INSIGHTS: Consider these fundamentals before purchasing a professional practice

March 31, 2014

If you are thinking about purchasing a professional services practice, whether it be a dentistry practice or other, there are a number of important matters to consider. In advising prospective purchasers, we sometimes see prospective purchasers get carried away with the idea of owning their own practice but do not properly consider some fundamental business issues.

Prior to purchasing a practice, we recommend that at a minimum, you consider the following:

Is the practice you are considering purchasing worthwhile as a business proposition?

Usually people consider purchasing a professional services practice to obtain a client base, an existing location and in some cases, equipment. If all of these things are acquired, the purchaser ends up with a ready made practice. If everything goes to plan, the purchaser should, over time, make a reasonable return on his or her investment. However, this does not always happen and acquiring a practice does present risks that need to be managed. Very early on it is important not to make any assumptions and “do your homework”, before committing to the acquisition.

This article touches on some of the things that practitioners should do when considering acquiring a practice.

  • Due diligence

It is essential to conduct proper due diligence prior to purchasing a practice. The kinds of things that need to be considered (at a minimum) include:

    • financial records;
    • employment contracts and contracts for services – who are the key people, and are they bound by obligations designed to protect the practice goodwill? Are there any “contractors” who are in fact employees?
    • technology and database management – is the database well secured, who has access to it, and has it been compromised?
    • leases (both premises and equipment). The premises lease can be a critical asset as it underpins any location goodwill. Check on tenure (balance of term and options), rent and review mechanism, outgoings, statutory disclosure of lease terms, redevelopment provisions (which can lead to an early end to the lease);
    • deferred payment arrangements for ongoing services, and other arrangements amounting to prepayments for services;
    • corporate structure;
    • insurance claims history; and
    • GST and tax compliance.

 

If these matters are not the subject of due diligence, the purchaser may end up purchasing a practice with major financial problems and indeed, may end up purchasing something different from what was expected.

  • Get legal and accounting advice

Purchasing a practice is a major financial undertaking. You need to give yourself the best chance of ensuring that you fully understand and receive what you are setting out to purchase. Legal and accounting advice is an additional expense in circumstances where you are already making a considerable financial investment, however these costs are likely only to be a relatively small amount compared to the investment itself, and should in fact be viewed as part of any rational investment.

  • Make sure the acquisition is properly documented and managed

Typically it is the vendor’s lawyer who prepares the sale contract. We see a good number of post-acquisition issues arise where the purchaser has not taken any independent legal advice in relation to the sale contract. It is impossible in this short space to list all the matters that the sale contract should address from the purchaser’s perspective. It is critical that any areas of concern in due diligence are addressed, for example: if the premises lease is about to expire, the purchaser will want to ensure the purchase is conditional on an extension of lease or new lease being agreed with the premises owner; if it is intended that the vendor will work in the practice for a period after settlement, a separate services agreement should form part of the transaction documents. A prudent purchaser should also obtain reasonable warranties from the vendor, especially in relation to the accuracy of financial data provided to the purchaser, and that the vendor has complied with all laws in carrying on the practice. One area that is deserving of special mention is the inclusion of enforceable restraint obligations binding on the vendor.

  • Have you negotiated an adequate restraint?

If the vendor of the practice is retiring and does not propose to work again, it may seem that a restraint preventing him/her from working in the general geographical location of the practice is not necessary, but this would be a mistake. The vendor may have intended to retire but, for whatever reason, changes his or her mind and subsequently wishes to start up again, perhaps on a part-time basis and perhaps with a friend down the road.

If this were to occur, it could potentially be disastrous for a purchaser who has only recently outlaid a considerable sum to acquire the practice goodwill. Ensuring there is a well crafted restraint clause is a way in which you can ensure the vendor is not able to take back some of the patients that you thought were included in the goodwill of the practice you purchased.

It is not uncommon for the vendor or the key practice principal to stay on in the practice after the acquisition, usually as a consultant or contractor. This must be managed with extreme caution and is something of a “two-edged” sword – on the one hand, if properly managed, the presence of the former practice principal can be instrumental in ensuring that the transition is seamless for the patients and that the goodwill is transferred to the purchaser; on the other hand, this can lead to a complete failure to transfer the goodwill to the purchaser, and can allow the vendor to then leave the practice without any restriction. It is critically important that the vendor and any practice principals are bound by robust and enforceable post-settlement and post-departure restraints.

  • What makes up goodwill, and how is it transferred?

Whether an acquisition proves to be successful depends upon a number of factors, most of which bear upon the question of whether or not the purchaser actually gets to enjoy the benefits of what he or she set out to purchase. This usually requires the goodwill of the practice to be effectively transferred to the purchaser. For patients, the transition must be seamless – this requires a combination of good communication and ongoing service, familiar faces (are existing staff/contractors staying on?) and a “business as usual” approach.

However, effectively acquiring goodwill is not an exact science and oftentimes, when a professional services practice changes hands, patients are lost. This can obviously have a detrimental impact on the practice’s financial viability, particularly for smaller practices.

What can a purchaser do to minimise the risk of patient loss?

There are a number of recognised mechanisms for ensuring that both the vendor’s and the purchaser’s interests are protected in circumstances where it is not clear how many patients will remain with the practice after the sale and the revenue that those patients will generate for the business. One way to facilitate goodwill transfer is for the purchaser to withhold a percentage of the purchase price for a period of time after settlement until it is possible to ascertain what percentage of patients have remained with the practice. This can be combined with an arrangement where the vendor/practice principal remains in the business for a period of time to assist with the smooth transition of the business. This approach, along with the inclusion of robust and enforceable restraint covenants, can provide a strong commercial incentive for the vendor to do what it can to transfer the practice goodwill to the purchaser.

Are you expecting the practice to be more successful under your ownership than under the previous owner?

It is not uncommon for acquirers of professional practices to anticipate that they are going to be able to build the practice to be bigger and better than it was when it was acquired. This may well be achievable, but it usually rests on an assumption that the existing patients will all remain with the practice. For the reasons outlined above, this should not be assumed and the first step in successfully growing the practice is to ensure the transfer and protection of the practice goodwill.

As part of the due diligence process, it is necessary to consider how long it will take to make the business more successful and to consider whether the business model is sustainable with the added burden of finance. You should also objectively consider why it is that you believe you will be able to grow the practice. A starting point is to test the assumptions on which the proposed acquisition is based, and do the best you can to manage the various risks involved in making an investment of this nature.

At Meridian Lawyers we regularly advise prospective purchasers of professional practices and assist purchasers and vendors of professional practices in circumstances where disputes arise. Contact Mark Fitzgerald or Douglas Raftesath if you are thinking about purchasing a professional services practice.