Despite volatility in the broader U.S. economy, the market remains favorable for those seeking to buy or sell a veterinary practice. Sellers are receiving prices that, while perhaps not quite as high as they were at their recent peak a few months ago, are still much greater than only a couple years ago. On the flip side, buyers remain motivated to buy because veterinary practices continue to demonstrate strong and steady growth. Whether you are buying or selling, the process usually kicks off with one key document: a letter of intent.
What is a letter of intent?
Surprisingly, buyers and sellers of veterinary practices often spend little time on the letter of intent, which is the single most important document in the process. A letter of intent (also known as an “LOI”, indication of interest, or a term sheet) is a document between 2-10 pages in length that summarizes the key deal points of a practice sale using minimal legalese.
The primary purpose of a letter of intent is to make sure the parties agree on the main deal points before they spend significant time and money negotiating the detailed legal contracts needed to complete the practice sale. It can take between 1-4 months to finalize the legal contracts, so it’s imperative to have a clear roadmap set forth in the letter of intent before the contracts are prepared.
Why does a letter of intent matter?
It is critical that buyers and sellers work closely with their respective attorneys, tax advisors, and business stakeholders to negotiate and structure the letter of intent before it is signed. The reason is simple: once the main deal terms are agreed to in a letter of intent, it’s hard to “un-ring a bell”. That is, it’s an uphill battle to later convince the other side that you need to change something you already agreed to in the signed letter of intent.
Unfortunately, I’ve seen many instances when a buyer or seller signs a letter of intent before they discuss it with their attorney, tax advisor and/or all key business stakeholders. In these cases, my client is often surprised to learn they agreed to terms that have unexpected or unfavorable legal, tax or business implications. But at that point, it’s difficult to renegotiate the deal.
What is the recommended strategy for reacting to a letter of intent?
In particular, sellers are notorious for rushing to sign the first letter of intent they receive from a potential buyer. This might be because the vast majority of sellers have never before sold a veterinary practice. Many of these sellers worry that if they don’t quickly accept the buyer’s first draft of a letter of intent, the buyer will suddenly withdraw the offer and the seller will have blown their only opportunity to sell their practice.
In reality, revising the first draft of the letter of intent rarely causes the other side to walk away from the deal. And if it does, question whether you really want to do business with someone who adheres to the “my way or the highway” ethos.
More importantly, a buyer or seller’s first offer is rarely their best offer. So by signing the first draft of a letter of intent, you are usually short changing yourself.
Will the market shift soon?
The ability to quickly move a practice sale from initial offer to closing is paramount. Many anticipate that key industry players could soon file for an initial public offering (also known as an IPO) and that, if and when they do, the success or failure of that initial public offering will directly affect whether the market for veterinary practices remains strong in the short-term.
To minimize the likelihood that this or other factors derail a practice sale, be sure to negotiate a quality letter of intent.
What goes into negotiating a letter of intent?
A letter of intent should strike a balance between addressing the key business, financial, and legal deal points without becoming overly detailed. The right balance depends on the parties and their priorities.
For example, a party who is thrilled with the purchase price set forth in a letter of intent might lean towards accepting a shorter letter of intent because the benefit of the favorable purchase price could outweigh the risk that the unaddressed deal points will turn out to be dealbreakers down the line. But use caution with this approach—even a great purchase price can quickly become unattractive if it later turns out the other side wants unreasonable legal protections as part of the sale.
On the other hand, a party who feels the purchase price is “just ok” may require a more detailed letter of intent to ensure they receive favorable terms on the non-monetary deal points as a tradeoff for the less than impressive purchase price.
Regardless of your situation, a quality letter of intent should include:
- The overall purchase price.
- The form of the purchase price (cash or equity).
- When the purchase price will be paid (all up front or in installments).
- Whether the purchase price will include an escrow, holdback and/or earnout component.
- The legal structure of the purchase (e.g., asset purchase, stock purchase, merger or joint venture), which directly affects the tax consequences for the buyer and seller.
- The key indemnification terms.
- How long the selling practice owner(s) will be required to work at the practice after the sale, and under what terms. An often-overlooked issue is whether there will be a severance component.
- The implications for the physical location for the practice. Will the property be sold to the buyer? If there is a lease, can the seller assign the lease to the buyer without the landlord’s consent?
- Whether there will be key conditions to closing. In other words, are there issues unique to the practice that need to be resolved in connection with the closing?
Bottom line: Be intentional about your letter of intent
Put simply, any practice sale requires a complex negotiation of various financial, legal, and business terms. While it requires a little more work up front, a well drafted letter of intent makes the sale process faster and more efficient. That is because the parties are already on the same page before they draft the definitive legal documents.
Proceeding with no letter of intent—or a poorly drafted letter of intent—creates the risk that you may pay your attorney and CPA for many hours of work to write or review a 30ish page purchase agreement, only to have the other side reject it outright because it turns out the parties were not in the same ballpark.
Spend the extra time to carefully craft any letter of intent that you extend to a potential seller or receive from a potential buyer—it’s the most important step you can take in the entire process!
