Veterinary Practice Purchase Price Consideration: Earn Outs

One form of potential purchase price consideration paid in the sale of a veterinary practice is a contingent future payment, or series thereof, to be made by the buyer the amount of which is contingent upon, or calculated from, the financial performance of the practice over some post-closing period of time, typically 1-2 years.  This type of performance-based, fixed timing contingent payment obligation is referred to as an "earn out."

Earn outs can be very good for sellers because it can enable them to secure additional value on a transaction that would not otherwise be securable.  They also serve to align fairly well the financial interests of the buyer and seller in the post-closing period.  

Earn outs might be structured to pay out and amount equal to some multiple of any LTM ("last twelve months") Revenue or, more frequently, EBITDA increase that occurs between the time of closing (or the date of the execution of the LOI ("letter of intent") whose terms governs the closing) and the end of the "earn out period," which may typically be 1 or 2 years.  The structuring of earn outs is very nuanced and, advisably, correlated to the financial condition of the practice at the time of LOI or closing, so it is advisable to have an expert financial advisor that has performed a detailed analysis of the practice's financial performance, to assist in this structuring, because of this high level of nuance.

Earn outs are unsecured obligations of the buyer, but are typically relatively short term (1-2 years) in nature, so the "credit risk" associated with them is manageable.

A typical earn out structure might behave something like this.  Assuming a 10x deal multiple, that the purchased bought 100% of the practice (no JV equity was offered as purchase price consideration) and that the current LTM EBITDA at the time the purchase terms were agreed was $500,000 and that one year later the LTM EBITDA was at $600,000, a 1-year earn out might agree to calculate after the first anniversary of the practice purchase closing the earn out to be equal to 10 times the $100,000 increase in EBITDA since closing and pay that $1,000,000 earn out payment to the practice seller within 90 days of the 1-year anniversary of the deal closing.  If the original deal included 30% JV equity, so the buyer was economically really only purchasing 70% of the practice's post-closing financial performance, then the payment might be computed as 10 times 70% times the $100,000 LTM EBITDA improvement, which equals $700,000.  This lower amount is offset for the seller by the fact that the 30% JV equity it retained has likely increased in value, as well, with the improvement in the practice's LTM EBITDA since closing.

Earn outs can be very helpful in allowing a practice owner to ultimately get paid the true full value of their practice, but they also often require very careful structuring, informed by a very detailed analysis of the practice financial performance, so a seller should avail itself of the financial analysis expertise of an experienced financial advisor whose financial interests are well aligned with its own.