A previous article has discussed why private equity has invested in veterinary consolidator groups throughout the United States. This article discusses the elements of being a part of a private equity veterinary group that are relevant to DVM veterinary practice owners who will become employees / shareholders upon the completion of a practice sale
Skin in the Game
Almost any buyer of your practice prefers that you continue to practice, at your practice, post transaction. There are many reasons why this is preferred, not the least of which is that continuity in ownership, begets continuity in veterinary professionals, begets success.
Don’t expect free reign to take up and start a new practice down the road after a practice sale, particularly to a corporate. Every corporate deal I have seen contains negative covenants for the selling owner, including a non-compete. Non-competes are a “stick” to encourage, but not require you to stay at the practice post-sale.
The more significant encouragement comes from carrots. The carrots are consideration in the form of “equity.” I put “equity” in quotations because some parties call consideration “equity” when retention bonus, or performance bonus might be more honest. The basic idea is that the practice seller trades consideration today for the opportunity to own a security that will grow in value over time.
The equity carrot, ideally, aligns your incentives with the incentives of the corporate owner. You do well, the practice does well, the portfolio does better, everyone wins. It’s simple. Or is it?
Many offer letters that we see offer an opportunity for the selling practice owner to take some of the sale consideration in the form of “equity” in the acquiring entity (Corporate Equity). This equity is different from the equity one might receive in his own practice (JV Equity). Owning corporate equity gives a selling DVM exposure to the performance of a portfolio of veterinary hospitals while JV equity gives the selling DVM exposure to the performance of the hospital, or hospitals they are selling.
Many times the Corporate equity in offer letters is presented as having value beyond the consideration you are rolling into it. For instance, I often see offers that suggest the $1M being rolled into corporate equity may be worth $2M, or $3M in a future sale. These kinds of returns are not without precedent, but it’s important to realize that any equity investment carries risk. You can have some piece of mind knowing that you are, more or less, in the same boat as your private equity owner. Private equity firms are professionals and generally do all they can in good faith to see that their investments perform well. Still, just because we haven’t seen any major blow-ups in private equity investment in veterinary doesn’t mean that we won’t. Almost every other industry has seen them, why not veterinary?
The Corporate Operating Agreement
If you agree to take a portion of deal consideration in corporate equity, you will be asked to sign up to the Operating Agreement (or LLC Agreement etc) governing the rights of all corporate unit-holders, including management and the private equity owners. The provisions of this operating agreement merit careful review, but some in particular can have significant consequences for DVM unit holders:
1. Waterfall – to the extent the operating agreement defines different classes of unit-holders (which they often do), the waterfall determines which shareholders get which returns, and when. Oftentimes, private equity owners have preference returns relative to DVM owners.
2. Exit – As a unit holder and employee, there may be provisions allowing the Company to purchase your stock if you stop working at the practice or Company. The price and terms at which this purchase can occur are likely to vary based on the circumstances of the exit. For instance, if you quit the practice earlier than expected, the Company may be able to buy your shares back at the lesser of fair market value or cost. These provisions can have a major impact on what your corporate equity will be worth in the future.
3. Restrictive Covenants – Sometimes the operating agreement will require DVM unit holders to agree to extend, or accept additional restrictive covenants (i.e. a non-compete) in a change of control, or to agree to roll some portion of their owned equity into a new deal. Such provisions, move back the goal post of when you may be able to get liquid on your corporate equity.
These are just a few provisions that can impact the value to the deal. A notable problem is that you won’t see the operating agreement until after you have accepted an LOI, at which point you have the least amount of leverage. Oftentimes the Operating Agreement is presented as a “take-it or walk” deal document and at the last possible moment, leaving you little or no room to negotiate, and limited options beyond walking away if you don’t like it, if you even get the chance to read it entirety.
If your first glimpse of the operating agreement occurs after you’ve let your staff know you will be selling your practice, you may have no choice but to accept its contents. Sounds fun, right? Someone who has been through this process should know how to avoid this scenario. If you don’t have the right team, this moment will certainly expose that as fact.
With any corporate equity deal, the stakes are high and the terms matter greatly. If you like your corporate partner and maintain a good working relationship with them, you may not encounter any issues. But, the private equity company that owns your corporate partner can change and / or the relationship can sour, leaving you thinking about a way out, but unable to leave without leaving behind a material amount of wealth you’ve worked hard to build. If you find yourself in this position, you will almost certainly wonder what if I had approached my practice sale and negotiation differently.
A lawyer can help you protect your down-side but is less likely to be able to help you maximize your negotiating leverage to improve the business terms that apply to you. You hire an expert financial advisor to do exactly that, among other things.