Letter of Intent
A letter of intent is a non-binding document that states that a certain party or parties intend to buy or sell a practice. It allows the parties to contemplate a potential transaction without creating a legally binding offer, sets out a framework for negotiation, allows the parties the right to further negotiate the definitive transaction documents, and to consider any due diligence findings. While the letter of intent is non-binding, it does obligate both parties to negotiate the definitive transaction documents in good faith. One party’s failure to negotiate in good faith may create a legal claim by the other party to recover its transaction expenses.
In the previous months’ articles on Selling Your Practice, we discussed why so many physicians are selling their practices. We counseled you to continue to run and grow your practice, to prepare early, and to assemble a team of experts.
We then suggested you begin to educate yourself by learning the difference between the two most common type of transactions—a capital sale and an asset sale. We discussed the need to complete an objective analysis of your practice, and to develop a financial pro forma.
Then, we covered the need to prepare for negotiation by understanding what you want from a sale of your practice, and the need to determine its value. We turned our focus toward identifying potential buyers, and performing your own initial due diligence on potential buyers before putting your practice up for sale. Last month, we discussed the development of a confidential information memorandum (CIM), approaching potential acquirers, and signing non-disclosure agreements.
Most well-crafted letters of intent will include at least the following provisions:
- Form of the purchase transaction: Referring back to the third article in this series, Understand the Implications of a Sale Structure and Related Tax Considerations, the form of the purchase transaction will outline if the sale of the practice will be in the form of a capital sale or an asset sale.Remember, a capital sale is often the preferred approach for a buyer, and an asset sale is often the preferred method for a seller. Both sales structures have significant tax consequences on sellers and buyers, and therefore the form of the transaction is a material consideration of the sale.It’s worth noting that most medical practice transactions are in the form of an asset sale.
- Purchase Price: Simply put, the purchase price is the total economic value a buyer is willing to pay for a medical practice. The buyer often cites support for how the total purchase price was developed by representing the purchase price as a multiple of revenue and/or EBITDA. The purchase price is often referred to as a “headline number.” However, the devil is always in the details, and the real purchase price must take into consideration the assets and liabilities that are being acquired by the seller, the portion of the transaction that is subject to an earn-out, the ongoing employment terms, and the value of the representations, warranties and the amount of money left in escrow to indemnify the buyer if the representations and warranties prove to be untrue.
- Payment: The payment methodology is usually in the form of cash or rollover equity. Some transactions allow the buyer to take a portion of the purchase price in the form of equity in the new company. If it is structured correctly, taking equity in the new company may allow the seller to postpone the tax consequences of a prorated portion of the sale price, and participate in any value appreciation in the new company. The value not paid in equity is usually paid in cash.
- Escrow: An escrow is used to ensure the representations and warranties of a seller to a buyer.It provides comfort for the buyer by verifying that should the representations and warranties prove not to be true, funds will be available to pay for the settlement. There is usually a defined period of time in which the buyer can make a claim. Absent a claim, the escrow is paid to the seller after the time period has expired. Escrow balances are often held by a third party.
- Contingencies: A contingency clause is a provision that requires a specific event to take place in order for the sale to move forward. The contingency clause will require one party to satisfy the contingency clause, and if they cannot do so the party is released from its obligation. Perhaps the most common contingency clause is making the purchase of the medical practice subject to obtaining financing from a lender. In the event the buyer cannot secure financing, the buyer can walk away from the letter of intent in good faith.
- Conditions: Conditions outline the major terms of the transaction.In the case of a sale of a medical practice, the conditions will include the material terms for the employment contract for the seller, define restrictive covenants and any earn-out provisions, etc.
- In the event the seller is expected to continue employment in the practice, the material terms of an employment contract will often include the length of the employment contract, compensation terms and methodology, the work schedule and allowed time off, employee benefits, termination provisions, and restricted covenants.
- Restricted covenants usually include provisions for non-compete and non-solicitation of patients and employees.
- Earn-out provisions are often negotiated when a buyer and seller cannot agree on a final price. The earn-out provisions allow the seller to collect future compensation if the business achieves certain financial goals, and at the same time it reduces the risk to the buyer.
- Due Diligence: The letter of intent acknowledges that the seller has provided preliminary information, and used this information to complete an initial due diligence. However, to finalize an offer, a more exhaustive due diligence process will need to be completed. The buyer and seller must agree to cooperate in completing the due diligence process.
- Closing Date: Often, the targeted closing date of the transaction is documented. This provides an expectation on the part of the buyer and the seller that both will cooperate in completing the due diligence and definitive transaction documents in an orderly fashion.
- Exclusivity Period: The exclusivity period gives the buyer the exclusive right to complete due diligence, and negotiate the definitive transaction documents. Most buyers will not agree to sign a letter of intent or spend the money to complete due diligence or the definitive transaction documents without an exclusivity provision. As a result, sellers will often wait as long as possible to execute a letter of intent to let other bidders continue to sweeten the terms of the letter of intent.
Solicit a letter of intent and negotiate the material terms of a sale
In previous months, we discussed developing a comprehensive list of potential buyers, and approaching these potential buyers to engage in meaningful dialogue in order to determine the fit with the potential buyer, and gauge their interest. It is best to cast a wide net, and identify numerous good fits for your practice. If you can attract multiple buyers, your advisors will be able to invite these potential buyers to an auction. The prospective buyers enter the auction by submitting a letter of intent that outlines the material terms of the deal. Generally speaking, when there are multiple interested buyers, it usually translates into a competitive bidding process that drives up the price of the practice, and produces better terms for the seller.Certainly, price is not the only consideration when considering a sale of your practice. Even if there is a buyer that is the clear favorite, having multiple bids can help drive up the preferred buyer’s bid.
Once the first round of bidding is complete, the seller is not compelled to sign a letter of intent. Rather, these letters of intent should be construed to be “invitations to negotiate.” The negotiation process is completed formally by marking up the submitted letter of intent to create a counterproposal. When developing your counterproposal, refer back to the previous article where we discussed preparing to negotiate, understanding what you want from a sale, and determining the value of your practice. These previously-developed insights will help guide you in your negotiation and in developing your counter proposal, and it will help ensure you achieve your end goal.
Often, there can be multiple rounds of counterproposals before a deal structure is established. Once the letter of intent and the material terms of the transaction are negotiated and executed, the transaction moves into the due diligence, legal documentation, and final negotiation phases. Next month, we will discuss what to expect during the due diligence, legal documentation, and final negotiation phase