Peter H. Tanella
Legal Lingo columnist Peter H. Tanella chairs Mandelbaum Barrett’s National Veterinary Law Center. He earned his JD from Quinnipiac University School of Law and served as a Deputy Attorney General with the New Jersey Attorney General Office, Division of Law. where he was general counsel to numerous state agencies. He has advised hundreds of veterinarians on practice acquisitions, sales, mergers, partnerships, joint ventures and associate buy-ins, the structuring of management service organizations, and the development of practice succession strategies. He can be emailed at firstname.lastname@example.orgRead Articles Written by Peter H. Tanella
One of the most challenging exercises that veterinarians go through is planning for what will happen to their business if they die unexpectedly or become disabled. Emotional considerations and the stress of detailing a future business transaction can cloud the process.
Unfortunately, COVID-19 highlighted the importance of having both a succession plan and a business continuity plan that account for unforeseen emergencies. If your practice does not have those plans in place, now is the time for them.
The pandemic showed that all practices should have a business continuity plan that fluidly transfers responsibilities and facilitates communication between management and employees.
To determine the best way to tackle this uncomfortable issue, you first need to assess your situation. Are you the sole owner? Do you have partners? Do you have an associate veterinarian to whom you want to transition the practice?
The common starting point, regardless of your situation, is the practice’s operating or shareholder agreement. All veterinary practices, whether owned by a single veterinarian or many and whether structured as a limited liability company (LLC) or corporation, should have a governing document for its owners. In an LLC, that document is the operating agreement, while a corporation is governed by the shareholder agreement.
Understanding Buy/Sell Agreements
Perhaps the most commonly used mechanism for transitioning a practice in the event of a death or disability is a buy/sell provision within the operating or shareholder agreement. A buy/sell provision provides the owners with a clear process by which the surviving owners purchase the interests of the deceased or disabled owner. The provision will generally include the process by which the interests are valued, the purchase timeline is to occur and the method of payment. Buy/sell provisions can be incredibly intricate or relatively straightforward. Like most legal documents, the degree of complexity is dictated by your desired outcomes.
Structuring the buy/sell language can be done many ways, and veterinarians have many options for achieving the desired outcomes. However, the most critical aspect of the agreement is that it should be tailored to the practice and owners. For example, a buy/sell provision might require the surviving owners or the practice itself to purchase the interests in one lump sum or through a structured payment plan. If the practice owners do not want to burden the clinic’s future cash flow, they might opt for a lump sum. How the payment is structured will depend on the needs and financial situation of the practice and its surviving owners. Regardless, there are tradeoffs to any approach that must be thoroughly considered and addressed.
Selling to a Colleague
The process changes slightly if you are the sole owner and upon your death or disability the ownership will go to an associate or colleague. In this situation, having a buy/sell provision in the governing documents will not accomplish your objectives. After all, the associate or colleague is not a party to the agreement and as such, the agreement is not enforceable against them. Therefore, you need a separate buy/sell agreement.
Many of the same considerations and language will be in the new standalone agreement, but what’s important in these situations is to maintain open dialogue and a strong relationship with the purchasing party. Whereas a co-owner is privy to sensitive financial and operational data, an outside party is not. A delicate balance must be maintained in disclosing information necessary for the smooth transition and operation of the practice without comprising everything before the transition occurs.
Below are several key components of buy/sell agreements that should be addressed. Regardless of whether the language is a provision in the governing document or in a standalone agreement, you will want to ensure you give ample thought to these issues.
One of the biggest points of contention in any transition is determining a proper valuation. This is true in any business deal, not just when a transition is necessitated by the death or disability of an owner. However, in these situations, having a mutually acceptable and fair purchase price is much more important due to the emotional nature of the transaction. An opaque or overly one-sided valuation can cause friendships to end, resentment to breed and the practice to fall apart.
The best way to avoid these dramatic and unfortunately common consequences is to establish a clear valuation process in the governing documents to which all interested parties agree. This often takes the form of identifying an independent third party, such as a business appraiser or accountant, to conduct a valuation at the time of the owner’s death or disability. In addition to identifying an appraiser, a clear process sets strict timelines for obtaining the valuation.
Selecting the practice’s accountant or an individual known by the owner to conduct the valuation is tempting, but doing so can lead to conflict. Remember, relationships evolve over time and an individual universally trusted at the time the governing document was drafted might no longer be so reliable when an owner passes or becomes disabled. Therefore, drafting language that allows for the evolution of relationships but maintains independence and objectivity is crucial to the valuation process.
An additional component that you might want to consider is the utility of an ongoing valuation process that takes place before a transition occurs. You might want to include in the buy/sell language an ongoing requirement that the practice be valued regularly, perhaps annually.
This accomplishes two goals:
- It familiarizes all parties with the value of the practice before the transition. The party buying your interests is aware of the value in advance and can raise objections.
- It allows the parties to anticipate the financial steps necessary to prepare for a smooth transition.
Life Insurance Policies
If the surviving owners of a practice are purchasing your interests, the transaction will likely be one of the largest financial actions they undertake. One way to alleviate that stress and help ensure that the funds required for the buyout are readily available is to have a life insurance policy that benefits the practice. The language of the buy/sell agreement must require the practice to use the proceeds of the insurance policy to purchase your interests.
Another benefit of this approach is it allows you to require a one-time, lump-sum payment for your interests. While including this requirement in the buy/sell agreement will lead to increased costs — the practice generally pays the life insurance premiums — your estate can avoid the risk inherent in a structured payment plan. It is not uncommon for a practice to hold life insurance policies on all its owners for this reason.
Investing the time and resources early on to draft a well-thought-out and tailored operating or shareholder agreement is of paramount importance to ensure a smooth transition. However, even the most elegantly crafted agreement can become ill-fitting over time. Therefore, the most important action you can take after putting the agreement in place is to revisit it often.
As COVID-19 showed, life is full of unexpected twists and your circumstances years from now might be entirely different. Accordingly, you want the document that governs the transition of your practice to reflect those changes. Perhaps you had a falling out with the associate to whom you planned to leave the practice, or maybe several partners have come and gone since the inception of the operating or shareholder agreement.
Whatever the changes, your buy/sell agreement needs to evolve to reflect realities. If it does not, then you and the people you love might be forced to accept a transition that neither protects them nor reflects your intentions.