02 Apr Selling a Healthcare Technology Company: A Case Study
At the Austin Dale Group, we work with owners of privately-held technology businesses to grow and realize optimal value for their businesses. Entrepreneurs often ask us how the sale process works and what they need to do to make sure their company is in the best position when they get ready to sell.
To give entrepreneurs a real-world perspective we have documented this recent example of selling a healthcare technology company.
Company Background
DataWing Software grew out of a consulting engagement conducted by the owner, Jerry Porter. A healthcare industry client asked Jerry to develop a custom software application to manage eligibility data for patients. The system reconciled eligibility data from insurance carriers with medical groups’ internal systems to allow for managed synchronization. Recognizing a broader opportunity, Jerry converted this custom solution into a series of products that serve data management needs for the healthcare industry.
Over twenty years, Jerry’s business grew, steadily adding new customers, products, and features. He expanded his staff and operated a successful business with consistent profitability and satisfied customers.
Owner’s Objectives
Having reached his early 60’s, Jerry decided that it was time to retire from DataWing. He wanted to find a buyer who recognized the value of his business, would provide quality support for his customers, and could offer good opportunities for his employees.
After talking with several M&A advisors, Jerry selected the Austin Dale Group to help him sell his company. He chose ADG because of our understanding of both technology and healthcare, and our experience conducting transactions of this type.
Preparing the Company to Go to Market
The first step is a comprehensive review of the business. ADG looks at all aspects to identify strengths, weaknesses, and any issues that could derail a deal.
Our review confirmed that DataWing was indeed a solid company. However, as with most companies, there were differences in what was needed to run the business and what would be needed to successfully sell the company.
In the case of DataWing, the biggest difference was in financial reporting. DataWing financial statements were reported on the cash basis. Most M&A transactions are conducted on an accrual basis, requiring financial statements be prepared using Generally Accepted Accounting Principles (GAAP).
Additionally, DataWing used Quickbooks and a custom-developed software application to support its operational accounting functions. The custom software gave DataWing great flexibility in its internal processes but presented challenges when it came to GAAP-based reporting.
ADG worked closely with Jerry Porter and his outside accountant to recast DataWing’s financial statements on the GAAP basis that was needed for the sale. This conversion required several weeks of work by all parties.
Once the financials had been recast, ADG developed a set of marketing materials to attract prospective buyers. The principal documents were an anonymized “Teaser” document that provided a high-level summary of the business and a comprehensive Confidential Information Memorandum (CIM) that provided the details a prospective buyer would need to make an offer for DataWing. The CIM was provided only to qualified prospects who signed non-disclosure agreements (NDA).
Marketing the Company
From our extensive experience in the healthcare market, Austin Dale Group compiled a list of several hundred potential buyers for DataWing. This list also incorporated contacts that had previously reached out to DataWing regarding a potential sale.
With the blessing of Jerry Porter, we contacted prospective buyers about the opportunity and provided the Teaser document to spur interest. We also posted the company on several Internet listing sites.
We found a significant amount of interest for a couple of reasons. Healthcare is a relatively hot M&A segment and the business Jerry had developed was well-positioned to support changing reimbursement models in healthcare.
Managing Competitive Offers
Our sales process resulted in a competitive interest in the company from multiple buyers. Interested parties included private equity, strategic acquirers, and high-net worth individuals. Given the level of interest, we were able to aggressively pare down the list to the strongest buyers. This allowed the seller to be more selective and ultimately yielded a better price and terms.
Negotiating a Letter of Intent
Over a period of several months, we focused on two strategic buyers, with a further list of backup prospects. The relative strengths of the offers from the two bidder “finalists” provided the opportunity to leverage up the terms and valuation to the best outcome for the seller.
In the end, we chose the bidder who was in the strongest financial position and could execute the deal quickly. The Letter of Intent (LOI) outlined the high-level terms of the deal, including the assets to be included in the sale, the valuation, and an earn-out for the seller, based on revenue after closing realized by the company. We worked closely with the seller, his attorney, the buyer, and their outside counsel to ink the LOI.
Managing Due Diligence
The Due Diligence process can be tedious and time consuming for all parties, and it can involve a surprising number of participants. In this case it included the seller, certain key employees of the seller, the seller’s attorney, the seller’s accountant, the buyer’s business representatives (executives, sales, finance, product, human resources), the buyer’s parent company’s M&A team (Private Equity), the buyer’s attorneys, the buyer’s outside accounting team, the buyer’s outside HR and benefits consulting team, and ADG as the seller’s advocate and representative.
For a seller, the number of parties involved, and the amount of information involved, can be daunting. In this process, ADG’s job was to filter and prioritize the requests, rationalize the process, and protect the seller.
Findings during the due diligence process can have a material impact on the deal (generally negative vs the LOI) and can kill a deal, in the worst case. The best rule of thumb is to disclose any material items early, prior to the negotiation of the definitive sale agreement. Negative surprises late in the deal negotiation almost always delay the deal and impact trust between buyer and seller.
In this deal, the biggest thing that came out of due diligence was a complication related to the nature of the business that DataWing conducted. Some of the third-party data sources that DataWing used made periodic changes which impacted availability of the data needed by DataWing’s customers. These issues were in the normal course of business and beyond DataWing’s control. DataWing had always worked in good faith with their customers, offering credits to customers until the data sourcing issues could be resolved.
While these credits built a strong degree of trust between DataWing and its customers, they introduced a degree of risk into the financial performance projections, post-acquisition. There was a lengthy negotiation on additional terms in the agreement until a compromise was reached that was satisfactory to both parties.
The buyer also elected to hire an independent national accounting firm to do a Quality of Earnings (QoE) review, which is becoming more common for mid-market deals. This was a rigorous process that entailed a deep dive into DataWing’s accounting records and a significant amount of work by the Seller with support from the Seller’s accountant and Austin Dale Group. The preliminary work that had been done to recast the financial reports on the GAAP basis proved crucial in supporting this effort. The independent QoE report validated the work that had been done in preparation for sale and gave the buyer added confidence in the value of DataWing Software.
Negotiating the Definitive Agreement
As discussed above, the definitive sale agreement is generally negotiated in parallel with Due Diligence. Findings in the due diligence process can have a material impact on the final agreement terms and valuation.
There is a classic conflict in this process, in that the buyer doesn’t want to commit themselves to detailed terms until they get further along in the due diligence process, but they typically also have time pressures and want to close the deal quickly once due diligence is complete.
On the other hand, the seller needs time to review the definitive agreement in depth with attorneys, accountants, tax advisors, and others, so the seller wants to see the agreements early in the process. The compromise usually means that there is considerable back-and-forth and piecemeal review. Some critical disclosures (e.g. up-to-date financial performance) cannot be made until the last minute, leading to stress on all parties.
The most important thing is to build trust and open dialogue among the parties early in the process and maintain it through the ups and downs of due diligence and final deal negotiations. We work to avoid surprises which can erode trust and create contention.
In the DataWing deal, the biggest issue was to address the perceived need for down-side protection by the buyer’s financial advisors, resulting from the nature of one aspect of DataWing’s business. Negotiating mutually agreeable deal language to address this issue added several weeks to the negotiation process.
Closing the Transaction
Closing a transaction is all about timing and coordination. Legal, financial, communications, and human resources all must be synchronized to affect the transfer of ownership. While every transaction is different, there is always some type of last-minute complication that injects a bit of stress and causes all parties to sigh with relief when the transaction is closed. With DataWing Software, the last-minute complication was the need for formal releases from DataWing’s customers for the transfer of their contracts to the buyer.
Some customer contracts require an explicit release from the customer before they can be transferred to a new owner or servicing entity. For other contracts, a release may not be formally required, but some buyers consider it a good practice to reduce their risk of post-close issues with customers.
A further complication is that the seller doesn’t want to reveal the transaction to customers and seek these releases until it is certain that the deal will close. At this point in time both the buyer and seller are ready, even anxious, to close the deal, but they need to wait for explicit releases to be signed by customers.
These releases often need to be reviewed by legal counsel for the customers and reviewing and signing a vendor change of control release document is rarely the top thing on their priority list. Each individual release can require negotiation between the seller, buyer, and customer before exact wording can be finalized.
After both the buyer and seller exhibited a considerable amount of patience in obtaining these releases from customers, we were able to close the sale of DataWing Software.
Both buyer and seller felt that they got a good deal and still had a cooperative and collaborative spirit which would be valuable in addressing any post-close issues which could arise.
Key Take-Aways for the Entrepreneur
- Selling a company can be a lengthy and complex process with numerous potential pitfalls. Engaging competent, experienced advisors can help to avoid pitfalls.
- Selling a technology business requires more specialized skills and experience than selling a Main Street business. Understanding the business by the advisors is often crucial, as buyers are larger, sophisticated national or international entities.
- Adherence to GAAP financial reporting standards will generally reduce transaction costs and speed up the deal process.
- In the due diligence process, be prepared for an intense period with high demands. Avoid scheduling vacations or other time-consuming parallel activities during this period.
- When negotiating contracts with customers, vendors or partners, particularly long-term renewable contracts, keep in mind that you might want to eventually sell the company. Make sure that those agreements have change of control provisions and give a potential acquirer enough flexibility to address changing circumstances.
