Strategy & Due Diligence: Best Practices In Partnerships & MergersMARCH 1, 2018 | 1:00 PM – 2:00 PM ETJOSEPH P. NAUGHTON-TRAVERS, SENIOR ASSOCIATE, OPEN MINDS

Introduction and HousekeepingHousekeeping:

• Slides are posted at MCTAC.org

• Questions not addressed today will be: • Reviewed and incorporated into future trainings and presentations

• Added to Q&A resources when possible

Reminder: Information and timelines are current as of the date of the presentation

What is MCTAC?MCTAC is a training, consultation, and educational resource center that offers resources to all mental health and substance use disorder providers in New York State.

MCTAC’s Goal Provide training and intensive support on quality improvement strategies, including business, organizational and clinical practices to achieve the overall goal of preparing and assisting providers with the transition to Medicaid Managed Care.

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About Our PresenterJoseph P. Naughton-Travers, Ed.M., Senior Associate, has more than 30 years of experience in the health and human service field. Joe brings to OPEN MINDS a broad range of experiences in private and public sector delivery of behavioral health and social services.Since joining OPEN MINDS, Mr. Naughton-Travers has developed business solutions for provider and professional organizations, state and county government, technology companies, and venture capital firms. His primary areas of expertise include strategic planning and metrics-based management, electronic health record (EHR) and technology selection and implementation, operations improvement, and corporate compliance. For the past decade, over half his consulting practice has focused on aiding organizations in technology selection and implementation, including all aspects of strategic technology planning, functional specifications development, request for proposal development, vendor selection, and contracting.Mr. Naughton-Travers received his Bachelor’s degree from Miami University of Ohio and his Masters’ of Education in Counseling Psychology from Boston University.

AgendaA. Aligning Partnership Choices With Organizational

StrategyB. Finding The Right Partner: Organic & Planned

ApproachesC. Completing An Effective Due Diligence & Partnership

Analysis ProcessD. Sample Partnership Analysis MaterialsE. Final Thoughts

A. Aligning Partnership Choices With Organizational Strategy

Strategic Planning & Management In Today’s Healthcare Environment

1 • Develop vision of future competitive advantage and market positioning

2 • Scenario-based strategic plan incorporating alternate future positioning options

3• Detailed plans – marketing, financial, operational, I.T., capital, HR, etc. – to implement strategy

and future vision

4• Key performance metrics and metrics-based management to track strategy implementation,

and allow for mid-course adjustments

5• Optimization of current operations to keep current programs as competitive (and profitable) as

possible for as long as possible

6 • New service model development to support future vision

7 • Collaborations and partnerships as needed to facilitate new market vision

Key Questions For Long-Term Strategy

• What do we want to do for consumers? • How do we want to be viewed from an internal and external perspective?• What are we currently doing that is not being conveyed?

Mission

• Where do we fit in the current and future service system?• Where do we fit in the current and future reimbursement system?• What does the long-term (future) look like for us?

Service Delivery

• How do we address competition?• Is our proposed price attractive compared to the competition?• Do we have superior ‘performance’ – for consumers and payers?• Is our marketing model attractive – in terms of convenience, rate structure,

service features, etc.?• Do we have an attractive brand?• Will consumers choose us?

The “Reality Check”

Market Drivers For Provider Partnership & Consolidation‣ What’s driving the push for provider partnerships and

consolidation in today’s marketplace?• Preference for service delivery models that focus on the integration of

primary care and behavioral healthcare and coordination of services for complex consumers

• Reimbursement models focused on value-based payment methodologies

• Increased use of competitive bidding and selective contracting by payers

• Consolidation among health plans and health care systems creates new competitive pressures in the rest of the health and human services market

• Providers looking for economies of scale and greater financial strength to support investments in infrastructure, staff, and development

In Particular, Mergers & Acquisitions Are On The Rise in Healthcare!‣ Healthcare M&A activity

exploded in 2015• 14% growth in total health care

activity – from 935 transactions in 2014, to 1,498 in 2015

• 58% growth in behavioral health care – from 24 in 2014, to 38 in 2015

• 104% in managed care – from 22 in 2014, to 45 in 2015

Consolidation has been seen by many CEOs as a strategy

necessary for long-term survival given the changing environment in health and human services –

including more value-based reimbursement, more managed

care, and decreased funding.

The Benefit Of Economies Of Scale‣ Economies of Scale: The phenomenon that production

becomes more efficient as the number of goods being produced increases.

• Larger organizations have the ability to lower their cost per unit – thanks to the ability to spread their overhead expenses over a larger number of units.

• However, organizational size doesn’t matter without strategy – there are many models that can achieve economies of scale, but your path to partnership and collaboration needs to be part of an overall long-term sustainability strategy.

“There is nothing so useless as doing efficiently that which should not be done at all.”

P t D k

Partnership & Consolidation As A Strategic Issue

Doing more of a service that is losing money won’t necessarily make it profitable. •Being bigger in this instance is only useful if it’s part of a strategy to reduce service cost or gain market clout to raise pricing. If the size doesn’t come with enough economies of scale to reduce the effective cost of service, the strategy won’t work.

Adding services and programs unrelated to your mission could result in more problems for marketing and management. •Being bigger can’t only be about a number. Some organizations in the field are big but not sustainable because they are diversifying without a strategic plan.

Increasing size may negatively impact the ability to innovate or adapt. •Being bigger has a disadvantage – big is rarely nimble. Larger organizations can be slow to change course, and in a market filled with policy changes, technology innovations, and shifting payment and service delivery models – the ability to adapt is a necessity.

B. Finding The Right Partner– Organic & Planned Approaches

The ”Organic” Partnership Process‣ These are opportunities that present themselves, not the

result of a formal search process. For example:• Other providers actually seeking to be acquired contacting your

organization.• “Failing” providers who may not be able to continue to operate

services.• CEO retirements leading the board of directors to consider

mergers.• Geographic factors pointing to likely partners in the market. ‣ While the opportunity may be organic, rather than a formal

search process, the strategic, vetting, and due diligence process should be the same.

The Planned Partnership Process‣ This is a formal process of defining the criteria for the

partner and then seeking out providers that fit that criteria. Typically, this may include:

• For-profit versus not-for-profit organizations• Size in terms of revenues• Geographic location(s)• Service lines• Clinical specialties and expertise• Key contracts, provider numbers, licenses, etc.‣ It is a very active process of seeking potential partners,

vetting them, and proceeding with the partnership process.

Step #1: Identify Partnership/Merger Candidate Organizations‣ What is the profile of an ideal provider for consideration for

a partnership/merger?• For-profit or not-for-profit• Size in terms of revenues• Geographic location(s)• Service lines• Clinical specialties & expertise• Key contracts, provider numbers, licenses, etc.‣ Identify provider organizations that meet the target criteria.‣ Determine how to approach and contact target

organizations.

Step #2: Initiate Discussions With Target Organizations (”Dating Phase”)‣ Non-disclosure agreements are usually signed.‣ May have agreement of ‘exclusivity’ for a specific time

period during this dating phase.‣ Key objective is to determine if the merger is a

reasonable possibility for both organizations.‣ This Dating Phase should not go on forever. The

parties should be able to determine whether or not there is a likely fit within months, not years.

Merger Deal Breakers: Three Key Issues

Chief Executive Officer• Who will be the surviving CEO?

Name• What will be the name of the surviving organization?

Board of Directors• What will the composition of the board of the merged

organizations?

Step #3: Signing The Letter Of Intent To Merge (“Engagement Phase”)

At this point, the executives and board of directors have agreed to a merger pending the due diligence process.

The Letter of Intent usually includes key areas of agreement and a specific time frame to complete the due diligence and make a final decision to execute the merger.

Step #4: Conducting Due Diligence(“Investigation Phase”)‣ This is the phase where a thorough due

diligence is conducted and documented.‣ There are two key goals here:• Ascertain that there are no problem areas that

would make the merger/acquisition a bad idea.• Determine financial feasibility of the merger/

acquisition.‣ Typically, this due diligence process can be

completed in 60-90 days.‣ The complete findings of the due diligence process should

be presented to the executives and boards of directors so a final decision can be made about where to proceed with the merger/acquisition.

Step #5: Develop & Execute The M&A Agreement (“Pre-Nuptial Phase”)

At this point, the executives and board of directors have agreed to a merger pending the due diligence process.

The Letter of Intent usually includes key areas of agreement and a specific time frame to complete the due diligence and make a final decision to execute the merger.

Step #6: Implement The Merger/Acquisition (“Marriage Phase”)‣ The final steps are to actually complete the

merger/acquisition and move on the all of the steps of integration.

Benefits Of A Merger

Increase financial strengthContinuation and/or

expansion of programs and services

Integration of services Reduced operational costs

Reduced donor fatigue with fewer organizations

asking for moneyThe opportunity to rebrand

Expansion of geographic/demographic

reachElimination of a competitor

for funding

Elimination of perceived duplication of services

Address delivery weaknesses

Open the door to new ideas and innovation

Risks Of A Merger‣ Negotiations may ultimately fail‣ Merged organizations may

prove incompatible, never achieving successful integration

‣ Cost savings may never actually materialize

‣ Tensions between leadership and personnel may never subside and eventually will interfere with operations

‣ The public, constituents, and donors may have a negative reaction

4. A tendency to look at mergers reactively, as a way out of financial or leadership problems – instead of

proactively, as a growth and positioning strategy

3. A failure to find the right partner to merge

2. A lack of funding for due diligence and post-merger integration

1. A lack of knowledge about how to approach, plan, and implement mergers

Top 4 Reasons Why Mergers Fail:

Key Merger/Acquisition Questions To Consider‣ Is your organization looking to acquire or

be acquired?‣ Does the potential partner organization fit

with/support our mission? ‣ Do I have a strategic reason for this merger

or are we growing for growth’s sake? ‣ Have we done our homework on the other

organization? ‣ What will we gain toward the

accomplishment of our immediate and long-term goals?

‣ How will a merger be perceived by the public, our financial supporters, payers, and consumers?

More Questions‣ Can we afford the acquisition or merger? How will it be

funded? ‣ Will the combined organizations have the resources to

address the needs of both organizations?‣ Is my board fully bought into this and willing to

actively participate?

C. Completing An Effective Due Diligence & Partnership Analysis Process

Key Components Of The Due Diligence Process

Company Information

Financial Information

Administrative Operations

Clinical Operations

Company Information1. Review Articles of Incorporation and other

corporation documentation.2. Review complete Chart of Organization,

including salaried FTE’s and independent contractors.

3. Review Balance Sheet to identify key assets and liabilities.

a) Review documentation on key assets.b) Review documentation on key liabilities, including loans.c) Review bank accounts and bank statements for previous twelve months.

4. Review documentation regarding any business relationships, joint ventures, or other contracts.

5. Review leases for property and equipment.

Company Information6. Review and investigate any pending,

threatened, or completed litigation that has occurred in the past five years.

7. Review any consent decrees, judgments, other decrees or orders, settlement agreements, and other agreements to which the organization is bound.

8. Review all payer contracts.9. Review a listing of all officers, directors, or other key

employees and related resumes and employment history with company, including any key employees who have left the company in the past two years.

10. Review the details for any intellectual property, including any patents, trademarks, copyrights, etc.

Company Information12. Review a list of insurance coverages in force

(e.g., business interruption, directors and officers, fire or casualty, extended coverage, general liability, motor vehicle, professional liability, unemployment compensation, etc.), including names of carriers, brokers, description of coverage, amounts of coverage, amounts of premiums, expiration dates, and significant conditions and benefits. Review details of any major claims or losses in past five years.

13. Review all information and correspondence regarding compliance with federal, state, or local environmental laws and regulations (including permits, permit applications, notices of violation, etc.).

14. Review any business, operational, or strategic plans.

Financial Information1. Review monthly P&L statements for the past

two years, including comparison of budget to actual data.

2. Analyze revenues and profit/loss by service line for the past two years.

3. Review most recently prepared budget.4. Review M&A overhead expense percentages for the past

two years as well as process for allocating overhead expenses to programs.

5. Review a list of all payers as well as the top ten payers in terms of total net revenues for the past two years.

6. Review all federal, state, and local tax returns for the past five years.

Financial Information7. Review any pending or previous tax issues

that have occurred in the past five years (such as audits, extensions, penalties, etc.).

8. Review summary aged trial balance of the accounts receivables.

9. Review or calculate cash flow budget for the next 12 months.

10. Review inventory of all equipment and other assets.11. Review current accounts payable listing.12. Review process for accruing liabilities, including process

for calculating bad debt reserve for the accounts receivable.

Financial Information13.Review a listing of all capital expenditures

made in the past two years.14.Review all outstanding debts and terms.15.Review documents of title for any property

owned.16.Recast financial statements for the past two years, if

needed, to adjust for any corrections or other changes to more accurately reflect profit/loss, based upon due diligence findings or other issues.

Administrative Operations –Finance1. Review any policies and procedures for all

key areas of finance:a) Accounting & auditb) Billingc) Purchasingd) Accounts Payablee) Payroll

2. Review process for tracking, reporting, and billing services.

3. Review billing and collection processes and staffing.4. Review private pay policies and processes, including

any sliding fee schedules.

Administrative Operations –Finance5. Review accounts payable vendor listing,

including total amounts paid to all vendors over the past two years. This should include a review of total payments in the past two years to any independent contractors.

6. Review payroll listing, including total amounts paid to all employees for the past two years.

7. Review information about any tax advisors or accountants and any related professional services agreements.

8. Review reports from any independent audits conducted in the past five years.

Administrative Operations –Human Resources1. Review any policies and procedures related to human

resources.2. Review employee manuals or handbooks.3. Review all HR related forms and documentation for:a) Hiring employeesb) Evaluating employeesc) Disciplining employeesd) Terminating employees

4. Review any employee agreements, collective bargaining agreements, severance agreements, compensation agreements, or other similar contracts.

Administrative Operations –Human Resources5. Review all job descriptions.6. Review history of any employee or labor complaints

or grievances for past two years.7. Review history of worker’s compensation claims paid

out in the past two years.8. Review staff turnover rates by position for the past

two years.9. Review details about any bonus or

compensation plans and payment amounts for the past two years.

Administrative Operations –Human Resources10.Review any confidentiality or non-compete

agreements.11.Review any loan agreement with employees.12.Review benefits packages, including detailed review

of insurance plans and contracts, retirement plans and contracts, profit sharing or stock option contracts, etc.

Administrative Operations –Quality & Compliance1. Review any quality management plans and

processes.2. Review corporate compliance plans and processes.3. Review policies and procedures for technical and

quality audits of consumer medical records.4. Review findings and action plans from quality and

compliance audits from the past two years.5. Review details of any critical or unusual incidents for

consumers served in the past two years.

Administrative Operations –Technology1. Review listing of all technology assets owned or

leased, including personal computers, servers, mobile devices, telephones, etc.

2. Review list of key software applications in use.3. Review technology infrastructure.4. Review any technology equipment, software, or

service contracts.5. Review all technology related policies and

procedures, including those related to ensuring privacy and confidentiality.

Clinical Operations1. Review policies and procedures related to medical

records.2. Review all medical record forms, including all

assessment, treatment planning, service documentation, and discharge forms.

3. Review processes for accessing psychiatric and medication services.

4. Interview clinical leadership to discuss treatment philosophy.

5. Conduct a select audit of medical records to assess the clinical and documentation quality.

Other Key Due Diligence Tasks

Merged organization chart

Integration plan for service lines

Merged board of directors

composition and leadership

Three-year merged organizational

financial statements

D. Sample Partnership Analysis Materials

Sample Financial Ratios for Comparison

Ratio Analysis Lifeskills Definition Target6/30/2014 6/30/2015 6/30/2016 6/30/2017

Current Ratio1.8 1.8 2.3 2.2

Current Assets/Current Liabilities - identifies how many dollars of current assets are available to

cover each dollar of current liabilities

Greater than 1.0, ideally 1.5 - 2.0

Quick Ratio 1.8 1.7 2.2 2.1 Cash+Marketable Securities+Accounts Receivable/Current Liabilities

Greater than .70, ideally greater than 1.0

Days Cash On Hand53 67 69 85

Cash+Short-term Investments/Daily Cash Required - identifies how many days of cash are

on to cover current cash expenses

60 - 90 days

A/R Turnover Ratio5 4 6 5

Annual Revenue/(Average Accounts Receivable) - assesses revenue cycle effectiveness

Varies based on organization and

industryDays of Revenue Outstanding 70 93 59 75 365/A/R Turnover Ratio - assesses revenue cycle

effectiveness30 - 60 days, industry

average of 42 days

Accounts Receivable Aging24% Over 180 Days

A/R arranged by categories of current, 30 days, 60 days, and over 90 days past due - assesses

revenue cycle effective beyond ratio averages, and specific payer issues

Varies based on organization and

industry

Debt Ratio 0.4 0.5 0.3 0.3 Total Liabilities/Unrestricted Net Assets - reflects leveraging of net assets for growth

Less than 2.0

Self Sufficiency Ratio100.3% 103.1% 102.7% 103.1%

Total Earned Income (Revenue)/Total Expenses - assesses capacity of operating revenue to cover

operating expenses

Greater than 100%, ideally greater than

103%

Net Operating Profit Ratio2.6% 3.4% 3.1% 3.0%

Income From Operations/Operating Revenue - assesses all operating income compared to

operating expenses

3.0% - 5.0%

M&G Percentage

6.7% 6.9% 7.8% No Data

Management & Administrative Expenses/Total Expenses - indicates level of management and adminstrative staff to manage the organization

(administration, accounitng, HR) Under 25%

Sample Organizational Operational Summary

Strengths & Opportunities

• A significant portion of the organization is fully CARF accredited which translates to effective business and service processes

• Current strategic plan identifies the need to improve the efficiencies and productivity within the agency, including more efficient workflows

• Well developed service continuum with good examples of taking advantage of available funding to expand services

Weaknesses & Threats

• Current EHR has been very difficult to implement with continuing payment obligations

• Current managed care contract rates create a market disadvantage

• Struggling with sufficient psychiatry/prescriber availability-Medical leadership limited

Sample Organizational Financial Summary‣ The following points are based on the analysis of data

provided prior to February 1, 2018:1. Key indicators reflect an adequate level of operating

cash and a consistent operating profit through FY 2017.2. FY 2017 indicates a drop in operating profit through the

fiscal year to date, however it is still positive.3. Days of revenue outstanding at June 30, 2017 is high

(around 60-considering a goal of 30 – 45 days), but down significantly from 93 days at June 30, 2016.

Sample Three-Year Projection Assumptions

Statement of Activities FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 FY 2019 FY 2020

RevenuesPre-Merger Operating Revenue 76,175,055$ 80,193,397$ 86,441,069$ 91,977,506 94,467,718 94,467,718 94,467,718

Merger Revenue Synergies Implementaton of Lifeskills Rates 94,869$ 376,383 376,383

Post Merger Operating Revenue 76,175,055$ 80,193,397$ 86,441,069$ 91,977,506$ 94,562,587$ 94,844,101$ 94,844,101$

ExpensesPre-Merger Operating Expenses 74,666,319$ 78,631,920$ 85,054,412$ 89,890,311 94,267,718 96,435,876 98,653,901

Merger Expense Synergies Combined Positions (119,843) (475,463) (486,399) Employment Organization Strategy (472,444) (1,405,779) (1,405,779)

Post Merger Operating Expenses 74,666,319$ 78,631,920$ 85,054,412$ 89,890,311$ 93,675,431$ 94,554,633$ 96,761,723$

Net Operating Excess (Deficit) 1,508,736$ 1,561,477$ 1,386,657$ 2,087,195$ 887,156$ 289,467$ (1,917,622)$ Net Operating Excess % 2.0% 1.9% 1.6% 2.3% 0.9% 0.3% -2.0%

Historical Projected

Sample Geographic Coverage Of Merged Organization1. The new organization will provide services in 20

counties.2. Current clinical coverage are clinics in 20 counties

(Organization One - 4 counties, Organization Two - 16 counties).

3. The two largest population centers are located in the middle of the cluster of counties currently serviced.

4. All twenty counties have some teleconference capacity to provide services

Current Services Of A Merged Organization‣ Both organizations have a full continuum of crisis and

intake services, including crisis stabilization• Organization One has a fully operational single point

of entry program. Organization Two is still developing their program.

‣ Both organizations have a full continuum of behavioral health services for adults and children.

• Most of Organization One’s services are fully CARF accredited

‣ Both organizations emphasize ACT models of care.‣ Organization One has a full continuum of ID/D services

Sample Merger Operational Analysis Summary

1. There are two different electronic health record systems in use. -Will need to move to a single system to improve communication.

2. Purchasing and contracting protocols that can maximize the benefit of economy-of-scale with both supplies and services will need more in-depth exploration. Example: Purchase of employee health benefits

3. Consistency of protocols for all internal business and clinical processes -both organizations have identified the need for improvements in these workflow areas.

4. Currently, both organizations have limited capacity to assign leadership to address new initiatives. Any partnership will need to address the most efficient staff levels in all administrative levels to complete the necessary tasks effectively and address new opportunities such as improving marketing and payer relations.

Each organization has operational strengths that will benefit the other. The key items that will need to be addressed are:

Sample Partnership Analysis Options1. A full merger taking on a single corporate name, single

governance board, and single executive team.• A negotiated acquisition that will address the needs of both parties.• Maintaining the mission, while also planning for market changes.

2. A selective partnership with agreements to work together for selective business and contracting opportunities.• Purchasing supplies, possibly health care coverage.• Contracting any new managed care opportunity.• Developing new business.

3. No partnership at this time.• Reconsideration at a different time.• Look at other options.

E. Final Thoughts

#1 Strategy matters!‣ The New York State public behavioral

health system is undergoing rapid and monumental changes in the coming years.

‣ Your organization must have a current strategic plan that carefully evaluates internal and external factors and then results in high-level objectives and an action plan.

‣ This should include a clear picture of your market-positioning – where your organization will fit into the New York healthcare landscape in 2-5 years.

#2 Explore Partners & Partnership Options‣ Your strategic planning process will help you identify if

you need or could benefit from partnerships with other health care providers.

‣ Clarify what partnership option or options make the most sense for your organization.

‣ Determine what potential partners to approach and how to approach them.

#3 Be Thorough About Due Diligence & Execution‣ Formal and thorough due diligence is during the

partnering decision-making and planning process. This is particularly critical for the mergers/acquisition end of the partnership models continuum.

‣ Once a decision to partner (in whatever form) has been made, execution of the partnership arrangement must be carefully planned and monitored to ensure success.

Questions and Discussion

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