The Importance of Buy-Side Diligence: Evaluating Assumptions in Healthcare

Written by Grant White, CPA, Colin Haslett, and Joe Scott, CPA

In the healthcare industry, investors evaluate potential investment opportunities that typically first come through sell-side marketing materials like teasers or confidential information memorandums (CIMs). These materials show the company’s financial performance over the past two years and projections for the current and next two to three years. It’s crucial to note that these projections naturally involve assumptions about future growth.

While these assumptions help buyers grasp the company’s strategic direction and growth opportunities, relying solely on them might lead to overestimations in purchase prices or underperformance post-acquisition. Financial projections have the potential to be biased and overly optimistic by overlooking potential market shifts or industry trends that may impact performance.

For instance, in the healthcare services industry, projected financial performance might hinge on key events such as:

• Introducing new or expanding service lines
• Hiring additional providers
• Opening new facilities
• Transitioning procedures from inpatient to outpatient settings in company-owned ambulatory surgery centers
• Renegotiating contracts with commercial insurance payers

Prudent investors recognize the importance of buy-side due diligence. This diligence serves not just to verify historical data, but also to test the credibility of projected financial assumptions. Diligence teams must reconcile key documents, analyze historical financial and operational trends, and engage in candid conversations with key management personnel to evaluate these assumptions.

To illustrate this point, consider two scenarios wherein a company projects $1 million in revenue from hiring a new provider in its CIM distributed to potential investors:

• Scenario 1: The provider began employment six months ago, has demonstrated consistent growth, and is on track to reach the projected $1 million revenue in the upcoming year.
• Scenario 2: Management intends to hire a provider but lacks a signed employment contract to validate their revenue projection.

In summary, buy-side diligence is instrumental in verifying management’s claims and assessing the feasibility of a company’s projections. The insights gained through the diligence process help buyers make informed investment decisions, guard against inflated purchase prices, and provide buyers with more accurate expectations of post-close performance.