Veterinary practice valuations have increased significantly since 2016, leading to increasingly complex deal structures. Buyers aim to align incentives and mitigate risks with each acquisition, employing deal structures such as joint ventures or offering TopCo equity to safeguard their interests. For practice owners who could experience significant growth and therefore benefit from selling later, buyers sometimes offer earnouts to encourage immediate sales, sharing the post-closing upside with the seller. More risk-averse buyers frequently utilize contingent notes or payments to protect against downside risk.
What makes Rich Lester an expert on this topic?
– Founder + CEO of a corporate buyer
– 16+ years in the veterinary space
– Dozens of practice transactions
What is an earnout?
An earnout is a future payment to the seller based on achieving specific performance targets that are defined before the transaction closes. Historically, earnouts have been based on profit or EBITDA targets, but they are progressively moving to revenue-based targets instead.
The shift away from EBITDA-based targets is primarily due to sellers achieving significant success in late 2020 and 2021; they grew their practices post-closing at a rate exceeding historical averages, resulting in unusually large earnout payments. In response, revenue and EBITDA-based earnouts still occur but may now include a cap on the total dollars that can be earned. This cap mitigates a buyer’s risk, offering a clear picture of the maximum additional purchase price they will pay.
Many earnouts include a hurdle that must be met before the earnout applies. These hurdles typically require revenue or EBITDA growth to exceed market expectations, meaning an earnout generally does not apply at market levels of revenue or earnings growth. Additionally, the longer the timeframe for an earnout, the higher both the hurdle and the cap tend to be.
of practices sold by Ackerman Group in 2024 featured earnouts in their deal terms.
Why use earnouts in veterinary practice sales?
Earnouts are used to motivate sellers to close deals before they fully see the benefits of their efforts. But, there’s a need to balance this. Buyers don’t want to pay extra for changes they can make themselves, like getting better vendor deals or just maintaining average growth.
When does an earnout make sense in a practice sale?
While every situation is different, buyers frequently offer earnouts to practice owners in the following events:
- The seller recently hired one or two new DVMs who are expected to boost the practice’s production. They haven’t been there long enough to make a big impact on profits yet, but that’s likely to change soon.
- Historically, the practice has been doing really well, with revenue growing by at least 10 percent each year for several consecutive years, which is well above the average market rate.
- In the past 3-6 months, the seller made some changes to how costs are managed. These changes haven’t fully shown up in financial results yet, but they’re set to benefit the new owner.
- The seller is either in the middle of or planning an expansion project at the practice that should significantly drive growth.
What should I look out for?
Earnouts are set up in all sorts of ways. It’s key to understand the market to make sure you’re getting a fair deal for the value your practice adds. Unfortunately, we’ve seen some earnouts where the seller gets only a small financial boost for delivering big returns to the buyer — clearly, that’s not fair or ideal.
As a seller, keep in mind that most buyers won’t even think about earnouts unless they have clear data showing the upside potential of your veterinary hospital. Negotiating these terms can be tricky and you really need to know your stuff, backed by solid market data to protect your interests. A trusted advisor like Ackerman Group can guide you through understanding these terms, dealing effectively with buyers, and negotiating the best deal for you.
What are contingent notes?
We’re discussing contingent notes (or contingent payments) alongside earnouts in this article because they essentially serve opposite purposes. An earnout offers potential upside to the seller, whereas contingent notes provide downside protection for the buyer. Contingent notes are a part of the purchase price that is paid post-closing and is only paid out if certain benchmarks are met after the deal closes. If things don’t go as planned with the veterinary hospital in the immediate years after the sale, the buyer ends up not paying the contingent note, lowering the effective purchase price.
Why are contingent notes used in veterinary practice sales?
Contingent notes help ensure that the seller sticks around; they’re designed to keep the seller committed to fulfilling their post-closing employment duties and to discourage them from leaving before their employment agreement expires.
A handful of buyers use contingent notes to protect their investment in the practice. Contingent notes can sometimes be simple, like: if you work all three years of your contract, you receive the money. Other contingent notes are more complicated and may have production targets for the seller or revenue targets for the hospital. Typically, contingent note targets are reasonable and are put in place to ensure the business revenues maintain current levels or grow.
Case Study:
Dr. Joseph Kinnareny
- Employed TopCo equity & contingent notes
- Achieved “best case” scenarios for co-owners
- Gained work-life balance to focus on other interests
How common are contingent notes in practice sales?
At Ackerman Group, we’ve noticed that contingent notes are more common in smaller, two to three-veterinarian practices where the risks are typically higher than in larger practices. However, some corporate buyers include contingent notes in all their deals, regardless of the practice’s size.
These types of deal structures are complicated and come with risks for the seller. Getting expert advice can help ensure that the terms of these contingent payments align with market standards and minimize your risks as much as possible.
Ackerman Group guides veterinary owners in corporate practice sales. To learn more about what we do, or to receive guidance tailored to the sale of your practice, contact us to get started.
Navigate contingent notes with confidence, work with Ackerman Group to protect your interests and minimize risks.