a certain period of time? Am I going to have a restrictive covenant? All of those things I would put in the category of material business issues. And those are typically worked out at least in concept before lawyers are heavily engaged.

But the way I think of lawyers’ roles is to further refine that discussion between the buyer and the seller to make sure that there's no mismatch of expectations.

Stewart Gandolf (Healthcare Success): So in terms of when you're brought in typically versus when maybe you should be brought in, maybe it's the same time, maybe you'd recommend a little earlier or later. I don't know, are you brought in when they're still sort of verbally discussing deal points? Are you brought in after a formal LOI is in front of the seller? When does that typically happen?

Kayla Marty (McGuireWoods): Most commonly on the buy side, attorneys get involved when there is a kind of a clear business deal, a pathway to select an individual company for market. On the sell side, we typically are involved much earlier because we're often helping put the company on the market, do some preliminary diligence, and then fully negotiate all the deal points.

Because typically sellers are less experienced in doing this, particularly their founder owner. This is the first time that they've gone through the process. So their gut reaction is typically to include the attorneys earlier, which I think is a good idea.

Buyers that are serial buyers like PE funds or large strategic companies that do this all the time, they often have in-house resources that can get the deal for pretty far down the road before the attorneys are involved.

Stewart Gandolf (Healthcare Success): Got it. And so it's interesting what you just said there. That surprised me. The part about advising the seller pre-deal. Do a lot of your sellers have investment bankers working with them or some of them coming in cold? Or I guess maybe it varies all across the board.

Kayla Marty (McGuireWoods): Yeah, it varies. It's a mixed bag. I think it really is dictated by size of deal. So for deals that are expected to earn an enterprise value over about $50 million, the number of deals that have investment bankers go up significantly beyond that point.

And so I would say typically if there's an investment banker involved, they recommend that attorneys get involved earlier rather than later to make sure the business is prepared to go to market, they're prepared to put a bid draft out or an LOI out for buyers to then respond to particularly in auction-style deals. For deals that are smaller, those are often deals that are proprietary deals or deals that are done without an investment banker and without an auction process.

Sometimes attorneys are brought in really early because there's been a long-standing relationship with those entities and they feel more comfortable including the attorneys earlier. But more commonly, they bring people in when they're getting pretty close to a deal, but still usually pre-LOI. Typically, the attorneys are involved in the LOI process if it is any type of material transaction.

Stewart Gandolf (Healthcare Success): So I don't know how often you see this, but I've talked to people just socially that may be fee-sensitive about attorneys and like they just want to use just anybody to negotiate, especially with PE. I'm like, wait, you're dealing with professional buyers with like really strong lawyers. Do you recommend in that case, I mean, I know it's going to sound self-serving, but to really find somebody, not a contract attorney, but an M&A attorney who really understands this field?

Because I think it's important to understand that because it's, you know, it's, yes, it's expensive, but it's expensive to make a mistake. I'm curious what you think about that.

Kayla Marty (McGuireWoods): Yeah, I agree. I actually believe the most worthwhile attorney in an entire transaction process is your corporate tax attorney that does transactional tax, right? That's not me, but it's somebody that we often have at our firm. And that is a very unique skill set, particularly in healthcare.

And so what I tell prospective clients all the time is you absolutely do not want to slight in the least on involving somebody in the structuring of your transaction and making sure it's done in the most tax-efficient way, as well as in a regulatorily compliant way.

That's the other place that we see people make a lot of mistakes is they hire someone that doesn't have deep expertise in healthcare, and healthcare, just like energy and banking is a deeply regulated industry that has. It a lot of pitfalls that aren't logical in the least. And so it is really important to have somebody who's been around the block in those type of transactions if you're playing in this space.

Stewart Gandolf (Healthcare Success): So actually, that brings me to a question I'll ask later. But you said something earlier about deals falling apart.

I would love if you can think of, going to put you on the spot here, but like the top three, the top five, whatever the number is, things that you see just seem to be things where they really fall apart a lot. We already talked about expectations, but maybe a little bit more specifically.

Kayla Marty (McGuireWoods): So what I see typically on deals breaking, and just to give you a sense, I would say less than 10% of deals that we see break, probably less than 5% that break permanently. Sometimes you'll have one that breaks and then it comes back to life. And so it is a very unusual event.

But when it happens, there's a very consistent thing. So one is it's a financial issue. Typically speaking, the particular seller or their particular investment banker has been overly aggressive on the EBITDA adjustments that they've made. And when the buyer really gets in the weeds on the financials, they realize and see that those assumptions were overly aggressive. And so they just can't deliver on them. And when they do that, they reduce the purchase price or need to change the purchase price as a result of those financial assumptions.

That's the number one reason that deals break. The other reason deals break that I see is sometimes people just aren't actually ready to sell their business and they figure that out through the deal process. And so I think it's really important that when you're looking for particularly a majority deal where you're looking to sell a majority of the equity stake, that comes with a majority of the governance stake too.

And particularly in founder-led deals, I think it's important for the founder to consider whether or not they really want to give up the level of control associated with with a majority transaction, because more often than not, we'll get into the negotiations with someone that hasn't necessarily deeply considered what it means to give up control. And when they do, they may not be happy with it, or they may just not be ready to sell. That's kind of the second reason I see most commonly that deals break.

And the third is usually like external third-party factors. So it might be there's a really material payer that the transaction creates a consent issue with, or there might be a hospital party that there's a large PSA with that can't be delivered on because the third party doesn't like the deal, where maybe a lender isn't financing the deal, right?

Some type of third-party action that through no fault of the buyer and through no fault of the seller, the deal can't close. I mean, those would be our top things that we see.

Stewart Gandolf (Healthcare Success): That's actually really intriguing. That makes sense. That number two must be frustrating for everybody involved. The seller just spent a lot of time. The investment banker spent a lot of time. The PE firm spent a lot of money and time.

It's funny. I'm imagining that as people go through the process, it's sort of like the Kubler-Ross model. They're excited, then they're scared, then they want to get out. And then eventually they come to acceptance and move on.

Do you see that emotionally? It's got to be an emotional roller coaster for some, especially if they haven't been thinking about it for a long time.

Kayla Marty (McGuireWoods): It is an emotional roller coaster. We tend to see it come in waves. So at the very beginning, everyone's very excited about the process. All the resources are put toward the process.

Then, for whatever reason, as the process goes on, people have this concept we call deal fatigue here at McGuireWoods, which is they are effectively working two jobs. They're working their regular job plus everything they have to do in order to complete a transaction.

And the longer that goes on, the more diligence there is. The more prolonged the purchase price negotiations are. That can become very wearing and tiring on both the sell side and the buy side.

And there's kind of an old adage that says “time kills all deals.” And one of the reasons for that is this concept of deal fatigue. Both the buyer and the seller are really excited at the beginning. So capitalizing on that excitement and doing as much as possible at the beginning is really important.

But as time drags on, it becomes more difficult to resource the deal in the way it needs to be resourced. People tend to get a little bit more stuck in their positions as they see the deal drag on.

Stewart Gandolf (Healthcare Success): That makes sense. I can see how, “oh, just forget it” becomes part of the response. That would be quite concerning.

What surprises founders once the deal begins? Is there anything they consistently say, wait, I didn't expect that? You're nodding your head, so I'm assuming that's a yes.

Kayla Marty (McGuireWoods): Yeah. There's usually two things. One is the level of diligence. And the second is the complexity of the transaction documents.

On the diligence component, as a founder or as a seller, you are intimately familiar with every element of your business. It's almost like second nature to you. But when you have a buyer coming in, they know the industry. They have a good understanding of the industry. But they really don't have an understanding until they go through the diligence process of how you run your business.

And it's critically important for them to understand that, both from a liability and risk mitigation perspective, but also from a post-closing integration perspective. So a lot of times sellers or founders, in particular, aren't expecting the level of questions they get from all sides, financial, legal, billing and coding, insurance, benefits.

It's just very overwhelming all at one time because, typically speaking, the buyer has resourced that with an infinite number of third-party resources. And so that can feel very overwhelming. So I think that's one thing people never expect.

The other is the complexity of the transaction documents, especially in a large transaction. Purchase agreements can consider all types of different potential issues that may come to pass or may not come to pass. And the attorneys are negotiating those and trying to keep their clients up to speed on what they're discussing.

Many of even the terminology is very foreign to sellers that have never gone through it before, or buyers where this is a first time in a particular industry. And so that's something that we also see as being very unexpected and sometimes difficult to digest and really cut through.

Stewart Gandolf (Healthcare Success): So I have to imagine, particularly if you're working with a physician's group, at some point it's like, “wait, you're calling my baby ugly.” If you're looking at, “you know, we're very proud of what we've created.” And all of a sudden, “oh, that's not right and that's not right.” Does that become an emotional barrier to the sale? Because I could imagine it happening, at least.

Kayla Marty (McGuireWoods): It can become emotional in some instances. I think it depends on the situation. What the buyer is trying to do by doing diligence is not criticize the business. It's not in any way degrade what the particular seller has created. But simply they're trying to price the risk of certain issues.

So one classic example is people that look into IT and other infrastructure diligence. In many instances, physician practices that have been independent but may then join a larger organization don't have IT infrastructure that will work in the world that we live in from a cyberattack perspective once they join a larger organization.

And so that's something that buyers are often in this current environment extremely critical about. Sometimes that can feel very off-putting to a particular seller, especially if they've invested a lot of resources in that particular arena.

But the particular targets that are coming at them as a smaller organization versus the particular threat actors that are coming after them when they become a bigger organization are just really different. And so the buyer may not be being critical of what they've done historically. They're simply trying to price in the cost of bringing it up to their IT standards, for example.

Stewart Gandolf (Healthcare Success): So that's actually a really good point. The world of healthcare is so complex, right? You have HIPAA laws, all kinds of different laws and compliance issues. Then you have security. Then it's state laws. And then you get into multiple states and all these different things.

When you're looking at it, I guess from a legal point of view, if I was the seller, I might think if these become issues, “wait, isn't that why you're buying me? You're going to solve these problems for me?” Especially the tech issues and those kinds of legal issues.

Is that real? Because I'm presuming a PE buyer is not coming in expecting all this stuff to be squeaky clean because that's not what they're buying, right?

Kayla Marty (McGuireWoods): Right. They're not expecting perfection in the least. But when they're doing diligence, they're trying to assess, “how much capital are we going to need to put in? And what service lines are underserved right now that we could assist in expanding?”

Part of diligence is assessing how they can assist in post-closing operations going forward. And so sometimes that's taken by sellers as being critical of their current operations, when in reality they're really just trying to price and figure out the capital requirements post-closing.

Stewart Gandolf (Healthcare Success): That makes sense. So I have another question that I hadn't planned to ask, but it occurred to me. From the principal side, there's definitely a concern sometimes, or at least I've talked to some attorneys. You know, some are really good at helping bring a deal together, and others are sort of impolitely called a deal killer. So what makes the difference there, Kayla? Help us know who to pick.

Kayla Marty (McGuireWoods): I appreciate it. So I think it really comes down to one thing. It's understanding your clients have a common goal. You want to protect your clients as much as possible. But they wouldn't have hired you if their ultimate goal wasn't to create a partnership with somebody else or exit entirely, depending on the structure of the deal.

I think some attorneys approach this from the perspective of “we're creating something.” Those are the people that tend to not be deal killers.

Then there are other people that approach it from the perspective of “I want to win every point.” By and large, those people will kill every deal because in any negotiation, a good deal is usually the hallmark that both people gave something to put together something bigger.

If one party wins every point, the other party is probably very unhappy and is more likely to walk away. So I think it's critically important as a seller and as an attorney that you ask your client at the very beginning of the transaction, whether you're on either side, “what are your five most important points that we need in order for this deal to work for you?”

Then we should spend our time and capital focusing on those five points. We should let some of the smaller things fall away because that's more likely to create a successful deal.

Stewart Gandolf (Healthcare Success): That's a great point. So part of your job is psychology, right? Talking people off the ledge for their own benefit.

Let's talk about, you alluded to this a little while ago, the idea of, first of all, control, and then we'll talk about life after closing, which are kind of related but not exactly the same thing.

If I can imagine somebody having led their business for many years and suddenly saying, “okay, it's up to you. Here you go.” That's got to be super hard.

Any ideas on how, not from I guess the legal part, but really practically speaking, how people get through that phase? That's got to be difficult for many. And that has to factor into it too, for sure.

Kayla Marty (McGuireWoods): I think it depends on what people's expectations are up front. This all goes back to that overriding point of setting expectations.

There's a few different deal structures that we typically see. One is a seller or a founder stays on as the principal executive post-closing. In many instances, that structure can be the least disruptive from an operational perspective, but can also be the most challenging for the seller or founder to be in a position where one day they have no boss, and the second day the board is now their boss, which they may or may not control based on the style of deal.

So I think that can be really challenging. It's important that there's clear expectations set about the level of control and what authority that person has to take certain actions in the business post-closing and what involvement the board is going to have. So I think you just have to have that discussion from the outset if your founder or seller is going to stay on as a principal executive.

The other structures, in some ways, are easier, and in some ways, are harder. One of the structures is a full exit where the founder or seller leaves the business completely. In that scenario, there tends to be a significant vacuum. And so you have to do a lot of integration planning.

But from a control and expectation perspective, the buyer controls that scenario. And so the negotiations are really quite easy. You just have to work really hard on finding the right replacement so you have business continuity.

Then the last model that we see most commonly is a minority-owned model. So the founder maybe is looking or the seller is looking for capital. And so they might sell 30% of the business, but they still have 70%.

In the negotiation there, the founder is not going to be giving up control of the business. But they are going to be responsible now for certain material actions like material spending, what they're going to do as far as growth plans, whether they're going to open in a new state.

Those tend to be the level of decisions that the minority owner has controls and say in. So setting those expectations up front so the founder or seller can continue to operate, but they can't do so exactly the same way that they did pre-closing on a post-closing basis because they have that other third party that has a capital or financial interest they have to keep in the loop.

Stewart Gandolf (Healthcare Success): So I don't know, we don't have to go too deep in this, but just curious. If there's an earn out, a big earn out, then control matters a lot.

That seems like an area where you could be pretty naive if you're a seller if you don't stop and think, “wait, all this money is relying on you guys to do what you say.” Does that come up very often? I imagine it must.

Kayla Marty (McGuireWoods): I would say in healthcare, earn outs are not incredibly common. There are a number of healthcare fraud and abuse reasons that people do or do not include earn outs on the particular fact pattern. So they're not as common as they are in other types of business like the auto industry or furniture, you name it.

But certainly they exist in certain types of businesses. In doing that, there is often a heavy negotiation about what are the triggers associated with a deferred payment? What are the conditions? Who controls the impact of those conditions? And then who measures whether or not they were in fact met?

That's a core negotiation of the purchase price and the purchase agreement, typically. But every deal is very bespoke because the triggers tend to be very bespoke.

Stewart Gandolf (Healthcare Success): That makes sense. So one of the last questions before we wrap up today would be, when we start thinking about the life post-sale. I've seen this a lot just working with multi-location providers, whether it's physician-owned, private equity-owned. If you've seen one multi-location business, you've seen one. I mean, they're all different.

There are some that do really a great job of all becoming the same operational system, patient experience, same brand. And there are others, I call it the bag of bolts, like a bunch of sort of uncoordinated things that all fit together. They don't really fit together. They're not really one. They just have a bunch of individual doctor offices.

That's a big deal from a marketing standpoint. Is that a big deal from the negotiation standpoint? Because if you're bringing someone in, typically you're trying to bring them into a system.

So I guess the question is, is this an area where you talk about expectations a lot? And is it an area where we should make sure we negotiate and have clear expectations? Because the back end can be difficult for sure.

Kayla Marty (McGuireWoods): It is really important to have expectations about what you expect from integration and cohesiveness.

I will say that platforms have very different philosophies and themes around this. A great example is names and branding. Some platforms have a philosophy that they absolutely will not change the name or the brand of the business that they purchase because they feel that in the community, especially because healthcare is particularly local, that brand has a very specific connotation and they want to retain that brand.

Other platforms on the flip side may have a thesis about cohesive branding, meaning that they do want anybody that comes into their organization to have a consistent name, have a consistent logo, have a consistent layout of their office or color scheme. You name it.

So I think it really comes down to what is the thesis of the platform that you're joining and you understanding that as a seller when you come in.

Then I think there are a couple of hot-button issues we typically see in the integration. The single biggest hot button issue is the electronic health record system.

Some platforms have the position that if you join their platform, you will switch EHR systems. Some say you can stay on your current EHR system. For physicians in particular and also for facilities, that's a very meaningful choice from an operational and business perspective.

So knowing what the expectation is of the platform I think is really important as much as the branding and the name in some instances. And then there's of course other pieces of technology that fall into that same bucket.

But every platform has a different thesis. They all have a different model. And that's what makes a particular buyer right or wrong for a seller in many instances.

Stewart Gandolf (Healthcare Success): Totally makes sense. So I find that my listeners like to know like what doesn't work or assumptions that, you know, so I guess my question is two-part. Tell me which side you want to answer this. What are common myths, conventional wisdom that often is wrong? Maybe and/or mistakes you see even sophisticated CEOs make in this category?

Kayla Marty (McGuireWoods): Yeah. So there tends to be two things from my perspective.

One is “price cures all ills.” And two is “we can figure it out later.”

Both of those two things tend to be difficult. Anytime you're a seller in particular and you're going through a transaction, it is always easy to say I'm going to select the buyer that has the highest price.

The highest price though at the end of the day may not be what works for your business. It may not be structured in the way that works for your business. It may not work from a post-closing integration perspective. And it may not give you the level of control that you're looking for.

So one thing I would encourage all of my clients and really anyone I talk to is the highest price is often good. But it's really important that you drill down beyond pricing and make sure that the buyer, partner, or fit is right for you. That's kind of a guiding principle from my perspective.

The second is “we'll figure it out later” and not having a plan or clear expectations about what you want. That's also a very negative situation, typically.

That can be applied in a lot of different ways, right? It's both the seller having clear expectations about what they want and not kicking the can down the road about “am I ready to sell? Am I not ready to sell? I'll just test the process.”

It's a very expensive and very time-consuming process to feel that way. Another way to think about it is “we just need to close the transaction. We just shouldn't think about anything that's going to happen post-closing.”

That would not be a good idea in my eyes because you need to make sure you can operationalize it. But sometimes you see that.

So the concept of “we'll deal with that later” is generally a recipe for not success.

Stewart Gandolf (Healthcare Success): Yeah. That sounds scary to me. I don't know, Kayla. That's a big risk. “We'll figure it out later.”

Okay. So last question. If you had a CEO about a year prior to deciding to sell, or they've decided to sell, they're thinking about a year's time, what would you tell them to start doing today to prepare as they go through this process?

Kayla Marty (McGuireWoods): So I think there's a couple things.

One is really understand the financials of your business because that is going to be the primary thing very early on in the diligence process that you're going to be receiving questions about. The buyer is going to be really deeply in your financials and you don't want to be blindsided by anything there.

A lot of people choose to hire their own quality of earnings provider to do a sell-side quality of earnings to really help them understand their financials and any blind spots they may have. I tend to believe that that's money well spent. But that's something I think very early on in the process you need to be thinking about.

The second thing is you need to be considering, what are those five things? What are those things that are so important to you that you couldn't conceive of selling your business unless they worked?

Then be very clear in communicating those with your investment banker, with your lawyer, with any business partners you have so you really are cohesive and talking with a single voice.

The last thing I would say is anything that you know needs cleanup, right? You have an outstanding piece of litigation that needs attention. You have some type of billing and coding issue that needs attention. You know that there are holes in your IT systems, right?

If there are known issues that you have, don't just kick them down the road thinking, “oh, we're going to sell. We don't need to deal with those right now.”

Stay on top of your business. Make sure your business is operating at its highest and best at all times because that's what will really set you up for success through both integration as well as the sale process.

Stewart Gandolf (Healthcare Success): Totally makes sense. You could still probably sell it, but you won't get the same value as you're not buttoned up, right? That may kill the deal.

Do you recommend sellers or would-be sellers, it depends on the marketplace. Sometimes some businesses get called weekly by potential buyers.

Do you recommend sellers or would-be sellers take meetings like that to understand the marketplace, to meet, develop relationships ahead of time? It seems like that would be a good idea, especially if they seem qualified, to get an idea of what's even out there.

Kayla Marty (McGuireWoods): Absolutely. I mean, I always say you have no obligations to anyone to just hear them out and understand their perspective and then voice your perspective.

Now, of course, if you have restrictive covenants or you have other restrictions prohibiting that, of course you should not. But if you're a founder owner and you're considering selling your business, I think it's critically important to hear from potential buyers, hear from investment bankers, hear from attorneys because you'll learn a little something from all of them, even if that person doesn't end up being your right partner.

Stewart Gandolf (Healthcare Success): Totally makes sense. Kayla, this was great. I knew it was going to be fun. Thank you for joining me today.

Kayla Marty (McGuireWoods): Yeah. Thank you for having us. We really appreciate it.