The internal sale- the right of first…… and last refusal09 Nov 2018 - Simon Palmer - Practice Sales
When a practice owner begins to think about selling their business, it often seems that the natural choice for the purchaser is close at hand, in the form of a trusted employee or contractor. They will often offer that trusted employee the ”right of first refusal” to purchase the practice, before they put it on the market.
There are a number of reasons why practice owners think this way, but it will almost always lead to suboptimal results for the sale of their practice.
What are the arguments for and against the right of first refusal?
Selling a business can often be a long and arduous process, with complex paperwork, confidentiality and compatibility concerns. Practice owners sometimes imagine they will be able to simplify the process if they sell internally. Somehow, selling internally seems less complicated, more predictable, a known entity. It's human nature to want to take the route of least resistance.
However, what is not factored in is that buyers in isolation with a valuation will still haggle on the price and terms, pointing out insignificant or irrelevant things that the valuation didn’t take into account. They can get more demanding when negotiating the terms of the contract, feeling very safe in the knowledge that their narrative of the value is the only one the purchaser is hearing.
2. Perceived time saving? Veterinary practice owners are (in general) very time-poor. You could forgive practice owners for wanting to save themselves some time and effort by trying to sell to the buyer they have, rather than seeking out others.
However, what is often not factored in is that buyers in isolation don’t have the incentive to hustle, as they don’t have to worry about getting beaten to the finish line. If a veterinary practice for sale is only talking to one potential buyer, that buyer can afford to get complacent, take their time to arrange meetings and get feedback from their accountant, lawyer, and financiers – which means taking their time to get back to you. Why would they hurry? Why would they feel any urgency in putting forward a great offer, when they know that the seller has no other prospects that they are considering?
3. Perceived obligation to the purchaser. A relationship is at the heart of an internal sale. The owner and employee/contractor may be friends, as well as colleagues. This can lead to the owner feeling that they have an obligation to keep the sale inside the company, particularly if the internal person wants and expects it.
If your neighbour asked you to sell one of your most valuable assets to them at huge discount and favourable terms, would you do it? Most people would answer ‘no’, and yet this is exactly what practice owners are doing when they agree to give an employee a right of first refusal. If the vendor truly feels obliged to give the internal buyer a chance at buying the practice, it should be done as a “right of last refusal” (see explanation later on).
4. Perceived obligation to the practice. A practice owner often has feelings of responsibility and concern for the ongoing prospects of the practice, the business itself and the patients. It can be painful to think of everything passing into the hands of a stranger. At some level, the owner imagines the employee/contractor will continue to do things the same way he or she was "taught", and that creates a certain sense of control of the practice, post-sale.
Feeling like you know the character of a key member of staff as an employee or contractor is no indicator for how they are going to behave as a practice owner. Internal prospects for purchasing the practice are usually untested as business owners. They have never had to handle the stress of business management and leadership, they have never had to deal with the stress of paying wages and meeting business KPIs. Their abilities in this regard are unpredictable at best. It is certainly far from a sure thing that they will run the practice in the same way the previous owner did.
5. Limited perceived downside. A price is usually ascertained in internal sales by way of an appraisal or valuation, done by an independent third party.
Giving an internal buyer a “right of first refusal” at valuation price gives him/her a chance to buy without market-testing the price. Effectively, it gives the buyer a huge potential discount on the sale.
The true value of any asset isn’t what the valuation dictates the value to be, but rather what the market will bear for that asset. The only way to sell the business at its true value is via competitive tension.
6. Perceived saving
There is a perception that selling internally results in a significant cost saving, as the vendor doesn’t have to pay a broker’s commission. While you may save yourself a brokerage fee, you could end up costing yourself much more in time, effort and sale price, by agreeing to give an internal buyer the right of first refusal over the sale.
The Right of Last Refusal
If you do want to give an internal person a chance to buy the practice, the appropriate alternative is something called the “right of last refusal”. This involves taking the practice to the market to let competitive tension set the market value. The internal buyer has the chance to match the highest offer made before it sells. A broker should be able to structure a campaign like this for you.