This is Scott Becker with the Becker's Health Care podcast. We're thrilled today to get to visit with Joe Scott. Joe is a Director of Health Care Financial Due Diligence at VMG Health. Vmg Health is one of the premier consulting firms in the United States with a tremendous focus on healthcare, I think, exclusively healthcare, just a fantastic firm. We're going to talk to Joe today about sell-side diligence. In healthcare transactions, what does self-site diligence mean? What are the pieces of How does it work? And a lot more. Joe, before we get started, thank you for joining us. And can you take a moment to introduce yourself and tell us just a bit about VMG Health?

Of course. Thanks, Scott. Pleasure to be on. As Scott mentioned, my name is Joe Scott. I'm a director with VMG Health's transaction advisory or quality of earnings team. I've been with VMG for a little over three years now, mainly focused on buy and sell side quality of earnings. My transaction-related experience is, give or take, 100 plus deals. Everything from smaller PPM rollup acquisitions with private equity to your larger physician group transactions, and then all the way up to larger hospital and their ancillary services, their groups and deals of that sort. Prior to BMG, I spent three years in a similar group at Dixon Hughes Goodman in Charlotte, North Carolina. So I've been specifically focused on healthcare buy-side and sell-side QAB for the last six plus years. Prior to that, I've had some generalist transaction advisory experience at DHG, and then also worked at PwC in their financial services assurance group in Charlotte and Atlanta.

Thank you very much. Tell me about this a little bit. You used the term QV Talk about what QV means, and what is sell-side diligence, and are there different types of sell-side diligence?

Sure. Yeah. Equality of earnings and diligence, they're pretty broad terms here. I think diligence in short, You're trying to identify and assess a company's value, its assets, strengths, weaknesses, uncovering anything you need to know so you can make the most informed decision in a transaction, whether you're the buyer or the seller. There's plenty of types. I mean, quality of earnings first come into mind here. What we're really trying to do with the quality of earnings report is, Scott, as you know, most private equity transactions or health care transactions in general, they're based off of a multiple of EBIT EBITDA. Ebitda times a given multiple depending on sector size, intangible qualities essentially. So quality of earnings is truly focusing on how do we get to that number, what do we use for EBITDA, and depending on what type of business or the size and complexities, that can vary widely. So quality of earnings can encompass a ton of different procedures and areas of focus. However, the end goal, typically trying to get to run rate, clear, free of noise, EBITDA figures so that an informed purchase price can be determined in a transaction.

So trying to find as predictable an earnings as possible, as predictable an EBITDA as possible. As you said, and I love that phrase, devoid of noise, like not special adbacks, not special add-tos, trying to get as clear as possible as what does EBITDA really look And when you look at self-side diligence, what type is most important in financial transactions? And talk to us about financial diligence, coding diligence, and more.

Yeah. I mean, so diligence runs the gamut. I mean, in every transaction, there's going to be legal diligence. The lawyers always get involved. So I would say outside of that, specific to health care transactions, I would say the most important or most common are going to be your financial due diligence or quality of earnings. Again, quality of earnings is only a little segment of financial due diligence, but a lot of times those terms are used interchangeably. Then I would also say the coding or regulatory diligence is also a key focus area just because between those two, those are the most common places where issues are going to arise, where you can hold up a transaction, whether that's through needing to renegotiate purchase price or uncovering regulatory issues.

Thank you. When you talk about the areas of focus in the cost and benefits of financial due diligence, tell us a little bit about the areas of focus in the cost and benefits.

Yeah. I touched on it a little bit, but you've really got to determine what that EBITDA figure is going to be used for a purchase price calculation a lot of times. In general, financial due diligence is to come in and basically verify the accuracy of the financial statements, make sure it's reflective of a go forward entity. The primary output of financial due diligence is the quality of earnings report, like we mentioned. As I said, we deal with transactions of all different sizes, from your mom and pop primary care office down the street up to giant health systems. The actual procedures can vary widely. Every accounting department looks differently. You've got people on cash basis, you've got people on a cruel basis, you've got people who are commingling their personal expenses with the business. What we actually have to focus on can vary a deal to deal. Then we know that most doctors aren't necessarily an MBA as well, so there could be some cleanup necessary. We'll make sure that everything ties out to the bank statements, tax returns, all that good stuff. Then we're typically converting the financial statements from cash to accrual if it's not already on an accrual basis, just so that it lines up with GAAP or your generally accepted accounting procedures, and make sure that we're paying the most accurate picture from a true date of service standpoint, which is a key consideration in healthcare transactions because unlike a grocery store, I mean, most cash or revenue, it's not received at the time of service.

It's going to be received weeks or months afterwards. We'll do a lot of work over making sure the timing of the expenses and the revenues are captured in the proper periods.

Thank you. Talk for a moment about financial diligence, QV, coding diligence. How does this from what an investment bank does? And again, our audience will be all over the place in terms of their, obviously, true private equity professionals who understand very much the difference between quality earnings and self-side diligence versus banking a transaction. But assume you're explaining this to both true private equity professionals and a wide variety of others that are very interested in what does the deal process look like and transients look like. So what does investment banking versus this diligence? What's the difference?

Sure. Yeah. So I would say that your your typical seller is going to be like, why do I have to pay for an investment bank? And also this quality of earnings report. Like, I thought I've already got some finance guys. What's the difference between these two? So it's a great question.

I would say that your financial due diligence is typically you're working with a team of CPAs who are going to do more in-depth digging.

So more of your accounting side and some light finance background. And then your investment bankers are going to be your heavy finance people. They're going to be a little lighter on the accounting. But I would say that the most important differentiating factor, why you need both, is because you want an objective third party versus maybe an investment bank that there's fees are structured contingently on a sale. So when you go present financials to a third party buyer, they're probably going to take it with a little bit more of a grain of salt if it's also put together by the team that is only getting paid if there's a transaction. So being objective, that's one thing that a financial due diligence team or a CPA firm can provide. I just think in general, they do blend together very well. Your investment banks are going to use a lot of the inputs from the quality of earnings in their market documents or their SIM, their Confidential Information Memorandum. There's a lot of interplay that goes on, but I think that the areas of specialty and the objectivity necessary requires you to have both.

Quite frankly, for deals above a certain size, having a The outside diligence report, a quality earnings report, has become very standard. The idea is it's going to make buyers feel like they could cut to the chase a lot quicker in their diligence because someone has spent a lot of money to put together a diligence report. It doesn't mean the diligence report isn't put together by the seller, but even with that, with high-quality firms like VMG Health, the buyer is now going to be able to move way quicker and way to the next step without as much doubt about what the company's financials and predictability looks like, and that's so important. And you're exactly right. Investment bankers want to have that sell-side diligence support, that quality earnings report, is almost another piece of the puzzle when presenting a company to potential buyers. Take a moment on... I've been through the QV process several different times, both as a principal and as an advisor. Take us through, what does the process look like? How long does a typical QV process take?

Sure. Yeah, it depends on the size of the company, obviously. I'd love to say that we typically shoot for a three to four week timeline, but there can be added complexities or it could be a giant business, in which case it takes a lot longer. I mean, obviously, scope matters. I mean, sometimes even from a Specifically from a sell-side perspective, you may not want to dig into networking capital and debt and debt-like items and deal with… You may save that for a later date. But I would say that in general, it probably falls between that three to six week timeline. But in terms of the process, we'll typically gather information for the first week, get Quickbooks files, whatever it is, Sage intact, all the different accounting systems. We'll also get goals of revenue data from your RCM systems, whether that's like an All Scripps or Athena. We'll gather all that information. We'll put together some trending documents. We'll get our feet wet with understanding the business. Then we'll sit down with management, look at all the different trends that we've identified, help them pick out items that may be, let's say, out of period. First thing that comes to mind is in a hospital transaction, your cost report true-ups.

We'll identify items that might be personal expenses. If this is a smaller physician practice, they may be running golf memberships through a car. Everybody sometimes likes the tax incentives of being flexible with your business expenses. We'll spend some time on that. There's also quality of revenue, and we're looking at individual codes and how reimbursements trending. We'll look at headcount trending. We'll really sit down with management, understand their business, what's driving margins, if there are any specific trends that are worth highlighting, whether they're positive or negative, how do we come up with an EBITDA number and adjust the reported EBITDA numbers to get to a clear and accurate picture of the business going forward. After we meet with management, we put together a report, we discuss it with the seller in this case. I would just say it's important to do this just before the buyers come because not only are you prepared when that buyer's Q of E team comes in, you've already got all the documents prepared, you've been through the process, you're an expert, so you feel. And on top of it, you do this ahead of time and you want Let's say that we did a sell-side report through the end of December, but now the buy-side team is coming through March, and there's been some changes in the business.

You're going to want to roll that forward. So you're comparing apples to apples. You can properly defend yourself against any potential findings. So if you've done this once, rolling it forward, everything is shelled out, you've already got an expert team in place that understands your business. That roll-forward process comes together a lot quicker.

Thank you very much. And take a moment. We've talked about the process of financial due diligence, quality earnings reports, self-side due diligence, that combination of things. Talk a bit about coding due diligence and why coding diligence is so important to quality of earnings into sustainability.

Yeah, absolutely. In healthcare, obviously, we've got a ton of insurance reimbursement. We've got payers that are finicky. They change how much they pay. They change what documentation standards there are. They change what they're focused on auditing every year. You've got the OIG that's coming in and focusing on specific issues via their OIG work plan. Coding diligence comes in. The first step is they're typically looking at a full data set of all the procedures done. They're going to look at distributions of codes. They're going to assess the risk of payer audits, and then they'll get down to a more on your level and take a sample of charts for each provider. When they pull those charts, they're going to be looking at things like whether the ENM documentation meets all the appropriate guidelines or not. They're going to look at and determine if diagnosis and procedure coding guidelines are followed. They're going to look at if if filed documentation routinely supports medical necessity for the procedures being done, whether the documentation is copy and pasted every single time or individually prepared for each unique patient. Then also from a broader standpoint, depending on how you engage them, they can also add value by identifying potential revenue opportunities, whether you're under billing or if the documentation that you're already doing supports billing additional.

So not only are they looking for potential liabilities that could exist, but from a sell side, there's also some tangible benefits of identifying potential opportunities and upside that the business has not historically captured.

Thank you. Take a moment on the cost and benefits of Coding Due Diligence. Also, how does Coding Due Diligence intertwine with the overall financial diligence?

Yeah, I would say from a benefit standpoint, it's similar to quality of earnings. You get that upfront picture ahead of time. You'll know the issues that may arise when the buy-side team comes in. But in general, another benefit is that even if you don't transact, you've got greater visibility. You'll be able to know where you stand, which providers may need some coaching in terms of their documentation. Like I said, there may be those additional revenue opportunities that are identified. But I would say that this is really important, especially for entities that are not doing audits on an annual or normal basis. If it's the first time that somebody is looking at in, let's say, 3-5 years, there may be some fine-tuning that's necessary, and you definitely want to get out in front of that. Remember, the overall goal of a seller, it's not just to maximize the value, but also get a deal done smoothly. Nobody wants to go through a three-year transaction process with four different buyers because every single time it drags out or they find something different. So getting your ducks in a row, it's imperative in these transactions. And then I guess from a cost standpoint, real briefly, typically the costs are structured.

It's based on how many charts you're reviewing, the size and the scope of the engagement. Cost is really just going to depend on the number of providers and how in-depth you want to go, whether it's just a regulatory review or red flag report versus a full report and also identifying some of those revenue opportunities or benchmarking against other organizations and how in-depth you want to go there.

Thank you very much. I'm going to ask you a couple of follow-up questions in this on the cost-pender analysis. I mean, more and more, company above a certain size, whether it's a nice-size practice, is it a bolt-on to a platform or a platform transaction, the bankers are going to want you to do a sell-side diligence, a QV report, and that's going to include at least partially some building and coding analysis to make sure that things seem relatively clean and relatively predictable, and people aren't buying a bunch of landmines. When people are shopping for their due diligence, financial due diligence, partner, company, we sometimes look at a suggestion from the banker. But what should people... Two questions. What do you look for in someone who does what you folks do? And second, what are some of the key takeaways for someone considering selling their health care business? Talk to us about those two issues.

Yeah, so I guess I'll take that in two parts here. So I guess first thing, I mean, what to look for in vendors. I mean, you want to make sure they have the expertise that they're specific M&A accountants rather than audit or tax accountants down the street. So you need to You need specific experts in that field. I would say it's also beneficial if the firm that you engage with or the vendor has a network to leverage for deal specific issues. Like take our organization, for example. We've got people who can do a fair market valuation. We've got people who can do the coding, the quality of earnings. We can benchmark physician compensation. A lot of these smaller practices that the doctors are just getting paid based on the EBITDA generation of the business. So going forward, it's going to look a lot different. So they want to make sure that their pay structure going forward is somewhat reasonable for them as well and makes sense. So you want to make sure that the experts that you employ can also assess the reasonableness of some of those software items in a deal process. Also for vendors, you want to look at specific qualifications they may have in the space, specifically.

If it's a big orthopedic group, you want to see that they've done orthopedic deals, either similar geography, similar size, number of providers, had those specialties, have they gone through successful processes and closed deals. So definitely look at qualifications from an experience standpoint. Like I said, you want to make sure that they have the industry experience, that they're familiar with the process, that they know how to work with the investment bankers, the buyers, really be able to add value. So you want to ask the questions around how their team is going to look from a construct standpoint, make sure you've got some higher-level experts as well as your staff-level experts on that team. And then you also just want to make sure that they're flexible enough based on how you want, how you envision the scope of the engagement and that they have the capacity and hit the timing and pricing that you're looking for. I mean, everybody cares about the bottom dollar. So obviously, cost is a standpoint there. I would just say that in general, you don't necessarily want to go with the cheapest bidder. I mean, all those other things I said to look for, you need to take those into account.

But also when you're getting proposals for doing this work, it tends to be an estimate in everybody's billing based on hours and time and materials, essentially. So it's a good question to ask, Hey, for those comparable deals and your qualifications that you've listed, how much Great. You quoted me $50,000, but did you actually get out the door for $50,000 on this very similar business, or was it $200,000? So I would say that's it. You want to make sure you're not getting bait and switched from a vendor as well.

No, 100 %. And take a second. The next question is any overall takeaway for somebody looking to sell their health care business?

Yeah, I would just say, if I was in their shoes, you get one shot to sell a business unless you happen to have a handful of them. So you just want to make sure you maximize the value that you're getting. You're making an informed decision with the best possible information, and then also make sure you're maximizing the likelihood of closing a deal. I mean, everything gets more expensive the longer it draws out. So if you ask most investment bankers, I mean, they'll highly recommend QV as Scott touched on earlier. I mean, it helps attract a more qualified buyer pool. They know that they're They're not going to spend a bunch of money on buy-side diligence for the numbers to shake out completely different. It really does show that there's some effort put into it. You're less likely to encounter obstacles down the road and that the numbers that you're going to market with shouldn't change substantially throughout the bidding process and as a transaction lifecycle progresses. I would say that's super important key takeaway for anybody selling. I would just say have the right experts on your side, especially If accounting and finance isn't your strong suit, make sure you've fully vetted any of your vendors and your investment bankers, make sure they understand your business and really vet them out.

And just don't let an opposing party find an issue before you do. Never looks good. Whether you truly didn't know about it or they think that you were hiding it from them, it's just going to complicate things, prolong the process, not maximize value. In general, I would just say, have all your ducks in a row. Don't go cheap on this stuff. I mean, realistically, I didn't really touch on it before yet, but from a quality of earnings standpoint, we can model pro forma and we can, whether you've added a new doctor who's ramping up or you've got a new service line you're going into, or you're going to build a new operating room, things like that. Those can all be factored into what the go forward business is going to look like and what EBITDA is going to create for a potential buyer. So a lot of times throughout Without these procedures, the goal would be for us to incrementally increase revenue and EBITDA. When you put that on a multiple, a lot of times the benefits tangibly from a financial standpoint, will exceed those costs? So at the end of the day, I think that making sure you get this work done ahead of time will save you time and help the transaction go I'm more in your favor.

Thank you very much. There's so much you said there that resonates correctly. One is the longer transactions take, the better chance they have of getting destroyed, and the more expenses they become, and the more problems they are. Second is this concept of what they call in law is bring out the bad stuff. You're far better off finding an issue and being able to demonstrate that you have a solution and a thought process on it to a buyer, than having a buyer find it and use it as an aha moment to try kill value or destroy the transaction. So much better to bring out whatever challenges there are and not try to hide them. Third is, yes, it's often the case that an efficient, intelligent QV approach can show cleaner earnings That's going to expedite transactions, and so it's going to also help purchase price as well. In fact, many of us, Becker, won't even go to market without a great QV report. Joe, I want to thank you. Joe, tell us your title again at VMG.

I'm a Director of Transaction Advisory.

Thank you so much for joining us today on the Becker's Health Care podcast, Joe. What a pleasure to visit with you. Thank you.

Thanks, Scott.