REPLAY: The Path to Successful Due Diligence in Today’s Accelerated Market
Paul revisits his conversation with Mike Rispoli on due diligence, covering normalization of earnings, quality of earnings, organized records, and tying your EMR to your P&L and bank statements.
Full transcript
Generated from the episode audio and lightly edited for readability.
Good afternoon and welcome to another episode of Paul Martin's crucial conversations. When I tell you this conversation that we had with Mike Rispoli who is our analyst that does a lot of the work involved in getting companies through the due diligence process is important. I am that is not an understatement. This is a really it's very important because what we have seen very recently is based on the fact of rising interest rates, rising inflation, it has caused acquirers to be much more diligent in making sure that what they are buying is exactly what they believe they are buying especially as especially as it relates to your financial performance.
So what I wanted to do today is based on our discussion with Mike is to pull out what I thought were some of the most important areas and kind of dive in on those. One of the things that he talked about that every acquirer that's the first thing they're going to do in due diligence is what's called normalization of earnings and the documentation of that. And this is something that we believe and that we help our clients do before they go even into the market. So that this is nailed and it has to be and it's so important because it will be again the first thing that they will do.
It's called Q of E quality of earnings. It's the first thing that they do in due diligence. So what this strategy in order to make sure that you are getting to that normalization of your earnings, it's your true cash flow, it involves conducting an indepth valuation of your business's finance. So you're evaluating those finances. Normalizing means identifying any what we consider nonrecurring expenses or income that may not reflect the true operating performance of the business. Okay? So, you're scrutinizing your profit and loss statements and identifying any one-time costs or other income sources that may be in your financials that are not usual and customary in this business.
This could include unusual expenses. This could be unusual or revenues that don't apply to the business. Any nonoperational items that aren't part of your regular business operations would also be included of having to be teased out to normalize your financials. And again, by doing this, you're going to present a much more accurate picture of the financial health of your business. I cannot tell you how many times we have been called by potential prospects who have been through either with a company that doesn't really understand physical therapy and how financials are viewed in physical therapy but they say they were dropped during due diligence because their ibida that true cash flow was not what the acquired expected it to be.
We cannot we do not let that happen in deals that we process. Another key thing that you need to do is keep your financial documents such as QuickBooks records, your employee handbooks, healthc care benefits, employee census, and other payer contracts. Keep them up to date and readily accessible. This will help speed up the due diligence process and increase your credibility with potential acquirers. Now we do this on the front end but if you have not done this for a number of years this process can take a long time and in a time that we really want to move fluidly.
So starting this today would be a great and look we can certainly help you with this but getting those books in order today and all your other records in order are really important. Next is what we call internal cons control scrubbing and preparedness. Okay. Now again keep in mind is a former auditor. Okay. So he did for a large company he did financial audits on large companies. And once you go through those financial audits the news is not only always good to those who are being audited but we want good news for our clients.
And one of the challenges that arise during a due diligence process is simply a lack of organization and preparedness. So again, having a solid system in place that you have keeping your documents very organized will make the process smoother and more efficient. And let me tell you, in this current industry, if it's not smooth and efficient, you go to the bottom of the line. Next is you want to organize and clean up your internal records. This involves reviewing and updating your contract agreements, your employee records, other documentation relevant to your business operations.
By doing this, you're going to significantly reduce the risk of potential pitfalls that can come up during a due diligence process. And then last, you know, be prepared to provide complete access to your financial records. And in many cases, that's done in QuickBooks. QuickBooks Online is what we recommend because you can then literally give us and or a potential acquirer access to your QuickBooks. And if they're done right, you you're clean. You're you're in good shape. You could also be prepared by creating a backup file, providing login details then to us and the acquirer, ensuring that potential buyers cannot edit any information.
And again, before providing any access, carry out some maintenance on your records to ensure that everything is in good order. And again, you might say, "Whoa, whoa, we're giving access to our QuickBook records to you guys and maybe to an acquirer." companies that do that, the due diligence process goes much more efficient, much smoother, and keeps that train rolling towards a closing. So, how can you be fully prepared for due diligence? Well, look, we everything that we're going to do, everything that you're going to do, in some respects, you probably can never be a thousand% prepared for due diligence.
It does seem as though each and every company comes up with a different request than those others. But first and foremost, we want to make sure that you have a deep understanding of your business from the financial perspective as well as operations. This includes literally tying your bank statements to your financials, understanding all of your payer contracts and knowing the human resources side of your business as well, including all of the benefits package. So, we go through all this with you, making sure that we understand it as well as you understanding it.
We want to make sure that you organize and maintain reports. Have all your reports organized, easily accessible, and this includes historical documents of your payer contracts, leases, as well as any debts or any leans on your business. Then finally, you want to engage expert help. Okay? You want to seek out professionals who understand the due diligence process. M&A experts with rehab experience can guide you through this if in fact they have somebody that knows and understands what acquirers are going to be looking for. You know [sighs and gasps] finalist the final thing we're going to talk about is the financial preparation and analysis that we absolutely are going to implore that you do.
Again we talked about this. You got to normalize those earnings. You want to you want to be aware of any discrepancies in your financial reports. For example, if you're physical therapist, if you're a physical therapist paying yourself significantly more than the market rate, so you're an owner, you're a physical therapist, you're paying yourself significantly more than your market rate. You need to normalize that for a buyer down to what the market rate would be. You don't take your entire salary out, especially dependent upon your role.
If you're treating therapists, if you're a direct manager, that salary has to stay in. And again, if this is all confusing to a buyer, it's going to cause them to take a step back. You want to make sure that you have accurate financial reporting ensuring that the IBITA, that's the earnings before interest, taxes, depreciation, amortization, the true cash flow is accurate and can stand up to any and all scrutiny. This is the area that we find companies that have done this on their own or have used folks that really don't understand the rehab industry get into a lot of trouble.
Again, if you've overstated your earnings, it's going to end up decreasing the value of your company exponentially. It doesn't always just decrease it based on the value that it comes in because now an acquirer is very tuned in to what else is in there that may not be accurate. And finally, we are now advocating for our clients that they tie out your EMR that ties to your profit and loss that ties to your bank statements. This is a process that we are finding now many of the folks that people are hiring to do due diligence are actually doing.
You're saying, "Wait a what does my EMR have to do with my P&L have to do with my bank statements?" Well, they all tie together and there are some timing discrepancies, but in the end they should all tie together and that's very important that they do. So, if you're today considering that at some point in time you might want to take your bit, it could be five years away, three years away, one year away or one month away. This is the time to have that assessment.
You know, you can call it an audit, but have that assessment done on your operations, your financials, and everything about your business and to look at your business as how acquirers would look at your business and where you would rate today if you were going through a due diligence process. If you're asking yourself those questions and you would like to talk to me about how we can get started on helping you to get your business prepared for the most crucial the most excruciating due diligence. Click below and let's talk.
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