June 12, 2008 by creddy.

Pitfalls To Watch For In Professional Practice Mergers & Acquisitions

Empirical evidence suggests that many small to midsized professional practices are increasingly disintegrating into solo practices or getting merged into or acquired by larger professional practices. The factors driving this trend are: retiring baby boomer practice owners, burned out owners, increased cost of regulation, pervasion of web-based services, and ever increasing infrastructure costs. 

In these uncertain times, middle market practice owners concerned about their financial security need to make some careful choices in deciding which way to go forward. This is especially true for the owners who are close to their retirement. Fortunately, most mid market practice owners have several options: sell the practice, merge with another practice, grow through acquisitions, or continue on the current path and let the chips fall where they may. The latter option is clearly not recommended for practitioners who seek financial security and have the need or desire to feather their nest egg.

If the practitioner is forced by personal issues, familial issues, or does not have the energy or drive to run the practice, a sale of the practice may be the only option. However, merging, reorganizing, or growing through M&A can be desirable paths if the practice ownership has the energy, skills, and sophistication. For the purpose of this article we will refer to the process of merging, reorganizing, or acquiring a practice as a “merger”.

For most practice owners, the biggest benefit of a merger is the size of the combined practice. Increased size can result in several advantages:

Ø  Resources: The resources of the combined organization may allow the practice ownership to attain previously unattainable personal and professional goals or attain them sooner than otherwise would be possible.

Ø  Better Lifestyle: Larger practices afford less administrative overhead for the practitioners while simultaneously providing better coverage for each other with less adverse impact on customer support and retention. A larger practice can help practitioners provide better coverage for the customer without sacrificing personal time-off.

Ø  Customer Leverage: The combined practice can increase the effectiveness of the marketing programs, improve ability to reach customers, expand the range of services that can be offered, and increase the number of touch points to the customer.

Ø  Supplier Leverage: Larger practices typically have more leverage with suppliers resulting in better prices and terms. A larger revenue stream may also enable the practice to attract suppliers unattainable prior to the merger.

Ø  Cost Reduction: Consolidation, with proper planning, leads to more efficient and streamlined use of staff, space, systems, and equipment resulting in lower administrative costs. These cost savings fall to the bottom line and make the practice more profitable and valuable.

Ø  Increased Market Share: Combining practices increases the market share and this by itself can become a virtuous cycle and further propel the practice to newer heights.

Ø  Built-in Exit Strategy: The terms of the combined practice can be written in such a way that there is an automatic exit strategy for an individual practitioner within the group in the event of disability, death or other agreed upon event. If planned well, the outcome for the owner or owner’s estate can be significantly better than what is possible in a smaller practice. 

Ø  Increased Valuation: Practice valuations for mid-market practices vary widely depending on the size, transferability and strategic value of the practice. Transferable, larger practices routinely command EBITDA multiples dramatically higher than smaller practices without a proper management structure.

While these benefits make the M&A path very attractive to practice owners, there are several disadvantages of taking the M&A path and several pitfalls to watch for to arrive at a successful outcome. Here are some concerns and pitfalls and the approaches that can be taken to overcome them.

Ø  Loss of Control: The biggest disadvantage to practice merger is the loss of control and autonomy, real and perceived, by the parties. While the loss of some control is a reality in most mergers, the problems arise when the perceived loss is more acute than expected or when the perceived benefits of the merger are less than expected. In order to minimize the chances of this outcome, ensure that you have a clearly defined buy-sell agreement and an agreement defining roles and responsibilities of the parties post merger. Both these agreements will be of great benefit should the merger not materialize as planned.

Ø  Owner Satisfaction: While successful practice mergers are aplenty, it is not uncommon for owners to be disenchanted with the merged practice. To increase harmony and streamline integration, the goals of the merged practice should be extremely clear and well understood by all parties. What is the purpose of the merger and what is the strategic direction? More services? Broader market? Practitioner coverage?  Going after a different customer base? Whatever the reasons are, if the expectations are clear, the satisfaction of the practitioners and the probability of success of the merged practice is enhanced.

Ø  Capital Structure and Voting Stock: One of the sore aspects of a merger involves lack of agreement on capital structure and control of the practice. A retiring practitioner may care little about control but a lot about the finances. On the other hand, the partner looking to grow may have stronger feelings about control. To avoid this, efforts should be made early on to separate the capital structure from voting rights structure. The financial and governance needs of key management members and the ownership should be addressed and codified. A good set of Bylaws along with delineation between what needs to be approved by board vs. shareholders vs. officers of the company should be well documented.

Ø  Compensation Structure: Compensation structure and division of income for the owners, and key staff members must be developed with an eye toward tax impact as well as fraud and abuse considerations.

Ø  Benefit Plans: A substantial discrepancy between the benefit plans of the merged corporations is another potential problem area in practice mergers. Benefit plans of the merging entities and key individuals must be reviewed carefully and adjusted as needed to ensure there are no post close surprises.

Ø  Compatibility between Practitioners: Practitioner incompatibility is another disadvantage of practice merger/acquisition. This problem can be especially acute if the practice includes several specialty areas and the needs of the specialists are not compatible with the needs of the organization as a whole. Consider this aspect of the merger carefully and put plans in place before the merger to head off any issues.

Ø  Offices & Personnel: Offices & Personnel is another area of friction in practice mergers. Care must be taken to ensure which of the office locations and personnel will continue with the combined practice after the merger. If resolution of this issue is expected to occur post close, bylaws and governance rules can be created to ensure the process for resolution is agreeable to both parties.

Ø  Liability, Fraud & Abuse: Liability, fraud and abuse issues should be addressed to make sure that the combined organization and the key individual needs are adequately addressed. Merging parties typically would indemnify one another from liabilities that predate the merger.

Ø  Supplier & Customer Contracts: Ensure the supplier/customer contracts are reviewed carefully and any differences between two different contracts with the same supplier or customer are reconciled to the advantage of the joint organization (costs, reimbursements, etc.).

Practice mergers can be of great benefit to mid market practice owners. However, practice owners need to be cognizant that practice M&A can be complex and the results can be adverse unless considerable amount of preparation and deal making occur prior to the finalization of the agreement. Extreme care should be taken to ensure that issues such as the ones mentioned above are carefully considered and addressed prior to close. To adequately address these and other complex issues, practice M&A can take an extended period of time. Six to eighteen months of preparation/negotiating from signing of the LOI to the close is common.

The time and money spent upfront to avoid typical merger pitfalls and achieve a common understanding of the deal can go a long way in ensuring the personal and financial goals of the M&A process are realized as planned.

Posted in Business Sucession Planning, Exit Planning, M&A, Valuation, Finance | No Comments »

May 9, 2008 by creddy.

Business Succession Planning Fundamentals

“Dream as if you’ll live forever, live as if you’ll die today.” - James Dean

For every business owner the day will come when it is time for him/her to move on. The reason for the departure may be old age, health, disability, familial changes, burnout, or any number of other reasons. Business succession planning involves planning for a smooth transition of the business in the event of the owner’s voluntary or involuntary departure.  The impact of business planning goes well beyond the survival/transfer of the business and extends to the financial and emotional well being of the owner, his/her family, and the employees of the business. To be effective, business succession planning should start preferably three years before the anticipated date of the business owner’s exit. For most mid-market business owners, their business is the largest component of their estate. In spite of this reality, most business owners do not find business succession planning to be a priority. They stay busy with mundane operation issues and neglect succession planning until it is too late.  The result of the lapse can be catastrophic. Empirical data suggests that less than a third of family businesses survive the first generation of business ownership. Only a tenth of the businesses make it past the second generation. These statistics would likely be significantly better if the owners did business succession planning. By reading this article, you are already a step ahead of a typical business owner. No business owner who cares for his estate or his employees should ignore the business planning process. To ensure financial security, and to properly transfer the wealth to the next generation, business succession planning must be a part of the estate planning process. The first step in business succession planning is to understand the end goals of the overall estate planning process. The goals, for most owners, are financial security, transferring the wealth to the next generation, continuing the family legacy, etc. In translating these goals into business succession planning, the owner is faced with several possible scenarios:

There is a single potential successor: In this scenario the business owner needs to determine if the successor is ready, willing, and able to take over the reins of the business. Increasingly, the potential successor, typically a son or daughter, has interests that differ substantially from the business owner’s.

In some cases, even a capable and able successor may not have the motivation and drive necessary to take over the business and make it flourish. The business owner needs to contemplate if a transition to this successor will result in the desired financial and other outcomes. If the business owner suspects that the estate’s goals are not likely to be met with the transition, then (s)he needs to determine if it makes sense to recapitalize the business or sell the business and transfer the proceeds to the estate.

There are multiple potential successors: It may sound logical to split the business among the successors and give them different roles in the company (some roles could be operational and others could be non-operational). Empirically, a business with multiple owners tends to wither away as each stakeholder pulls it in a different direction. It is common for multiple successors to be embroiled in a power struggle that tears the company apart and negatively affects the interests of the family, the estate, and the employees.

The other common problem with multiple successors is that the successors who end up becoming active owners will very likely end up getting a dramatically larger share of the benefits of the company at the expense of the non-active owners.  Unfair distribution of wealth and the violation of rights of minority shareholders is a common theme in many family business transitions. Given these realities, multiple successors pose a particularly difficult choice for a business owner. The owner needs to seriously consider how the business may be run by multiple successors in his/her absence and see what steps can be taken to arrive at an equitable and harmonious transition that preserves the will of the estate. If the owner wants any semblance of equity and harmony in such a situation, advice from a competent business succession planning expert is mandatory early in the process. If a fair and cordial resolution is unlikely or unsustainable, the owner and the heirs’ interests may be better served by selling the business and distributing the proceeds to the heirs.There are no likely successors: If there is no potential successor that could run the business, the choice is clear and the best value for the business can be attained by a recapitalization or a planned sale.

Regardless of which scenario the business owner finds himself/herself in, the planning process should begin early so that proper arrangements and precautions can be taken to maximize the value of the business. The outcome of the business succession planning should include a clear understanding of the goals, the process to achieve the goals, and contingencies in case of unexpected developments.

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