Medical M&A Due Diligence: Key Checklists for Legal, Financial, and Labor Aspects

To ensure the success of a medical M&A, it is essential for the acquiring party to accurately grasp the target company’s value and identify potential risks in advance through “due diligence (DD)”. The medical industry, in particular, has many unique issues such as licenses, medical fee claims, medical malpractice insurance, and labor problems. This article systematically explains specific due diligence checklist items for medical M&A from legal, financial, and labor perspectives, supporting smooth M&A execution. By collaborating with experts and conducting comprehensive DD, let’s facilitate post-M&A business integration and maximize return on investment.

1. Purpose and Importance of Due Diligence in Medical M&A

Due diligence (DD) in medical M&A is a process where the acquiring party meticulously investigates and analyzes the target company’s assets, liabilities, rights, business operations, and management status in an M&A transaction. Its main objectives are as follows:

1. Risk Identification and Assessment: Preemptively discover risks that may materialize after the M&A is completed, such as legal violations, litigation risks, unpaid debts, and risks of license revocation, and assess their impact.
2. Verification of Enterprise Value Calculation Basis: Validate the appropriateness of the target company’s financial statements and business plans to confirm whether the presented enterprise value is fair.
3. Formulation of Post-M&A Integration Plan: Based on the information obtained through DD, concretely formulate plans for post-M&A organizational integration, system integration, and personnel allocation.
4. Negotiation Material for Contract Terms: Use the findings from DD, such as identified issues and risks, as a basis for negotiating a reduction in the purchase price or revision of contract terms.

Medical institutions, in particular, are businesses that handle human lives and are subject to special legal and economic regulations concerning various licenses, medical fees, and employment of medical professionals. Fully understanding these factors and conducting DD from a specialized perspective is key to increasing the success rate of M&A.

2. Legal Due Diligence: Thorough Verification of Licenses, Contracts, and Litigation Risks

Legal DD verifies whether the target company has legal issues and if there is a possibility of future legal risks. Numerous items specific to medical institutions require verification.

2.1. Verification of Licenses and Registrations

Operating a medical institution requires licenses and registrations based on a wide range of laws, including the Medical Practitioners Act, Dental Practitioners Act, Public Health Nurse, Midwife and Nurse Act, Medical Care Act, and Pharmaceuticals and Medical Devices Act. Verifying the validity, renewal status, and compliance with conditions of these is extremely important.

• Status of Establishment Permits, Designations, and Registrations: Whether permits for establishing hospitals, clinics, medical care facilities for the elderly, designations as medical insurance providers, or designations as designated in-home service providers, etc., are valid.
• Renewal History of Licenses: Whether licenses requiring periodic renewal have expired and if renewal procedures have been properly conducted.
• Procedures for Succession: Licenses are generally personal and non-transferable; verifying whether procedures for succession (name change, reapplication, etc.) accompanying M&A can be smoothly carried out.
• Compliance Status with Laws and Regulations: Whether various laws and regulations are complied with, such as advertising restrictions under the Medical Care Act, proper use of medical devices, and compliance with the Act on the Protection of Personal Information.
• History of Past Administrative Dispositions: Whether there is a history of administrative guidance or dispositions from public health centers or other authorities.

2.2. Verification of Contractual Relationships

Medical institutions enter into contractual relationships with diverse stakeholders, including patients, suppliers, employees, and contractors. It is necessary to verify the appropriateness of these contract terms and the feasibility of their transfer after M&A.

• Major Service Contracts: Contracts for outsourced services such as testing, diagnostic imaging, rehabilitation, cleaning, medical equipment maintenance, and IT system maintenance.
• Lease Agreements: Lease agreements for the land and buildings of the medical institution (especially if the seller does not own the building).
• Leasing Contracts: Leasing contracts for medical equipment, vehicles, etc.
• Post-M&A Succession: Confirming the possibility of succession, as some contracts may require the consent of the other party or may be terminated after M&A.
• Contracts Related to Personal Information Protection: Contracts concerning the handling of patient and employee information.

2.3. Verification of Litigation and Dispute Risks

Identify potential litigation risks, including medical malpractice, labor disputes, and troubles with business partners.

• Past and Pending Litigation/Disputes: Existence of medical malpractice lawsuits, labor arbitrations, debt collection lawsuits, administrative litigation, etc.
• Liability Insurance: Coverage status, insurance amounts, and past claim history for medical malpractice insurance, product liability insurance, etc.
• Complaints and Medical Incident Reports: Existence of past serious complaints or medical incident reports and their handling status.

3. Financial Due Diligence: Understanding Hidden Debts, Off-Balance Sheet Liabilities, and Profitability

Financial DD meticulously analyzes the target company’s financial condition, business performance, and cash flow status to grasp financial risks and the reality of its profitability. The collectibility of medical fee claims, unique to medical institutions, is also an important verification item.

3.1. Analysis and Verification of Existence of Financial Statements

• Profit and Loss Statement (P/L): Trends in revenue (medical fees), cost structure, and factors affecting profitability fluctuations. Particularly, analysis of increases and decreases over the past several years.
• Balance Sheet (B/S): Existence of assets (cash and deposits, accounts receivable, inventory, fixed assets, etc.) and completeness of liabilities (accounts payable, loans, accrued expenses, etc.).
• Cash Flow Statement (C/F): Status of cash flows from operating, investing, and financing activities.
• Off-Balance Sheet and Contingent Liabilities: Existence of liabilities not recorded on the financial statements (e.g., provisions for retirement benefits, provisions for lawsuits, unpaid overtime wages).

3.2. Verification of Medical Fee Claims

The collectibility of medical fee claims, the primary revenue source for medical institutions, is crucial for assessing financial health.

• Accounts Receivable (Medical Fee Claims) Aging Schedule: Existence of delayed collection claims and the proportion of long-overdue claims.
• Verification of Medical Fee Billing and Collection Process: Whether there are any issues that could lead to billing omissions, incorrect billing, or collection delays.
• Accuracy of Recepts (Medical Fee Claim Statements): Accuracy of billing content and the recept checking system.
• Uncollected Amount Management System: Method of managing uncollected amounts and the status of collection efforts.

3.3. Insurance Claims and Other Receivables/Payables

• Life Insurance, Non-life Insurance: Verification of contract details, beneficiaries, and surrender value.
• Other Receivables: Loans to officers, unpaid retirement benefits, etc.
• Loans and Accounts Payable: Interest rates, repayment terms, existence of collateral, and existence of joint guarantees.

3.4. Verification of Tax Risks

Verify the status of past tax audits and the accuracy of tax filings.

• History of Past Tax Audits: Existence of amended tax returns and the content of any findings.
• Accuracy of Tax Filings: Whether there are any errors in the treatment of executive compensation, depreciation, consumption tax, etc.

4. Labor Due Diligence: Understanding Unpaid Overtime, Work Rules, and Employment Risks

Labor DD verifies employee-related risks, particularly unpaid overtime, which is a common issue in medical institutions, and deficiencies in work rules. The employment status of professionals such as doctors and nurses is also important.

4.1. Verification of Basic Employee Information

• Employee Roster: Position, employment status (full-time, contract, part-time/temporary), years of service, salary, and social insurance enrollment status.
• Labor Condition Notices and Employment Contracts: Whether documents are prepared for all employees and if the content is complete.

4.2. Verification of Unpaid Overtime Risk

In medical institutions, there are cases where premium payments for overtime work by doctors and nurses are insufficient.

• Reality of Working Hour Management: Whether objective working hour management is conducted using methods such as time cards, IC cards, or attendance management systems.
• Overtime Pay Calculation and Payment Status: Execution and filing of Article 36 agreements, compliance with premium wage rates, and existence of unpaid overtime.
• Existence of Fixed Overtime Pay: If fixed overtime pay is implemented, its amount and whether it deviates from actual working hours.

4.3. Verification of Work Rules and Wage Regulations

• Preparation and Filing of Work Rules: Obligation to prepare and file work rules in workplaces employing 10 or more workers at all times.
• Appropriateness of Content: Whether there are any provisions that violate laws such as the Labor Standards Act.
• Wage Regulations: Provisions regarding salary structure, raises, bonuses, retirement benefits, etc.
• Harassment Countermeasures: Provisions and implementation status of measures to prevent sexual and power harassment.

4.4. Turnover Rate and Retirement Benefit Risks

• Past Turnover Rate: Turnover rate compared to the industry average, especially for specialized professionals.
• Retirement Benefit System: Existence of retirement benefit regulations, accounting status of provisions for retirement benefits, and utilization of systems such as the Small and Medium Enterprise Retirement Allowance Mutual Aid (Chutai Kyosai).

5. Steps and Points to Note for Conducting Due Diligence

It is important to conduct due diligence for medical M&A in a planned and systematic manner. Generally, it is carried out in the following steps:

1. Formulation of DD Plan: Determine the scope of DD, checklist items, schedule, and responsible parties (experts such as lawyers, certified public accountants, tax accountants, and social insurance labor consultants) considering the M&A objectives, target company’s size and industry, and risk tolerance.
2. Information Gathering: Collect and conduct preliminary checks of documents provided by the seller (corporate legal affairs, financial statements, contracts, licenses, employee rosters, etc.).
3. Investigation by Experts: Experts in each field meticulously examine the collected documents, conduct on-site investigations as necessary, and interview relevant parties.
4. Preparation of Report: Prepare a report summarizing the DD findings, identified risks, issues, and assessments.
5. Reflection in M&A Agreement: Based on the DD report, finalize the terms of the M&A agreement (purchase price, representations and warranties, indemnification clauses, etc.).

6. Benefits of Conducting Medical M&A Due Diligence with Experts

Due diligence for medical M&A requires specialized knowledge and experience. Collaborating with experts such as lawyers, certified public accountants, tax accountants, and social insurance labor consultants offers the following benefits:

• Comprehensive and Accurate Risk Assessment: Experts familiar with the legal regulations and business customs unique to the medical industry can accurately identify risks that might otherwise be overlooked.
• Objective Enterprise Valuation: An objective perspective from experts allows for the calculation of the target company’s true value, preventing transactions at an unfairly high purchase price.
• Enhanced Negotiation Power: Objective data obtained through DD serves as a strong basis for price negotiations and adjustments to contract terms with the seller.
• Reduced Post-M&A Integration Risks: By understanding risks in advance, potential troubles during post-M&A business integration can be prevented, leading to smooth operations.

Q: What is the most critical point to be aware of during due diligence for medical M&A?

A: In medical M&A, the continuity of licenses, collectibility of medical fee claims, scope of coverage for medical malpractice insurance, and labor risks such as unpaid overtime are particularly important. These items directly impact the business continuity and financial status of medical institutions, requiring detailed verification.

Q: How much does due diligence cost?

A: Costs vary significantly depending on the size of the target company, the scope of the investigation, the type and number of experts involved, and the investigation period. Generally, it often falls within the range of several million to tens of millions of yen, but it is important to obtain an estimate for each individual case.

Q: Is it possible for the acquiring party to conduct due diligence themselves?

A: While the acquiring party can conduct basic information gathering themselves, they may overlook important risks if they lack specialized knowledge and experience in legal, financial, and labor fields. Therefore, it is strongly recommended to engage experts (lawyers, accountants, tax accountants, social insurance labor consultants, etc.).

Q: How long does the due diligence investigation take?

A: Depending on the size and complexity of the target company and the scope of the investigation, it generally takes about 1 to 3 months. For prompt M&A execution, it is crucial to formulate the DD plan early and proceed in collaboration with experts.

Q: If problems are found as a result of due diligence, should the M&A be canceled?

A: Not necessarily. Problems and risks discovered during due diligence can be reflected in negotiations for a reduced purchase price, revisions to contract terms (strengthening representations and warranties, establishing indemnification clauses, etc.), or the formulation of post-M&A improvement plans. It is possible to proceed with the M&A while managing risks in consultation with experts.

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