How to sell to an associate for a corporate price

(Shutterstock.com)No doubt you've heard this before, but just in case: There are lots of people out there who think buying a veterinary practice is a great investment. But some of today's potential buyers are not the traditional associates ready to own of the past. Instead, they're large, multi-practice corporate entities, venture capital groups and other investment companies. Again, no surprise, but many of these groups are willing and able to pay more for a practice than has typically been considered “fair market value” (the standard usually used to determine purchase price for most sales amongst individual veterinarians). These prices are often beyond what an associate can pay.

In the early days of large, multi-practice corporate groups, the idea of selling to one wasn't very attractive to many veterinarians, primarily because they didn't believe in the concept and didn't like how some of the groups were run. Some veterinarians still feel that way, but the difference in what a corporate group will pay and what an associate could afford can be substantial. Even doctors who'd prefer to sell to an associate can't turn down the money.

Could the bubble in corporate offers for veterinary practices POP?

Yes, in my opinion, for several reasons.

First, many corporate buyers want to bundle up these practices and then resell them, and the goal is to sell at a higher price. If there isn't a lot of room to increase profitability, the higher prices paid may not allow for much return on investment.

Secondly, there's a lot of competition for practices right now, and that's propping up prices. What happens when most of the “good” practices have been sold and investors turn their sights elsewhere? I think a good-quality, highly profitable practice in a good area will always find a buyer for a good price, but I don't know how long these current prices paid by corporate groups will continue.

Think about it. Let's say you're the owner of a practice with a fair market value of $1.5 million, determined by a reputable veterinary appraiser. A great associate wants to buy and can get financing for that amount. You've always wanted to sell to an associate, not a large corporate group.

Sounds perfect! However, you've been approached by several nonveterinarian buyers, and after some discussion and a review of your financials, three of them have made offers. These offers range from $1.8 million to $2.6 million. GULP. That's a pretty big difference ($300K to $1.1 million more) between fair market value and the sale price to a corporate group. Why can the corporation afford to pay so much more? They're not in the business of throwing away money. Remember that price and fair market value aren't the same thing. The higher price offered by a corporate group is often an investment value-what that practice is personally worth to that particular group at this point in time vs. what it's worth on the open market.

For many practice owners, the additional dollars are too big to ignore even if they have a potential associate buyer or could list the practice with a broker or otherwise sell to another veterinarian. And in many ways this may be the easiest option, selling now and fully cashing out, even if the owner will need to work at the practice for a year or more.

Sounds pretty grim for the ambitious future practice owner and the principled practice owner who wants to sell to another entrepreneur. Is there another option that will allow a practice owner to sell to an associate and take home more than fair market value?

Yes, but it may take a little more time and effort on the part of the seller. The basic concept is a phased buyout, and here's how it works ...

The basics of a phased buy-in

• The practice owner sells small parts of the practice (say, 10 to 20 percent) each year for an agreed-on number of years (usually not too long because often at this point the seller is ready to be done). The buyer could be one associate or a group of them.

• During this time, the seller mentors the associate as an owner. Many associates are concerned about their ability to run a practice, so this makes the sale more attractive and smooths the path.

• At the end of this time, the practice owner sells the remainder of the practice to the associate. The owner will be cashed out when the last portion is sold; the buyer will get bank financing for all remaining amounts.

• The additional money going to the practice seller, which is more than a 100 percent, one-time practice sale, comes from:
• A share of the profits from the practice each year he or she remains an owner

• Interest income (if the practice owner finances the initial partial sales amounts in the early years)

• Potential appreciation in value (depending on how the total transaction is structured with the buyer).

Pros and cons to a phased buy-in

• Positives:
• The seller walks away with more income.

• The associate takes over the practice and team in a slow, thoughtful management transition.

• The associate benefits from mentoring for a few years from a practice owner who directly benefits from the practice's success during the phased buy-in.

• Potential negatives:
• The seller needs a talented associate who's interested in buying.

• The practice owner can't just walk away. He or she needs to remain involved enough to mentor the associate and to make sure no harm comes to the practice until the sale of the final portion. The seller may cut back on hours worked and take time away from the practice, but the seller is still retaining the financial and legal risk of ownership. (Don't forget that if the practice owner sells to a corporate group, they may be required to stick around for a while too.)

• The seller has to work with a partner, the associate buying in. Not all practice owners are good at this or even want to try. Having a partner means joint decision making and not always getting to do things your way. (Remember, if the practice owner sells to a corporate group and continues working at the practice, he or she will have to deal with some of this as well.)

• The owner has to spend time mentoring the associate. How much will depend on the individual.

• During the years of the buy-in, the associate could decide ownerhip's a bad choice and walk away (or at least try to). Sellers can mitigate this risk by picking the right buyer, providing appropriate guidance and instituting clearly written penalties in the buy-sell agreement.

• During the years of the buy-in, things could go wrong for the practice before the final portion is sold, and the seller would still be on the hook, as a co-owner, to deal with them.

For the right buyer and seller who have a good working relationship, who think about issues of risk and co-ownership and who navigate those together, this can be a nice alternative. Not every practice fits the corporate model. Corporate chains typically prefer larger practices ($1.5 million in revenue and growing) in good locations (generally urban or suburban) with healthy profitability or profits that can be improved with simple changes. They also prefer at least one owner and management team member willing to stay around for several years post sale along with expectations that the remaining doctors and staff will also continue to work in the practice.

While practices that don't fit this model may not have an immediate alternative to selling to an associate or listing the practice, working for a few more years may make retirement financially sweeter for any practice.

The decision to sell to a corporate group often comes down (in a seller's mind) to a choice between legacy and money. But not always. Corporate sales don't always ruin the practice legacy. And with a phased buy-in to an associate, as you can see above, a seller committed to selling to an associate might not have to settle for less money.

As always, it's important to run the numbers to understand what the overall difference in the dollars received in a phased buyout sale versus a corporate sale would be. Variables include the initial price difference, the profitability of the practice, the interest rate used in seller financing, and the timeframe for the entire sale.

Regardless of when and how a practice owner sells, the practice owner and the associate need to secure some good advice from both a legal and a financial perspective. The world is too complicated (and too litigious) not to!

Karen E. Felsted, CPA, MS, DVM, CVPM, CVA, has spent more than 15 years working as a financial and operational consultant to veterinary practices and the animal health industry and is a frequent contributor to dvm360.com. She also spent three years with the National Commission on Veterinary Economic Issues as CEO and is a frequent speaker at CVC conferences.