Elizabeth Bellavance, Simmons Canada
It is becoming more common for suppliers of veterinary products and services to enter into long-term contractual agreements with veterinary practice owners. These agreements can have far-reaching implications for veterinary practice owners, especially if owners want to sell their practice during the agreement term. Read on to learn why we advise caution before signing these long-term agreements.
How Veterinary Practice Leases Affect Practice Value
As veterinary medicine has become more sophisticated, it has required some practices to invest in expensive equipment such as digital radiographs and MRIs. The equipment may be purchased outright or through financing. Capital leases are frequently used to acquire the equipment and are considered financing leases.
Liabilities play a role in practice value. In an asset sale, the purchaser buys the business’s assets and not the liabilities. With a share sale, the purchaser is buying the shares of the business. Unless other arrangements have been negotiated, it is expected the seller will pay off the long-term debt, including the lease debt, when selling their practice. If the buyer assumes the debt, it will likely be reflected in the price the buyer is willing to pay.
An equipment purchase using financing is a liability that can impact practice value calculations. Capital leases are also forms of financing that can impact practice value. Many operating leases recorded on income statements, when examined in detail, are actually capital leases and should be treated as a financing lease.
There is risk involved with an investment in capital equipment. For example, will it generate enough cash flow to cover financing expenses? What happens if a practice owner enters into a lease agreement involving a major capital investment a year before a practice sale? A practice purchaser may be reluctant to take over a lease agreement without a proven track record of the asset generating the revenues to pay for itself. Even when the agreement provides that there will be rebates or credits to offset the liability payments, there are still consequences to the buyer that may not be acceptable.
If a practice sale is contemplated soon, consideration should be given to how a potential buyer will view the lease agreement. In some cases, an agreement may not be transferable to a new owner.
Service Provider Contracts
Suppliers of veterinary practice services such as laboratory services are also trying to secure long-term service agreements with veterinary practices. These long-term arrangements can benefit both the supplier and the practice, but they can also be problematic for sellers and buyers when contemplating a practice sale or purchase.
Some of these service agreements involve an attractive ‘discount’ on services. However, closely reading the fine print will indicate these discounts must be refunded if the service agreement is discontinued. What if a practice purchaser does not wish to use the same laboratory services? What if they do not wish to enter into the same agreement? If the agreement is for 5 years and the practice has fulfilled 2 of the 5 years, the practice owners could be liable for 2 years of discounts if the agreement was terminated upon the sale of the practice.
The words “non-cancellable” and “non-transferable” may also appear in these long-term contracts for various services. The owner(s) who signed these agreements could find themselves fulfilling contract obligations well beyond their practice sale.
Upon the sale of a practice, sellers may find the long-term agreement they signed:
- is not wanted by the buyers.
- is non-transferable to the buyers.
- cannot be canceled.
- requires sellers to pay back any cumulative discounts they earned since signing the agreement.
- requires sellers to payout a lump sum to end the contract.
These details can cost sellers dearly when they sell their practice. Suppose the lease or relationship is assignable and transferable. In that case, it may be possible to transfer it to the buyer, but this frequently includes a negotiated purchase price adjustment for the liability.
Simmons Is on Your Side
In conclusion, protect yourself. Use caution when entering into a long-term agreement or relationship. Read the agreement details, and consider the implications if an ownership change is in your future. Assess the agreement from the buyer’s perspective and the buyer’s attorney. Just because it is assignable or the relationship pays the cost does not mean that the buyer will accept it.
When it comes to doing what is best for you as a veterinary practice owner, Simmons Veterinary Practice Sales and Appraisals has helped owners like you for decades through expert guidance, resources, and services. Contact us today to learn more about how Simmons can help you navigate the world of veterinary practice ownership.