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A previous article has discussed why private equity has invested in veterinary consolidator groups throughout the United States and North America. This article discusses the elements of being a part of a private equity veterinary group that are relevant to DVM veterinary practice sellers who will become employees / shareholders upon the completion of a practice sale.
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 (Join Venture - 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.
Having a continuing equity stake in the practice, or practices you are selling might be preferable since you will have more direct control over how your investment performs. We like JV equity for owners who have built and enjoy running successful practices. In theory, with some help from a professional manager and access to sophisticated corporate functions like recruiting, such an owner can grow her practice beyond what she could do on her own, and profit from that growth.
That’s the theory anyway, but reality exists in the details as manifested by the contracts you sign. To consummate a JV sale, you will be required to sign up to an operating agreement for the new entity which will be owned by your corporate partner and you, the seller. Almost always, you will be the minority partner. By definition, you will be required to defer to the decisions of the majority owner (the corporate partner) in certain areas. The details of these agreements vary by party, but all contain key provisions that determine how much of the upside in the practice you may be able to participate in
- Exit Value – the JV operating agreement will specify the value you can receive from the sale of your stake in the JV. The valuation is typically determined by a practice level exit multiple and the adjusted EBITDA of the practice. Beyond this, the devil is in the details. Sometimes the exit multiple is fixed in the agreement, other times it is tied to the exit multiple the corporate obtains when it sells. The corporate partner may be allowed to deduct capital charges, corporate allocations and / or the management fee and other expenses from its calculation of EBITDA, and you may, or may not (probably not) have the ability to disagree with the calculation.
- Exit Timing – The agreement will also dictate when you might be able to sell your JV stake and under what circumstances. Sometimes you can only sell when the corporate sells, other agreements have put rights that allow you to sell after a certain period of time and if certain conditions have been met. Like with corporate equity, there may be provisions which require you to roll some of your remaining stake into a deal with a new corporate owner. Almost always, the multiple at which your stake is valued will be determined by the circumstances and timing of the sale. These provisions can have a material impact on your ability to participate in the future value creation you drive at your practice.
- Termination – the agreement will specify (or make reference to another agreement which does – possibly the employment agreement) the circumstances under which your involvement with the JV practice can be terminated for Cause and what happens if you leave voluntarily before it is expected. Getting terminated for cause will almost always allow majority partner to pay you less for your JV stake, sometimes way less. For instance, if you quit earlier than expected, or are terminated for Cause, the exit multiple applied to your JV stake may be the lower of cost or market value. If you’ve helped generate meaningful value at the practice prior to that point, you will have no ability to capture it in this case. Tough luck.
- Management Fees - some agreements call for the practice entity to pay management fees to the corporate owner. The services provided for these fees may be clearly spelled out, or left pretty ambiguous. In all cases, they are deducted from the profit of the clinic available for distribution to the owners.
- Debt – Every private equity firm backed corporate has a corporate debt facility. In many cases, the JV agreement gives the lenders who extend this credit access to your JV equity as collateral. If so, you may generate a lot of value only to find that your JV stake now belongs to a lender because the corporate entity failed to perform. Sorry ‘bout it.
These items are just the tip of the iceberg. As with the corporate equity operating agreement, you will not see a draft of the JV operating agreement until after you have signed an LOI. If you haven’t considered these issues prior to accepting an LOI, you may find that the value described in your offer has more risk than you had believed. At the time you realize this, your ability to negotiate any of these key provisions has most likely come and gone.