A Steal or a Bad Deal? 5 Pitfalls to Avoid in Skilled Nursing Facility Acquisitions
By Steve Zicherman, CPA
Managing Partner, LTC Finance and Advisory Services
Consider this scenario: A skilled nursing facility (SNF) is on the market, and you’re interested. If you’re a seasoned nursing home administrator ready to move into an ownership role, a successful SNF owner interested in expanding your portfolio, or an entrepreneur seeking investment opportunities, you’ve taken steps to minimize the risk. After a careful review of the historical financials and some number-crunching, you’re certain that with diligent attention to increasing the census and cutting expenses, you can project a healthy profit in year one. So now it’s time to trust your intuition and move quickly to capitalize on the opportunity, right?
Not so fast. After more than a decade on the front lines of SNF acquisitions, we’ve learned why some acquisitions succeed while others struggle to realize their goals. Here are some key points:
- Numbers don’t lie?
Those historical financials paint a pretty picture of a nice little “fixer upper” that just needs some TLC. Sure, the margins have tended to be slim, but with some decent marketing and ancillary contract trimming, this facility has real potential.
Or does it? Don’t let the numbers they provide be the only story you see. Unfortunately, there’s plenty of creative accounting in SNF operations that can mask or minimize significant issues. Add a few strategic management or corporate allocations here and there, and a money pit looks like a reasonably manageable turnaround candidate with great prospects. It will take robust, skeptical due diligence during the underwriting process to break through the façade and reveal the truth.
- Projections: Live with them, don’t die by them.
In pursuit of lower rates on those critical terms and A/R loans, ambitious plans to slash expenses in the first year will certainly impress lenders. But you can count on unexpected challenges, and daily operations will almost certainly be a distraction from your turnaround strategy.
Don’t get tripped up! Setting projections that will make the bank happy while still being practical and achievable is an art form. Close coordination with your mergers and acquisitions advisor before closing can help you set realistic covenants and ratios, and it can also assist you in negotiating terms that will satisfy all parties and ensure uninterrupted cash flow.
- Got the loans! Great—but that’s not enough.
Planning for your strong A/R line of credit to cover your startup costs? Even the most generous lenders don’t want to be on the hook for more than 60 to 75 percent of total A/R, after factoring in collectability and advance rates. It’s easy to overestimate the collectability of your receivables, and your projected profitability may be months out. Are you ready to meet the shortfall?
Bottom line: A realistic cash flow projection will help ensure smooth operations until revenue stabilizes.
- I know! I can work with the vendors…
Maybe you’ll find some breathing room on the AP side. But remember—you’re the new kid. Your track record isn’t established yet, and your leverage is limited. Squeeze vendors too hard and they’ll terminate, leaving operations in turmoil and investors heading for the exits. That’s a recipe for disaster.
Strike the right balance. Your advisor can provide realistic strategies for astute management of AP, and tough negotiations with suppliers can deliver significant results if handled with care.
- Cut staffing for sure-fire savings?
The payroll looks pretty bloated on paper. It’s a classic strategy: cut your way to profitability. Trim some nursing positions here, pay a few department heads less there, get rid of deadwood—and bingo, hundreds of thousands in savings. Works every time, right?
Actually, there are many obstacles to this approach. This is a people business, and that overpaid supervisor who’s been here forever could be the heart and soul of the operation. New ownership makes everyone nervous, and if morale crashes, hundreds of disgruntled employees may suddenly decide to shop their resumes around. There are plenty of opportunities in the current highly competitive labor market, and new minimum wage rates in many states will make new hires significantly more expensive. Good luck replacing them without significant onboarding and incentive costs. And what will high turnover do to your facility’s reputation?
What’s more—this is a highly regulated industry. State-mandated staffing ratios need to be maintained if you want to survive past the first survey. Star ratings, Medicaid reimbursement, and simple resident satisfaction are all directly related to both staffing ratios and costs.
There are savings to be had, but cuts must be made with a razor, not an ax. An accurate staffing analysis can provide a cost-effective solution to optimum staffing.
Bottom line:
There are great acquisition opportunities out there, ready to outperform under good management. Making sure you get one of them is a challenge, and an experienced M&A team on your side can make all the difference.