A lower risk practice purchase means the buyer and seller both win and the practice sells. It may be obvious that win-win is best, but sales are made that are not win-win or low risk. The practice sale may be to an independent third party or to an inside person, usually an associate doctor.
A lower risk practice purchase means the buyer and seller both win and the practice sells. It may be obvious that win-win is best, but sales are made that are not win-win or low risk. The practice sale may be to an independent third party or to an inside person, usually an associate doctor. The practice sale can be 100% cash out from the buyer's cash savings or cash from financing. Even with cash from financing, it could be 100% cash out with no down from the buyer. This is because some of today's specialty lenders are willing to make those 100% loans even when veterinary practices generally have a sale price including 60% to 80% goodwill. The reason lenders make these high leverage loans is because veterinarians are good credit risks. Losses nationally are only in the 1% to 4% range. In general, if sufficient due diligence is done, risk is reduced.
A practice sale can be a partial sale to an associate or a 100% sale to the associate or a third party. If the sale is a partial sale, unless the buyer has cash, the seller will have to finance the sale. Only if the seller will subordinate 100% of the practice as priority security to the bank, will the bank lend on a partial sale. Most banks will not lend for a partial sale.
Other than financing issues, the main win-win (lower risk) issues have to do with the sale price and (if it is a partial sale) with the timing of when the partial buyer may be able to purchase more shares or even to purchase controlling interest.
Another main area of issue for a buy out win-win is: was the price fair? To have a fair price the price should be the fair market value (FMV) based on a practice valuation by a practice valuator or appraiser. This person should have experience with the valuation methods used in the current market place to arrive at a practice value based on earnings. A practice valuation is to be based on the excess earnings or a prediction of future earnings of the practice after the seller's (and any other veterinarian's) compensation has been adjusted to a production basis with earnings set at about 22% of their production for small animal practices.
Another (one of many) important adjustment that is commonly needed in the practice profit and loss statement, before the valuation is complete, is that the rent for the physical facility must be imputed, if needed, so that it is at fair market rent. This market rent adjustment is based on other commercial buildings in the same geographical area, as determined by a third party person in the real estate field.
Other adjustments for the valuation will require the valuator to look at non-recurring costs and other expenses sometimes listed as private expenses for automobile or excess continuing education travel or personal items taken from the practice and paid for by the practice.
The records are reviewed on a cash basis. Non-cash expenses like depreciation and equipment amortization are removed. Leases for equipment are removed because it is presumed the buyer would be a cash buyer unless it is an associate buying only a minority interest. After all the adjustments are made, an excess cash earnings calculation is made. There is usually a deduction for return on the investment in capital that is to be invested for the tangible assets. The final excess earning is usually calculated in a growing practice by giving more credit to the more current years, by using a weighted average method for calculating the excess cash earnings that predict future earnings.
After these future cash earnings are calculated, there is an analysis of subjective risk factors made by the valuator to determine what a potential buyer's return on investment should be as compared to the risk factors. This return on investment rate, after also considering the growth rate of the practice, will allow the valuator to arrive at a capitalization rate usually in the 33.3% to 20% range resulting in a multiplier of the excess earnings being 3 to 5 for the calculation of the good will.
If the non-win-win practice sale occurs, because the practice value was not properly determined, there is a much higher likelihood that the buyer may fail or not be able to pay for the practice from proceeds of the practice earnings after paying himself an adequate compensation for being the onsite or one of many veterinarians.
In practices with a low excess cash earnings the practice value may be only computed based on a post sale cash flow basis which is heavily calculated from the loan payments that exist on closing. This method of calculating value may work in the short run for a practice purchase that is in a growing area but has much higher risk to the buyer. The above issues and terms are some of the important items in helping a buyer and seller arrive at a win-win reduced risk practice sale.
The buyer usually takes the first step to begin a discussion on purchasing a practice. The buyer should, with the help of an attorney, draft a letter of intent. This is a multi page document that is non-binding on either party, but sets out the terms of the potential purchase, from the buyer's perspective including any pre-agreed terms from the seller.
The terms of the letter of intent include most of the terms of the subsequent binding purchase and sale agreement with the exception of some of the representations and warranties of both parties and other binding terms.
The letter of intent will include the time of the purchase, the price and percentage of the practice that is to be purchased and how the purchase price is to be paid. It will include the details about whether the purchase is to be a stock purchase or an asset purchase. Most buyers prefer to buy only assets so they have a tax depreciation future write off. If the practice is a corporation or LLC and the buyer is a partial buyer, he or she will not have a choice, but will have to purchase a specific amount of shares of the corporation or a specific number of membership units of the LLC. Depending on the price negotiations and the tax consequences to a seller, occasionally a seller may demand the sale is a stock sale even with a 100% sale.
Once the letter of intent is delivered to the seller, the negotiation can begin. This will result in changes to the letter of intent, hopefully resulting in agreed upon terms. This negotiation may include alternative capital requirements.
These final agreed terms are then transferred to a more formal and binding purchase and sale agreement. It will almost always include a purchase subject to financing contingency depending on what role the seller agrees to play in financing. Once the purchase and sale agreement or stock sale agreement (for a corporation) or membership unit sale agreement for a LLC is finalized by signatures, it can be presented to lending institutions for soliciting financing offers from lenders.
When the offers to the buyer are received from lenders, the buyer can select one and make plans for the sale closing. Most lenders will require adequate disability insurance and life insurance on the buyer. This requirement may hold up the closing if there are any health issues with the buyer. The buyer needs to plan ahead and apply for these insurance coverages early. It may take 6 to 12 weeks to get the insurance necessary before the sale can close. This insurance issue is a risk reducer for both buyer and seller.
Whenever there is a sale for less than 100% of the practice, there must be an agreement that includes the following contingencies, to allow one of the owners to get out (sellout) upon one of the following trigger events. Otherwise all owners would have to sell the whole practice, and attempting to work together if possible while waiting for the sale. These major buy sell agreement in addition to setting valuation methods must also have the following:
when a buyer or seller just wants to get out
when there is a disability
when there is a marriage
when there is a divorce
when there is a death
when there is a bankruptcy
It is obvious that anytime there is more than one seller, there is always the risk that the relationship will not work out and one or the other shareholder just wants to get out because it is not working out. This should be reason enough, that there is an agreement to provide how one or the other of the shareholders shall remain and what they will pay and what terms they will use in closing that final sale to the departing owner. Spelling out future valuation methods reduces risk and may reduce capital requirements of all parties.
If there is a disability of one of the parties, so that party may have to get out if he or she is unable to continue working as a practicing veterinarian. They will need to be bought out.
If there is a marriage of an owner there needs to be an agreement spelling out whether or not there are any rights of ownership going to go to the new spouse, and if yes or no, what would be done in that situation.
If there is a divorce by an owner, there obviously are issues of whether the practicing spouse or the non-practicing spouse shall be able to remain an owner. The remaining owner (if any) needs to know how they would be paid off to have their shares purchased by the remaining owners.
If there is death, it is obvious there should be a payoff to the estate. Sometimes the terms of a buyout of a veterinarian's estate, might be different than the terms for another type of buyout.
If there is a bankruptcy, by one of the shareholders, obviously there are issues of how to pay out the bankruptcy owner, because their money will be needed to settle the bankruptcy rather than own part of a business.
Upon retirement, a seller may want a long term buy out to assist with retirement income.
In retirement, there are many issues about whether or not the retired person can work part-time. If they work, what would the compensation be? Can they own and most importantly, can they have management or voting rights in the business if they are only working part-time or not working at all.
If all the above issues are considered, there is no reason a practice sale can't be a win-win reduced risk transaction that may reduce capital requirements of either party.