Exiting or entering into 100% practice ownership: know the strategies (Proceedings)

Buying or selling a veterinary practice generally is a long and arduous process. Preparation and a good lawyer are key to smoothing the bumps along the way.

I. PLANNING

How well you plan determines whether you will control the process or vice versa. Beyond identifying what is to be sold and the purchase price therefor, here is an overview of the main planning issues:

     A. What Seller should be doing. Future retirees should note that it can take a decade to properly prepare a practice for sale.

          • Tax. Find out how the sale price will be taxed. Tax planning may require transformation of the practice legal structure and long waiting periods to optimize tax on sale. Bear in mind that the buyer may not accept the structure you wish to use for the transaction (e.g., he may prefer to buy assets rather than an interest in the practice entity.)

          • Practice Appraisal. To increase practice profitability and sales price, it may be worthwhile to get an appraisal. Implementing the appraisal's recommendations may take several years. From the buyer's perspective, a purchase without an appraisal may mean the practice does NOT have the cash flow to fund the purchase payments. If the buyer defaults on the payments, seller may have to take back practice, long after retirement.

          • Cleaning Up. Consult with your lawyer to see if there are any liabilities that should be taken care of before the sale (e.g., settle a claim). You also need to address any personal guarantees you have given to the business, and third party claims on any assets to be transferred (such as spouse and secured lenders). If the practice entity owns the real estate, you may need to divest it (at what tax cost?) back to yourself or another entity you own because the buyer may be unable to afford to buy both.

          • Financing. Many potential buyers can't afford to pay cash and can't get bank loans on acceptable terms. Consider whether you should provide financing by taking buyer's promissory note (secured of course) for a portion of the purchase price.

     B. What Buyer should be doing. Buyer's planning phase usually is much shorter than seller's. Try to minimize preparation expenses until you are reasonably sure that you have a deal with the seller. If the deal is aborted, you want to be as little "out-of-pocket" as possible.

          • Hiring Counsel. When hiring counsel, trust your instinct. If you don't feel comfortable with him or her, get another one, there are plenty around. You find a good lawyer the same way you find a good doctor: by word of mouth. Your lawyer should be at least as smart as you are. Avoid lawyers that not nothing about assisting buyers purchase medical practices.

          • Tax. Find out how the sale can be structured to minimize taxes down the road for the new owner(s) and the practice, including taxes when you sell or withdraw from the practice. (Remember every buyer is destined to be a seller.)

          • Due Diligence. You don't buy a house without visiting it, nor a car without a test drive. Buyers need to spend time at the practice to "kick the tires." One of the most important goals of due diligence is to make sure buyers are not picking up hidden or poorly identified liabilities. Due diligence allows early detection of potential problems, so that the parties can address them...or separate. Not infrequently, good due diligence leads to a reduction in purchase price.

          • Financing. If you can't pay cash, you need to line up financing (or be prepared to ask the seller for same) well before the sale.

          • Co-Ownership Issues. If you are just buying a portion of a practice or joining with other partners to buy a practice, there are many co-ownership issues that need to be addressed. Like marriage, co-ownership works a lot better if the principal terms governing the relationship before getting hitched. At least as much time and effort should be allocated to properly establishing and documenting your relationship with your partners, as to the purchase itself.

          • Investment Vehicle/Practice Structure. Unless you are buying into a pre-existing structure, consult with your lawyer to find the investment vehicle or practice structure best suited to fulfill your tax, financing and (co)ownership goals. (In making this choice, do not omit to factor in you succession or exit strategy.) Even if buying into a pre-existing structure, be aware of the consequences. For example, stock purchases are riskier than asset purchases because all of the liabilities of a corporation automatically are transferred with the stock, whether or not such liabilities were disclosed to buyer.

     C. What Seller and Buyer should be doing Together.

          • Employees. The practice's employees constitute its most valuable asset by far and it's in the interest of both parties that the transition take place smoothly. For the buyer, smooth transition is critical, since the departure of one or more key employees can cripple the practice. While legally (to avoid trailing liabilities), the buyer will insist that all employees be terminated prior to the sale (and to the extent the buyer wants to retain them, rehired after the sale), it is up to the parties to work together to ensure that the ownership change disrupts the employees as little as possible.

          • Contracts. In asset sales where contracts are to be transferred (e.g. real estate and equipment leases), the consent of the other party to the contract is required. Obtaining such approvals is often easier when both buyer and seller approach such other party together (although as a contractual matter, it is almost always the seller's responsibility to get these consents).

II. NEGOTIATING THE DOCUMENTS

     A. Preliminary Documents. At some point during the preparatory stage, the parties usually negotiate some form of preliminary document which can range from: (a) a short letter of intent, pursuant to which the parties agree to negotiate in good faith with each other (in some cases exclusively) and confidentiality; to (b) a detailed memorandum of understanding detailing the process for going forward; to (c) an at least partially binding detailed letter of offer which sets forth the main terms of the deal. The parties should make absolutely sure they understand to what extent these documents bind them to go forward, and what liability, if any, a party will incur if he withdraws from the deal.

     B. Purchase and Sale Agreement. While the preliminary documents set forth an intent, a process or a framework, the purchase and sale agreement (called stock or asset purchase agreement depending upon the transaction) is the contract in which the buyer binds himself to purchase the practice and pay the price, and the seller binds himself to sell the practice, in each case subject to a limited number of conditions precedent to closing the deal. Some conditions precedent are applicable to both parties obligation to close (e.g. no litigation exist challenging the transaction). Some are applicable to only one party (such as buyer obtaining satisfactory bank financing).

Other than the price and conveyance language, the most important clauses of the purchase agreement are seller's representations and warranties, pursuant to which seller makes a series of declarations about the business (there are no hidden liabilities, there is no outstanding litigation against the practice; all inventory is saleable in the ordinary course, etc.) These provisions are designed to protect the buyer in case the practice isn't what it appears to be, but the devil is in the wording, and both parties should make sure that they are comfortable with the language.

Another key clause is the non-competition provision (a.k.a. restrictive covenant) which prohibits the seller from competing with the practice for a certain period of time (e.g., five years) within a certain radius (e.g., 15 miles). This is an important provision to protect the practice's goodwill.

III. TOWARDS CLOSING

Signing the purchase agreement means that the parties commit to consummate the transaction once all of the conditions to closing have been satisfied. Closing the transaction means actually transferring legal title to the shares or assets and paying the purchase price. Between these two dates, the parties and their lawyers do what is necessary to ensure that the closing conditions in the purchase agreement for which they are responsible will be satisfied by the closing date. (For example, buyer may have to obtain bank financing and seller get certain third party consents to the deal.)

In many cases, the signing of the purchase agreement and the actual closing of the transaction take place simultaneously, in which case there are no closing conditions.

The preceding was merely a simplified overview. It seems that there are numerous issues and details that seller and buyer must keep track of when selling and buying a practice. That's why competent legal advice is crucial. But if you feel overwhelmed, just ask yourself how you'd behave if the transaction involved a house or a car. Usually the solution will come to you as if by magic.

Due Diligence Items Preparing for the Sale

     A. Corporate Organization and Capital Structure

          1. A description of the ownership structure and list of all subsidiaries and/or affiliates of the Company.

          2. Certificate or Articles of Incorporation, By-Laws, Partnership Agreement or Operating Agreement for the Company, in each case as amended to date.

          3. All minutes of meetings, "Board Books" and written consents of the boards of directors (or other governing body) (including board committees) and stockholders, partners or members of the Company, if available.

          4. List of all the officers and directors of the Company.

          5. All documents restricting the issuance or resale of the Company's assets, interests or capital stock, including buy-sell agreements and shareholder agreements.

          6. All reports filed with any state authority by the Company (e.g. annual reports, reports of issuance of stock or interests, etc.) for the most recent year.

     B. Governmental Regulations and Filings

          1. All reports and applications filed with, significant correspondence with, and transcripts of any significant proceedings before, any state or federal regulatory agencies and self regulatory authorities, including, without limitation, the EPA, EEOC, applicable state department of human rights and OSHA.

          2. All federal and state income tax returns filed by the Company for the last three tax years and all communications between the Company and the Internal Revenue Service, including notices of assessment and reports of revenue agents, with respect to matters raised by the IRS in the course of any audits.

          3. Copies of all current federal, state and local business licenses, qualifications and all correspondence relating to such licenses for the Company including, without limitation, all information regarding any actual, pending or threatened suspension or termination of such licenses or qualifications.

          4. Copies of all current federal, state and local licenses, including, without limitation, veterinary licenses, drug enforcement authority licenses, and any other permits or licenses for equipment, supplies, materials or drug use, for all veterinarians employed by the Company and all veterinarians contracting with the Company and any information regarding any actual, pending or threatened suspension or termination of such licenses or qualifications.

     C. Financing

          1. All documents, agreements and any amendments regarding any financing, merger, sale, lease, sale and leaseback, loan or other transaction to which the Company was a party together with any related "closing binders" or collations of documents, and related "due diligence memoranda."

          2. All documents and agreements (third party or intercompany) evidencing borrowings, whether secured or unsecured, by the Company, including loan and credit agreements, promissory notes and other evidences of indebtedness and all guarantees.

     D. Intellectual Property

          1. List all United States and state trademarks, service marks, trade dress, trade names or trademarks used or registered (presently or within the last three years) by the Company.

          2. List all United States copyrights owned by the Company.

          3. List of all software and copies of all software maintenance contracts used in connection with the operations of the Company.

     E. Material Agreements

          1. All documents and correspondence, relating to any acquisitions, dispositions or material transactions contemplated at any time by the Company or proposed for the future, whether consummated or not.

          2. All leases of a material amount of equipment and personal property to which the Company is party, either as lessor or lessee.

          3. All guarantees issued by or to the Company.

          4. All other material agreements to which the Company is a party, other than employment agreements.

     F. Labor, Personnel and Human Resources

          1. All employment agreements, including commission agreements and termination agreements, and material consulting agreements to which the Company is party.

          2. A schedule listing the number of employees of the Company, together with each employee's current hourly rate or annual compensation.

          3. All documents relating to both current and previously terminated bonus, retirement, profit sharing, incentive compensation, deferred compensation, stock option, stock purchase, pension and other employee benefit plans or agreements of the Company or other funds, programs or arrangements maintained for the benefit of employees, including any 401(k) program.

          4. Copies of all charges or complaints against the Company filed with or by any state or federal court or governmental agency dealing with any form of employment or employment discrimination matter within the past two years.

     G. Contingent Liabilities

          1. Information concerning any pending or threatened workers compensation claims, litigation or judgments involving the Company. Specifically, please describe all pending lawsuits to which the Company is party including a description of the potential liability, the name of counsel engaged and the current status of the litigation.

          2. Copies of all notices received from, and documents regarding, any regulatory action or examination (pending or threatened) at any time during the last five years.

     H. Miscellaneous

          1. All consent decrees, judgments, other decrees or orders, settlement agreements and other agreements to which the Company is party or by which it is bound.

          2. Any other documents or information which should be considered and reviewed in connection with the transaction.