How to Keep a Bigger Piece of Your Pie
Mariana Bracic, BA(Hons) JD – Founding Lawyer, MBCLegal.ca
Jon Walton B.Sc., C.C.O.V.I. – General Manager and Sales Representative, MBCBrokerage.ca
Imagine you just bought a practice and paid, let’s say, the better part of a million dollars for it. Now imagine that six months later, something about the practice requires you to spend an additional 20 per cent of your purchase price which you had not anticipated. Is this a disaster? Yes, it is. Is it common? Yes, it is. Is there something you can do about it? Yes there is.
This disaster is essentially what happened to Dr. S. He purchased a practice which employed a number of staff, including Judy, an assistant who had worked for the selling doctor for approximately 23 years. While some elements of Judy’s employment changed under Dr. S’s ownership, Judy generally continued to perform the same duties.
Six months after the closing date, Dr. S terminated Judy’s employment. Not surprisingly, Judy sued for wrongful dismissal. Also not surprisingly, her lawsuit claimed her entire period of employment as a basis for determining her entitlement to pay in lieu of notice. Dr. S’s position was that her entitlement to reasonable notice should be based only on the six months of service she had with him and that he was not responsible for the 23 years of service she had given to the selling doctor.
The Court had little trouble holding the purchasing doctor responsible for Judy’s entire period of service, including the 23 years spent with the selling doctor. The decision cost Dr. S approximately $42,000 just to cover the damage award to Judy. When you factor in the legal fees a doctor in that situation would have incurred, as well as the portion of the employee’s legal fees the court would likely order the doctor to pay (as the Court did in the case under discussion), such a scenario will typically cost the doctor the better part of $100,000.
The Court emphasized the implied term that employees continuing in the service of a purchased business will be given credit for past years of service. Provincial employment standards legislation across the country has deemed continuity of service provisions where there is a sale of a business. If all or part of a business is sold, the employment of employees of the business is deemed to be continuous and uninterrupted by the sale. This is an issue very often mistakenly handled where a specialized employment lawyer is not involved. The number of myths out there (such as that the vendor can “terminate” and the buyer “rehire”!) are legion.
The effect of a deemed continuity of service is to make purchasing a practice inherently more risky and vastly more expensive. From a business transition and ownership perspective, some if not all of these longstanding employees are typically valuable to a purchaser when buying an established business. It is important that you recognize, however, that from an employment law perspective, and a business valuation and sale perspective, existing staff represent an enormous potential liability to a purchaser. This staff liability question is becoming an increasingly more prevalent issue as professional practice sale prices continue to rise in value and become ever more sophisticated. Even in a heated sellers’ market, your staff can affect your business as a vendor in three major areas: its value, its saleability and its final sale price.
Advice from the trenches
There are a number of things you can do as a business owner and eventual vendor to protect yourself from such expensive legal liability during your ownership of a practice. By actively taking some prudent, precautionary steps, you will not only increase your business’ value, but you will also enhance its saleability, minimize your stress level should you have to terminate an employee, and proactively protect your eventual sale price…in other words, let you and your family keep a bigger piece of your pie.
During your Ownership
No matter where you are in the ownership cycle, transitioning your staff to high quality contracts makes sense. The business reality is that an expensive employment law problem can arise at any point and often does so without warning. High quality contracts and policies protect you and your practice from myriad HR-law problems.
Preparing to Transition Out of Practice Ownership
As a professional practice business valuator, we can tell you with absolute certainty that your staff and the inherent risk they pose to your business directly affects the value of your business. Just as having high-quality employment contracts mitigates your risk as a business owner and eventual vendor, so too does it reduce how risky purchasing your business looks through the eyes of a purchaser and their team of advisors. The purchaser and their advisors will be analyzing all the risks of your business’ ability to continue forward after the sale, both from the standpoint of revenue and that of the costs that they may incur after the sale; the biggest single risk is your staff.
From our decades of experience, and particularly in the current market, we clearly see that those sellers who properly prepare their practices for sale with risk mitigation strategies (like transitioning all staff to high-quality contracts) are rewarded with a higher level of genuine interest in their practice than those who solely worry about the revenue. As specialists in this field, we are also typically able to secure a higher sale price for you, particularly if you have industry recognized employment packages, such as MBC Legal’s Practice Protection PackageTM (PPPTM). Buyers are increasingly savvy. A well informed and professionally advised buyer will be willing to pay considerably more for a practice with a PPPTM than one without, ceteris paribus (i.e. other things being equal) because it dramatically reduces the risk and contingent liability of buying the practice. The buyer knows they will then keep more money in their pocket, save time, reduce stress and sleep better at night.
For both seller and purchaser the real lesson from a case such as Dr. S’s is the enormous value of having high-quality contracts with staff that limit the pay in lieu of reasonable notice that must be paid on termination. Had the seller or the purchaser in a case like Dr. S’s had such contracts, the doctor could have saved the better part of $100,000.
Protecting Your Sale Price from Offer to Closing Stages
In a heated market, buyers may approach the issue of staff and potential severance liability in a few different areas of a transaction. Should you as the vendor not have proper protection in place through employment contracts, purchasers may attempt to negotiate protective terms into the agreement of purchase and sale. Essentially, they would seek an indemnification from you, the seller, against such severance liability costs. Do you really want to get a call while you’re on the beach in Mexico (or wherever you plan to spend time in retirement) demanding tens of thousands of dollars, or more, that you now owe the seller who terminated one or more of your staff within the post-closing indemnity period?
Another route we have observed is the possible attempt by the purchaser to negotiate the right to retain part of the purchase price temporarily to cover the cost of terminating employees within a certain time after closing. This holdback ties up a portion of your money, allowing a purchaser to “take a test drive” with the staff, learn from them about your practice, and then potentially terminate them on your dime, which reduces the overall sale price you had agreed to, after the sale is completed. It is critical that, as a vendor in this scenario, you consider the length of time you will allow your funds to be held as well as the split in potential severance pay between you and the purchaser. A period of 90 days and also a split in the severance (vs. the vendor taking the entire severance hit) is obviously preferable from the vendor’s perspective. In this way, both the purchaser and the seller actively share costs, ensuring the purchaser does in fact give dueconsideration to the current staff of the practice, and the vendor acknowledges that they do believe in the current staff of the practice being the right fit for the business.
The much bigger issue here of dividing the severance costs between the purchaser and the seller has been for too long a virtual employment law secret for savvy employers: the pieces of the pie that are available for the seller and purchaser to keep after all is said and done can be made much bigger by dramatically limiting the amount that goes to employees in accordance with the minimums permitted by law. Too many doctors are paying their employees massive windfalls worth tens of thousands of dollars more than they would be required to do if they had legally effective contracts.
In a typical practice sale, when a purchaser keeps the staff on after the sale concludes, their risk is reduced and the continuation of the business in a positive direction with the new owner is strengthened. The staff matter in your practice before, during and after your sale.Written contracts represent a virtually unparalleled legal opportunity for you as an employer to safe-guard yourself against the risk and liability associated with the ownership of, and the eventual sale of your practice. Protect yourself and your practice from the potential tens of thousands of dollars you could be putting on the line, as in the case of Dr. S. Be proactive, contact us today to take advantage of this perfectly legitimate benefit available to you at law to save yourself tens of thousands of dollars. And keep a bigger piece of your pie where it belongs – on your family’s dinner table.