What is a Letter of Intent in the Sale of a Medical Practice
A Letter of Intent in Sale of a Medical Practice (LOI), also known as a “term sheet” or a “memo of understanding (MOU)”, is a non-binding outline of a transaction. It’s frequently used in the sale of a physician’s medical practice.
A letter of intent is a brief notation of the main terms of what the parties believe will be a binding formal contract, such as a medical practice sale agreement. The letter of intent is designed to make sure that the both parties are “signing from the same song book” concerning the primary points of the agreement they are looking to form. This letter of intent allows the buyer and selling physician to work out a deal before they spend money on lawyers, accountants, and due diligence. Better to have a transaction die an early death at this point than after you’ve paid some substantial expenses.
After the initial discussions to sell your medical practice, a letter of intent will be the first chance to memorialize specific ideas to writing…it will bring you and the buyer closer to commitment.
The letter of intent should contain the basic points of agreement that the parties want to cover in the purchase contract. Once the basic terms of the deal are agreed to by a letter of intent, the parties can more easily move the process forward and prepare a complete purchase agreement.
Arguably the most critical negotiation happens at this point—before the deal is fixed. Once the terms are put down in a letter of intent, there’s less room for negotiation. And even though a letter isn’t binding, it still creates a moral obligation on the buyer and seller.
What’s in a Letter of Intent?
The letter of intent should cover all of the basics, including price and payment. This is also the time to state which party will be responsible for payment of expenses associated with the transaction (typically, each party is responsible for his or her own professional fees). The letter should begin by explaining who will buy what from whom. This should be a description of the assets of the selling physician’s practice or the selling physician’s stock in the practice.
Further, a deposit should be considered. A selling physician may ask for a deposit in the event that the deal goes south, he or she can retain the deposit as compensation for their lost time and expenses. Deposits are not common in the purchase of a medical practice.
Structuring the payment of the purchase price is important. In addition, the parties may agree to adjust the purchase price at or soon after closing to account for circumstances that change daily.
This could be a modification for working capital on-hand at closing or accounts receivable, since these figures may have changed from the time the parties agreed to the purchase price and the closing.
Another element of a letter of intent may be an earnout, in which the buyer increases or decreases the purchase price based on the performance of the medical practice after the transaction is completed. The reason for doing an earnout is to provide the buyer with some security that he or she hasn’t overpaid for the practice. Sacramento business consultant Andrew Rogerson says that selling physicians dislike earnouts because it places their purchase price at risk—the buyer’s operation of the practice after closing determines this, and if he or she does a poor job of operating the practice, the seller’s profit will be decreased.
A buyer can also ask for an escrow (holdback of money from the purchase price) which is security for the buyer if the seller breaches the purchase agreement. Again, this is not to the seller’s benefit as the physician doesn’t want to see any of the sale price escrowed. One work-around to this is to limit the damage by setting a deadline for when the escrow must end, and the money given to seller. Another way to address escrow is to require that the escrowed amount be the buyer’s maximum recovery from seller for any breach or the purchase agreement.
A letter of intent also should address the medical practice’s accounts receivable. There should be a clear break in responsibility, such as all A/R for pre-closing work belongs to seller, and accounts receivable for post-closing work is the purchaser’s. It’s also a good idea to address who will collect seller’s accounts receivable. If it’s to be the buyer, specify the collection fee that he or she will receive.
The letter of intent sheet should detail how the parties will transition patients and referral sources and the amount of transition assistance the seller will provide to the buyer after the closing.
Typically, the selling physician will be asked to sign a non-compete covenant for a specific time frame, usually several years, within the geographic locality of the medical practice.
Finally, a contingency lets the buyer to call off the deal if a required event doesn’t happen. This could be something like obtaining financing for the purchase of the practice. Andrew has found that contingencies are usually the most difficult component of negotiation. Contingencies are not very common in the purchase of a medical practice. They only arise if the parties sign a binding purchase agreement before the closing, as the buyer is contractually obligated to close—even if he or she isn’t able to obtain financing. The contingency would let the buyer walk away from the deal. But rather than battling over contingencies, the parties can finalize the purchase agreement prior to closing—but only sign it after the purchaser receives its financing.
Successfully Sell Your Medical Practice – Read the Book!
Remember that the letter of intent in a medical practice sale will decide whether continued negotiations are needed. The terms in a letter of intent are generally not legally binding. It’s never too early to seek legal counsel.
Andrew Rogerson specializes in helping business owners sell their business including a medical practice and its many steps. This includes a practice valuation, creating a marketing strategy to find qualified buyers, and handling all phases of the transaction including third-party finance for the buyer, due diligence and escrow. He is the author of Successfully Sell Your Business which is available for immediate download.
Visit the Rogerson Business Service website for information or call Andrew Rogerson at (916) 570-2674.