Due diligence is often perceived as a mundane part of the mergers & acquisitions (M&A) process, but its importance in healthcare transactions is critical. Due diligence is one of the first steps of any transaction and involves a buyer undertaking an in-depth examination of the target to evaluate the business and uncover potential issues or liabilities. In the healthcare industry, diligence is especially important considering the heavy regulation of the industry, the unique areas of risk, and the significant liabilities that could be imposed upon a buyer if issues and liabilities are not identified before the transaction closes.

Some of the unique areas of risk in healthcare deals, and how to evaluate them in the due diligence process, are provided in the chart below.

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Recent transactions demonstrate the importance of due diligence in healthcare. For example, as part of due diligence, several hospitals that discovered physician contracts potentially violating the Stark Laws have self-disclosed and settled matters with the federal government as part of the closing. Some of these settlements exceeded $30 million, which is a liability the purchaser was able to avoid by conducting due diligence.

In light of the foregoing and the unique considerations in healthcare transactions, it is particularly important to customize your due diligence request list to expressly include the items listed above. That is, buyers beware of the form due diligence request list – it’s not going to work for your healthcare deal. It is also important to understand that if a material compliance issue is uncovered in diligence, the target may be required to self-disclose the violation to the government – which can be fatal to a transaction.

Finally, in addition to typical buyer due diligence, it is becoming increasingly common and recommended that sellers undertake a “defensive due diligence” well in advance of a transaction in order to proactively review the business for compliance with fraud and abuse laws. This allows sellers to address issues up front and best position the company for a more efficient transaction.