Deal Negotiations: Price vs Terms
Price and deal terms are both two things that you should closely analyze and intimately understand as it relates to any deal you are evaluating regarding the sale of your practice. While it sounds straightforward, the two may be inversely related which makes understanding the details critical to understanding the big picture of the deal you’re looking at.
Whoever you are selling to has most likely done intense due diligence in order to structure the deal in a way that makes sense for them. However, that DOES NOT mean that the price and terms of the deal make sense for you, the seller. That’s not to say that the buyer is trying to take advantage of you or pull one over on you, but it does mean that there is no way that they can know everything that you want to achieve and so the terms (or price) may not meet your expectations right out of the gate.
Chances are that you have a lawyer who is reviewing everything for you. If you do not, we cannot stress the importance of this enough. If you do, we still can’t stress how important it is for you to personally invest time and effort into understanding the parameters of the deal.
You can think about the difference between price and terms like this: price is what you get on the day of the close (i.e. cash, rollover equity, etc.) and terms are what you have to live with over the long term (i.e. non-compete time and distance, earn out clause, etc.). Here’s what we believe are the most important things to understand about price and terms:
Cash: Wherever and whoever the cash comes from, it’s all going to look the same in your bank account.
Rollover Equity: Rollover equity can be incredibly valuable. If you have an opportunity to acquire equity in the group entity, it could be worth several times more in just a few years. However, this is entirely dependent on the specific group that you’re working with and their current stock price. This means there are two very important things to understand as you evaluate rollover equity:
- Do you believe in the leadership & vision at the company? If not, then you shouldn’t acquire the stock. If you do believe in the future of the company, it might be a very lucrative option
- What does the growth potential look like? For example, if you’re working with a group that has 200 hospitals and grows to 300 hospitals over the next 3 years, value of your stock would see a moderate increase in value. On the other hand, if you’re working with a group that has 50 hospitals and may grow to 150 or 200 hospitals over the next three years, the value of your stock would increase significantly more.
Earnout: Buyers will occasionally include growth earnouts in the deal. This is structured to incentivize the seller to continue to be an active partner at the hospital and help grow the practice into the future. In the majority of cases, these earnouts will be based on revenue or profit growth over the course of a set amount of time. If you believe that your practice is on a path to grow substantially over the next few years, asking for an earnout to be included in your offer may be a great way to increase the total value of your practice.
However, if an earnout is included in an offer you are evaluating, it is critical that you fully understand the specific targets the buyer has presented you with, the time parameters required to achieve this earnout, as well as the timing and form of expected payment (either cash or rollover equity).
Employment Agreement: Most corporate buyers will require that the practice owner remain with the practice for a certain, agreed-upon timeline after a sale. As an owner, your employees look to you as their leader and key decision-maker, which is why most corporate buyers will do this to ensure that there is a smooth transition and that your employees feel comfortable with the decision you have made.
AT A GLANCE: 6 Things to Know for Deal Negotiations
|Cash||Wherever it comes from, it’s all going to look the same in your bank account.|
|Rollover Equity||It could make your deal worth several times more in just a few years.|
|Earnout||This is to incentivize a seller to remain an active partner in the hospital.|
|Employment Agreement||This ensures a smooth transition and helps your employees feel comfortable.|
|Non-Compete Agreement||This helps a corporate group protect their investment in you.|
|Facility Lease||In most cases a buyer will offer you a fair market rental rate.|
Additionally, as part of your employment agreement, a buyer will look to offer you a compensation structure. Often times, a corporate buyer will look to offer you compensation plan that offers you a percentage commission on your production (i.e., the revenue you bring in). A modified version of this is referred to as “pro-sal,” where a buyer will give you a set base salary and will give you quarterly bonuses to “true-up” to your percentage target. Before you agree to any specific compensation structure, you should consult with a financial advisor or accountant to see if this will make sense for you and your family. However, it is important to note that in an analysis of your practice’s profitability, corporate buyers may adjust your compensation on a go-forward basis, which may have an impact on the valuation of your practice. For example, if the labor costs for the hospital will be changing because your pay is increasing or decreasing, that will change the profitability and, in turn, the valuation.
Non-Compete Agreement: While non-competes tend to make veterinarians very wary, it’s important to understand why corporate groups are usually so adamant about including them in a seller’s employment agreement. In short, they need to protect their investment. If the corporate group paid you several million dollars and then you too open up a practice down the street, you would probably have a significant impact on the revenue and profitability that you just sold. It’s natural to have concerns when you hear about the concept of a non-compete, but in truth, the hospital and the group need you. Unless there is a serious and unsolvable cultural issue or unethical behavior, it is highly unlikely that the corporate group would want to part ways with you. The cost to replace a veterinarian and associated lost revenue makes every DVM incredibly valuable and that is compounded when we’re talking about sellers who have built loyal client relationships over several years. Think of the non-compete as a life vest for the corporate group, but don’t be afraid to ask for concessions regarding time and or distance either – you should be comfortable with the deal.
Facility Lease: Your facility is critical to the success of your practice. In most cases, a buyer will offer you a fair market rental rate for your facility and will enter into what is referred to as a “triple-net” lease. In a triple net lease, the lessee (i.e., corporate buyer) will pay all property taxes, utilities, and cover expenses related to routine maintenance and repairs (excluding major structural repairs). Similar to your compensation, the rent that a corporate group offers and the value of your practice are not mutually exclusive and may impact the profitability of your practice, which impacts the valuation of your practice.
Here’s the punch line: there are a lot of intertwined aspects of an offer to buy a practice. Spend some time prioritizing terms and price so you have open and meaningful dialogue with a potential buyer as you pursue a deal that you are happy with.