Surviving a Practice Breakup
Edward J. Guiducci, J.D.

Breaking up is hard to do. It can be even harder when it involves practice owners at the end of the road. The breakup of a veterinary practice is very similar to the breakup of a marriage. The parties are frequently angry about the issues that caused the breakup. The owners are concerned about what is going to happen with the practice. Some of the common concerns of an owner that is going through a practice breakup are: What happens if one owner demands that the other leave the practice? Who has the right to keep the practice location? Who gets to keep the practice name and phone number? Will either owner be prevented from opening up a practice in the same geographic area? What happens to the client base?

These questions are especially important when the owners previously failed to enter into an agreement to govern the breakup of the veterinary practice. The key to surviving a practice breakup is to have a thorough and well drafted ownership agreement.

The specific title of the ownership agreement will vary depending upon the type of legal entity that the practice operates under. However, the contract terms that will help a veterinarian to survive a practice breakup are the same. It is important that practice owners have agreements governing employment/ownership compensation. It is also important that a stockholder or buy-sell agreement be in place.

Ownership Employment/Compensation Agreements
Veterinary practice owners must have agreements governing their compensation for services rendered to the practice. These compensation agreements can be structured as separate employment agreement with the practice or can be tied together as part of an agreement between the owners. These terms are important in order to evidence the actual agreement of the owners. If one owner has not been fully compensated when a breakup occurs, the other owner may try to argue that he or she wasn’t entitled to the additional compensation.

There are two basic structures for owner compensation for services rendered. The compensation can be based on either the production of the individual veterinarian or based on ownership interest. These two structures, however, have numerous variations that can be used to customize the structure to the needs of the practice and the owners.           

The benefit to a production based compensation structure is that the veterinarians are encouraged to work harder by being paid more if they produce more. This production structure also has the benefit of minimizing problems between owners when one veterinarian takes more time off than the other.

It is important that the owners consider whether or not they want non-competition/nonsolicitation terms in their ownership agreements. If the owners do want these protections for their practice, the terms must be part of either the compensation or the stockholder/buy-sell agreement. This is an important issue because the practice is subject to being harmed if the owner leaves the practice and takes clientele with him or her. 

Stockholder/Buy-Sell Agreements
The principal objective of a stockholder/buy-sell agreement is to restrict the transfer of the ownership interest in the practice. There are two types of restrictions that are commonly utilized: 1) contract terms that prevent the sale of an ownership interest and 2) contract terms that require the sale of an ownership interest.

These restrictions on the transfer of ownership interests are especially important to minority interest holders or owners that own less than 51% of the ownership interest. Minority interest holders could be damaged if majority interest holders were allowed to sell their shares and the associated control of the practice was sold to an outsider who is not sympathetic to the minority interest holders concerns. Similarly, majority shareholders may suffer from the sale of even one share to a recalcitrant, argumentative shareholder, particularly in a veterinary practice where the owners must work closely together to make the practice a success.

There are a variety of triggering events commonly used to force or prevent a buyout. One of these triggering events involves a selling owner who has received a good faith offer to purchase his interest. It is important that the stockholders agreement define what a “good faith offer” is in order to prevent a selling owner from trying to avoid the terms of the agreement by falsely claiming that a good faith offer exists.

Another common triggering event to force a sale of ownership interest is the death or permanent disability of an owner. These agreements can be structured to force a remaining owner to buy out the interest of a
permanently disabled owner or the interest of the estate after the death of an owner. These agreements can also be structured to give the remaining owners the first right of refusal to buyout the interest if they don’t want to be partners with the buyer selected by the disabled owner or the estate of the deceased owner. A stockholders agreement can be very beneficial to both the family of an owner who dies or the owner who becomes disabled and the remaining owners. A disabled owner or the family of an owner that dies receives the benefit of having a market created for the sale of the ownership interest. The remaining owners of the practice are also benefited because it permits them to control the selection of a new partner. If the remaining owners are unhappy with the selection they have the option of buying the interest and subsequently finding a buyer that they are comfortable with.

There are other triggering events that are beneficial for a veterinary practice. The retirement of a veterinarian is a common triggering event. This provision can be open ended to be effective whenever an owner wants to retire from the practice of veterinary medicine or it can require the owner to be a certain age or have practiced for a certain period of time with the practice. This is an important provision for implementation of a selling veterinarians exit strategy.

Another triggering event is where the owner is terminated from employment with the practice. This commonly occurs when there is an employment agreement identifying grounds for termination. If there is not an employment agreement, it is common to include a provision in the stockholders/buy-sell agreement that it is a triggering event to force a sale when an owner fails to maintain his professional license or to maintain his production at a certain level. This will give the practice the ability to get rid of an owner who is no longer focused on the success of the practice or is not longer able to practice.

A choice must be made at the drafting stage between a restriction permitting a partial purchase of the offered stock or one requiring a purchase of all-or-nothing by the corporation or the shareholders. A seller of the stock is at a definite disadvantage if the remaining owners are permitted to buy less than all of the seller’s ownership interest. A seller that has received a good faith offer to sell the stock is likely to lose the buyer if less then all of his stock is available. In addition, a seller will be discouraged from selling his interest if he or she could be left with a partial share of the stock. This may, however, be the desired drafting approach if the goal is to prevent an owner from selling his ownership interest. In the spirit of fairness, it is a better approach to require that the entire ownership interest be bought or none at all. The ownership interest could still be purchased by a combination of the practice entity and the remaining owners but with the requirement that it be a combined all or none proposition.

It is important that the owners agree upon a value or a formula to value the ownership interest in the practice in the event that a triggering event forcing a sale occurs. An advisable approach is to designate a per share value for a set period of time i.e. 12 or 24 months. The agreement should then provide that after the designated value term expires that a specific formula should be used to value the practice. There are a variety of formulas that can be used to value a practice. If the owners designate a specific formula, it is important that the owners fully understand the effect of their selection.

Another option is for the owners to specify a specific appraiser to conduct the appraisal as opposed to a specific formula. If the parties do not wish to designate a specific appraiser, provisions should be made for the selection of an appraiser if the parties cannot agree.

The stockholders/buy-sell agreement should state how the purchase of the ownership interest will be funded. It is advisable, although not a requirement, that insurance be obtained to fund buy outs arising from death or disability. There are various options available to a practice and its owners that should be explored to maximize the tax benefits for the purchase and ownership of insurance to fund a buy out.

The stockholders/buy-sell agreement should also identify the terms for installment payment if the practice didn’t buy insurance or if the insurance proceeds are not adequate to fully fund the buy out. The focus of the owners should be to balance the desire of the seller to get paid as quickly as possible, with the desire of the remaining owners to continue to operate the practice while paying off the purchase debt.