The Letter of Intent (LOI) is the document that outlines the key business and contractual terms. This document forms the basis of an agreement between the Buyer and Seller before signing the final purchase agreements. In essence, this document is used by the Buyer to formally submit an offer to purchase the practice.
The parties entering into the LOI make representations to act in good faith with the intention of completing the purchase of the practice. The LOI generally contains contingencies to allow the Purchaser to complete due diligence of the practice, obtain financing, and secure an office lease or financing for the real estate. The LOI is usually not binding in its entirety, but is binding as to the terms relating to the confidentiality provisions and treatment of earnest money.
Below are some recommendations for Buyers to consider as they prepare a Letter of Intent.
The purchase price is usually the most critical point in the LOI. Unless multiple buyers are competing to have their offer accepted, the purchase price of the practice is usually the appraised value established by an experienced medical practice appraiser.
Making a full price offer based on an accurate appraisal will usually be financed 100% by lenders. This means that the lender considers the practice to cash flow at a healthy level at the appraised value. The large majority of the purchase price is comprised of the intangible goodwill of the practice. In essence the Buyer is purchasing the cooperation, support, and recommendation of the Seller to the patients, staff, and community. Offering to purchase the practice below the appraised value can often damage the goodwill between the Buyer and Seller.
If the Buyer decides not to offer the full appraised value of the practice, they should be prepared to explain their reasoning. The Buyer should ask – Does the practice cash flow at the appraised value? Perceived issues like older equipment or an above average sales price are typically not sufficient factors to lower the sales price as such factors are already reflected in the appraisal.
The purpose of the earnest money is to demonstrate the Buyer’s commitment to purchase the practice and act in good faith to proceed towards closing. The Seller, in turn, agrees to take the practice off the market for a reasonable amount of time to allow the Buyer to do their due diligence and prepare for closing. The LOI typically provides that the Seller will not accept additional offers from other prospective buyers.
The earnest money is submitted by the Buyer at the same time the Letter of Intent is submitted. Depending on how the LOI is drafted, the earnest money is either applied towards the down payment or returned to the Buyer at closing. If the transaction does not go through, the earnest money is returned to the Buyer only if one of the contingencies is not satisfied.
The amount of the earnest money generally ranges between $1,000 – $10,000. The exact amount depends on the sales price and the length of time the Buyer requests between executing the LOI and closing on the transaction. The higher the sales price and the longer the delay in closing, the larger the earnest money amount becomes.
Financing is readily available for the acquisition of a medical practice. Almost all practices we represent are financed at 100% by lenders that specialize in medical practice acquisitions. Furthermore, the Buyer is often loaned an additional amount for working capital. Occasionally the lender will require the Buyer to make a down payment, and in these situations the Buyer should not rely on the Seller to finance that portion of the transaction. Our firm can recommend lenders that specialize in medical practice acquisitions and understand the medical industry.
The accounts receivable of the practice are not included in the appraised value. The Buyer can decide to 1) purchase the accounts receivable separately at an agreed upon price; or 2) have the staff collect all outstanding payments from patients on behalf of the Seller and receive a nominal fee for collecting payments. We recommend that the Buyer purchase the accounts receivable with the practice as this tends to be smoother for both parties.
The accounts receivable are valued on a sliding scale based on the aging summary. The account receivables are broken out in the following periods: zero to 30 days; 31 to 60 days; and 60 to 90 days, with a discount typically of 10%, 20%, and 30% respectively. Receivables past 90 days are generally included with the purchase of the accounts receivable.
The real estate of the practice, if available, is not included in the appraised value of the practice. The sales price reflected on the LOI for the real estate is an approximation of value. This value is usually based on an appraisal completed recently or comparables of other properties that have sold recently. The sales price of the real estate is subject to a current appraisal.
Typically the lender requires the Buyer to provide a down payment as a condition for the financing of the real estate. Additionally, the Buyer is responsible for paying all closing costs associated with financing the real estate including the real estate appraisal. The mortgage is usually amortized between 15 and 20 years which may be a monthly payment similar to a lease payment.
Allocation of Purchase Price
The allocation of the purchase price is separated between two main categories: tangible assets and intangible assets. The tangible assets include the value of the furniture, fixtures, equipment, instruments, and supplies. The intangible assets include the value of the goodwill, covenant not to compete, and patient records. On average, the allocation is split approximately 70% and 30%, intangible and tangible assets respectively.
We recommend that the Buyer have an independent appraisal and inspection of the equipment.
The closing date is the day the transfer of ownership occurs from Seller to Buyer. From the time the Letter of Intent is executed, the Buyer is provided approximately four to eight weeks to prepare for closing. This period of time allows the Buyer to perform their due diligence, obtain financing, work out the lease or obtain financing for the real estate. The closing usually occurs at the end of a month but can also be scheduled at the end of the week or another time during the month.
The signing date is the day the purchase agreements and all other closing documents are signed. It is not uncommon to have a signing date prior to the closing date. Signing the purchase agreements early can help make for a smooth transition. Scheduling a signing date prior to the actual closing date is especially important if the closing will occur more than 8 weeks after the LOI is accepted.
A contingency is a legal clause that allows a party to remove themselves from a contract due to an unexpected future event or circumstance. The LOI includes contingencies to allow the Buyer peace of mind that if a critical component to purchasing the practice falls through, the Buyer is not obligated to continue with the purchase. There are generally four contingencies included in the LOI. The contingencies allow the Buyer to: 1) Perform his or her due diligence by reviewing the practice’s financials, practice reports, and patient records; 2) Secure the necessary financing to purchase the practice; 3) Accept terms of an office lease or secure financing for a real estate loan; and 4) Agree to the terms of the purchase agreements and other related closing documents.
The acceptance date should allow the Seller ample time to review the offer. Just as the Buyer takes time to carefully prepare the offer, the Seller should be provided time to determine if the offer is acceptable and if he or she feels the Buyer will be a good fit for his or her practice. Generally five business days from the day the Buyer submits the LOI is sufficient.