How to Sell Your Practice and Maximize Your Profits
Edward J. Guiducci, J.D.
It is the goal of virtually every veterinarian to be able to sell his or her practice at the time of his or her choosing for a maximum value. Unfortunately many veterinarians find themselves unable to locate a financially viable buyer at a time of their lives when they are ready to exit their practice. Veterinarians must plan an exit strategy in advance to increase the likelihood of their exiting their practice at a time of their choosing with the maximum amount of net dollars. I refer to this planning process as “succession planning.”
What Is a Veterinary Practice Succession Plan?
The concept of veterinary succession plans is foreign to many veterinarians. A veterinary succession plan is not a financial retirement plan, although there are important financial implications to a succession plan. It is not a tax plan, although there are important tax consequences to a veterinary practice succession plan. A veterinary practice succession plan is a plan of action to enable an owner to exit his practice at a time of his choosing and to maximize the after-tax profits from the sale. It can be very detailed if the veterinarian is wanting to begin implementing the plan in the near future or it can be very general if the veterinarian is not planning on acting on the plan for many years.
Benefits to Creating a Veterinary Practice Succession Plan
1. Forces Veterinarian to Do Long Term Planning For Practice
A veterinarian’s ownership interest in his or her practice is commonly one of his or her most valuable assets and is frequently a major source of retirement income. The planning involved in the selling of such a valuable and important asset needs to be managed with the same level of attention and detail as given to a retirement plan or a child’s education fund. A veterinary practice succession plan forces a veterinarian to direct his or her attention and energies to making long term planning decisions.
2. Expand Options to Minimize Risk
It is very important that a selling veterinarian be flexible and willing to consider all of his or her succession planning options in order to minimize the risks associated with these types of transactions. A selling veterinarian needs to understand that there is more than one structure that can be utilized to meet his or her goals. It is a very risky decision for a veterinarian to decide that there is only one way for him to accomplish his or her goals. An example is a selling veterinarian who has decided that the only succession planning structure that he or she is comfortable accepting when he or she is ready to retire is a cash purchase of his or her practice assets. All too frequently, buyers with the financial ability to purchase the practice do not appear when the seller is ready to sell. When this happens the selling veterinarian will be forced to continue practicing after he or she wanted to retire or be forced to hire an associate to operate the practice after he or she retires. This is risky for the selling veterinarian because the market value will be reduced if the practice is not maintaining a certain level of production. It is also a reality that certain buyers fail to comply with the terms of their agreements when the seller accepts a promissory note as part of the purchase price. When this happens, a selling veterinarian will normally be forced to take back the practice and operate it until he or she can find another buyer. This may not be a problem if the seller is 60 years old and is in good health, but it can be a big problem to a seller who is 65 and in bad health. In that situation, the seller may be forced to hire an associate to operate the practice until he or she finds another buyer. This scenario normally causes the seller to sell the practice for a reduced price.
3. Maximize After-Tax Value of Veterinary Practice
Veterinarians frequently fail to focus on the bottom line profitability of their practice that affects the after-tax value of the practice. All too frequently veterinarians fail to balance providing affordable care to owners of animals with the priority of having a productive and profitable practice.
We have found that one of the reasons that veterinarians are opposed to creating succession plans is that they do not believe that there is much value in their practice. We have been involved in transactions where veterinarians in multiple doctor practices have contractually obligated themselves to sell their interest for a below market value regardless of their ability to sell for fair market value on the open market. We have also been involved in transactions where selling veterinarians are interested in selling their practices to associate veterinarians in small percentages over a ten year period of time without requiring the value of the interest to be periodically updated. A selling veterinarian that agrees to such a structure is losing the increase in value that is occurring as a result of the work of the selling and buying veterinarian.
Careful planning of the structure of a succession plan can have significant after-tax effects upon the value of the selling veterinarian’s practice. In order to accomplish these goals, veterinarians must examine their succession plan options with enough time to implement. Many options to maximize the after-tax benefit cannot be implemented on a short term basis.
4. Create a Market For Your Practice
A thoroughly analyzed veterinary practice succession plan can expand the number of potential buyers and create a market that the selling veterinarian had not previously considered. One reason why veterinarians fail to create succession plans is because they are confident that they will find a viable buyer for their practice. Many veterinarians believe that a large public or private corporation will be in the market to buy their practice when they are ready to retire. Unfortunately, many selling veterinarians discover when they begin marketing their practice that large corporations aren’t actively acquiring veterinary practices of their size and location.
Selling veterinarians that believe that they will not have any trouble finding a qualified (non-corporate) buyer also learn that there frequently are few veterinarians looking to purchase a practice and many that are have bad credit preventing them from obtaining a loan to purchase the practice.
There are of course exceptions. There are more national lenders that focus their business on lending to veterinarians to purchase practices. These lenders realize that veterinarians are excellent credit risks so long as the veterinary practice can cash flow their debt services and the practice assets are pledged as collateral. There are also corporations that are purchasing veterinary practices to break into certain markets or to increase their market share in certain areas. We have also dealt with parents of young veterinarians either personally guaranty the loan of a buying veterinarian or simply purchase the practice for their adult child. However, like the large corporate acquisition, this is unusual in relation to the total number of practice transactions that occur every year.
Although a selling veterinarian may be lucky enough to have a large corporation purchase his or her practice or he or she may find a willing buyer with good credit to purchase a practice, it is shortsighted in our opinion for a selling veterinarian to rely upon such a scenario when it is not a guaranty.
When Should You Create a Veterinary Practice Succession Plan?
It is important for a selling veterinarian to explore succession plan options years before his or her target date for exiting the practice in order to maximize his or her options. It is not unusual for an associate buy-in structure to take up to ten years to complete. A selling veterinarian that waits until two years before his or her target date to separate from the practice has minimized his or her options in structuring a succession plan transaction.
What Are Your Options In Structuring A Veterinary Succession Plan Transaction
There are a multitude of options for structuring a veterinary succession plan transaction. The transaction will vary dramatically depending upon whether the buyer is buying all or part of the practice. A buyer that is either buying all of the stock in a corporation or all of the assets of the practice, will have a structure that is normally substantially different from a buyer who is buying into an existing practice. There are, however, a few basic transaction structures that encompass almost all succession plan transactions. The transaction will ordinarily fall into one or two general categories - asset sale or stock sale. There are some basic distinctions between the two types of sale transactions that are important for a selling or a buying veterinarian to understand:
Asset Sale Structure
A veterinary practice asset sale is almost always used when one or more buyers are acquiring an entire existing practice. The buyer will have formed his or her own business structure for taking title and operating the practice. If there is more then one owner of the buyer’s business structure, the owners of the buyer’s business structure will have entered into agreements between them to control the buyout of the owners’ interest in the event of the death, disability or retirement of the owners.
In a veterinary practice asset sale, the buyer has the opportunity to pick and choose what assets he wants to purchase from the seller. There are certain assets that selling veterinarians will commonly exclude or sell through a separate transaction. These types of assets include accounts receivable, cash on hand, bank accounts, company automobiles, and personal items of the selling veterinarian i.e. books, art, etc.
Another aspect of an asset sale is that the buying veterinarian can select which liabilities of the Selling Veterinarian that he or she wants to assume by taking over responsibility to pay. An example of this is a service contract on a software program that the seller has contracted to receive. The buyer may not be interested in using the current system and may refuse to assume the service contract obligation. This can frequently be a substantial issue for a selling veterinarian who will insist upon certain liabilities being assumed regardless of the buyer’s intention to not use the service.
There are also certain tax issues that are present with an asset sale that do not apply to certain stock sales. Sellers of assets will normally be required to pay taxes on the recapture of certain tax deductions that had previously been taken on the purchase of hard assets of the practice i.e. chairs, desks, computers. The amount of the recapture of the depreciation tax deduction will be based upon an allocation of the purchase price between the categories of assets being sold. If there is gain beyond the purchase price for the hard assets of a company, it will be taxed as a capital gain on that amount. This is a rare, however, because most hard assets will lose their value over time.
Buyers of assets need to be aware that the tax allocation agreement that identifies the purchase price for each type of asset being sold will control the length of time that buyer is permitted to depreciate the purchase price as a tax deduction. In 1993 the Internal Revenue Code was amended to permit buyers of assets to depreciate goodwill of a practice over fifteen years. Prior to this amendment, a buyer was not permitted to depreciate the purchase price for the goodwill of a practice. This was a disadvantage to a buyer who was unable to obtain a tax deduction for the value of the goodwill until the sold the asset.
Buyers and sellers will sometimes have difficulty in agreeing upon how to allocate the purchase price among the categories of assets being sold. A seller will normally want the tax allocation of the purchase price for the tangible assets to be less to avoid paying taxes on the recapture. This is in contrast to a buyer who will want to allocate a larger amount of the purchase price to tangible assets which are permitted to be depreciated over a shorter period of time then goodwill.
Stock Sale Structures
The principal difference between an asset sale and a stock sale is that in a sale of stock, a buyer buys an interest in the entire business of the selling veterinary practice. This is in contrast to an asset sale, where a buyer is picking and choosing the assets that he wants to buy. Stock sale structures are utilized in many different situations when the veterinary practice is being operated as a corporation. The structure is commonly utilized when one of the shareholders is retiring or leaving the practice. This structure is also utilized when an associate is buying into a practice by stair-step purchases of a selling veterinarian’s ownership interest in a practice. This structure can also be utilized when a veterinary practice is expanding and adding an additional owner.
A risk with buying stock in a corporate practice is that an unknown claim or liability could appear after you purchased your stock thereby reducing the value of your stock. The stock sale transaction documents will require that a seller disclose to the buyer any debts and other liabilities. Unfortunately, this is not always an effective remedy for a buyer because the buyer would be forced to sue the seller if he or she does not agree to compensate the buyer for the liability. In addition, if the seller was not aware of the liability the buyer has no claim against the seller. This is contrast to an asset sale where a buyer will take steps to only obligate himself or herself to buy specific identified assets and specific liabilities. The buyer will specify in the contract that he or she will not assume other liabilities of the selling veterinary practice and will require a selling veterinarian to comply with the necessary procedures to insulate the buyer from these liabilities.
There are benefits to existing stockholders when an associate is brought into a practice through the issuance of new stock. If a veterinary practice is wanting to finance expansion of its facility it will commonly do this, at least partially, through the issuance of stock to a new veterinarian. By financing an expansion through the issuance of new stock, the existing veterinarians will receive the benefit of the expansion without having to take on as much additional debt. The downside of course, is that the existing veterinarians will own less of the practice but if the expansion is successful, the value of the practice should increase.
The existing stockholders will also benefit from having an additional owner to fund a buy-out if one of the veterinarians dies, becomes disabled or retires. The addition of the additional owner through the issuance of stock to a new veterinarian establishes a succession plan for the remaining stockholders.
Sellers of stock in a veterinary practice operating either as a “C” or a “S” corporation receive favorable tax treatment. The gain on the sale of a shareholder’s stock will be taxed as capital gains. This rate, especially if held long enough to be classified as long term capital gains, will normally be substantially less then the veterinarian’s individual income tax rate.
The buying veterinarian needs to be aware of the tax effect of a stock purchase. A buying veterinarian of stock is not entitled to depreciate the purchase price for the stock like he or she would have if assets had been purchased. The buyer can, however, retain a high tax basis in the stock and depending upon the transaction could be able to retain the net operating loss (NOL) carry forwards with the corporation. A benefit for a buying veterinarian with a stock sale is that this could avoid a use or transfer tax upon the sale that may be present in an asset sale.
A stock sale structure between an existing veterinarian who wishes to exit his practice at some point in time in the future can be very simple or very complicated. Frequently, this type of a structure involves a selling veterinarian that is wanting to sell a portion of his stock in the practice in order to establish his succession plan. The selling veterinarian will want to contractually bind the buyer to purchase his remaining interest when he is ready to retire.
This type of a structure requires detailed analysis of the goals of the buyer and the seller in order to structure a legal relationship that will meet the goals of both veterinarians. This stock sale becomes more complicated when a buyer does not have the financial ability to purchase the seller’s stock without the seller financing the purchase price. Depending upon the value of the practice, this may create difficulties in structuring a purchase so that the seller has had most of his interest purchased and paid off before exiting the practice. This is especially a problem when the value of the practice is so high that the buyer cannot generate enough cash from his production and ownership in the practice to pay the monthly payments for the purchase of the stock and to live. In this situation, a seller either needs to accept the fact that it will take a long term payment structure to complete a succession plan with this buyer or that he will have no choice but to find another buyer.
If a seller of stock agrees to finance the purchase over a long term, the transaction will normally be structured to permit the buyer to buy the seller’s stock in small increments. The succession plan will require that the buyer pay the purchase price for each stock increment in full before buying the next increment of stock. This buy-in plan will normally establish deadlines when the buyer will be required to purchase the remainder of the seller’s stock. Although this would appear to be limiting to a seller, it actually benefits the seller by establishing deadlines for the buyer to have paid the seller for his stock. This type of a structure also benefits the seller because he or she will receive the increase in fair market value of the stock that is subsequently sold by the seller to the buyer.
This stock sale will also be structured to obligate the buyer to purchase the entire remaining stock interest when the next increment would give the buyer a majority stock interest. This protects the seller in that it prevents the buyer from having control over the practice without having bought out the entire stock interest of the seller. The sale can also be structured if the seller so desires, to require the corporation to hire the seller as an associate for a certain number of years after he sells the final increment of stock. The term of this employment agreement can parallel the term of the promissory note on the final stock purchase or it can be structured to permit the seller to keep working until he is ready to retire.