The Pros and Cons of Selling Stock for a Healthcare Business Owner
Selling stock in a healthcare transaction is one way for a healthcare business owner to raise funds to either expand their current business or start fresh in a new location. However, there are always pros and cons to business decisions, and The Ambulatory M&A Advisor discusses some of the more common highs and lows that physician owners selling stock to raise funds may face.
“The biggest reason for why someone would sell stock in their business includes one that is seen most often, and that is to raise funds,” says Steven R. Smith, partner with the DC office of Ober Kaler.
“Secondly, you sell stock when you are either selling parts or the entire business in a stock transaction, i.e., the sale of the company itself as opposed to the assets of the company. You see it frequently when it comes to bringing new partners and new groups into a deal. In terms of the division of ownership, the selling of stock also hands over some control of the operation as well.”
Grant Grayson, shareholder and partner at the law firm of LeClair Ryan says when it comes to stock sale versus asset sales in an acquisition, tax-wise, a seller likes the sale of stock because the transaction is so simple to close when you are selling stock or membership interest in an LLC, Grayson says.
“You simply sign over your interest. You sign over you shares of stock just like you would sell off a share of “Apple”. The buyer simply becomes the owner of that stock, and the company stays in existence and the buyer has taken over all operations of the company. The seller gets capital gains treatment on the sale of the stock, everybody is happy and they go home,” he says.
When selling stock to raise funds for the business, Smith says one obvious advantage is that the owner of the healthcare business is not taking on new debt. He says this is referred to as an equity transaction.
According to Smith when selling stock, an owner is raising funds through the equity market. An alternative to raising funds through the equity market is to do so by incurring traditional debt.
“The trade off in terms of selling stock is that you are “giving away” a part of ownership, a part of control, a part of the right to dividends and other distributions based on a share of ownership. Of course, you are also diluting your own ownership share of the company itself. That is where things show the trade off in this type of fund raising by selling stock,” Smith says.
“If we just look at a transaction with an ASC or something of that nature, and a corporation that controls the project itself; then you have decisions that get made in terms of control of the company. You have decisions with regard to budgets that have to be made every year. Of course, budgetary decisions are determining in part priorities for the business. Whether it is in terms of upgrading equipment, whether it’s trying to squeak by another year to maximize profits or to maximize distributions of investors; those sorts of considerations should be thought of in terms of distribution of control.”
Smith says there are a variety of disputes among the owners of a business that can arise where the issue of control is important. Whether it’s to look at another M&A transaction, bring in a potential ownership group or look at another sale transaction; those business decisions get made based largely on control. Smith says control is based on who owns what percentage of the stock (or other voting units of a business organization depending upon the type of entity) and the provisions of key organizational documents such as bylaws that set the required percentage of votes needed to carry different issues up for decision.
John Fanburg partner with the law firm Brach Eichler says when discussing issues and disputes that may arise when selling securities, the selling party must remember that buyers want freedom from liabilities that occur before closing but don’t materialize until later, says Fanburg.
“Successor liability” goes beyond legal liabilities to take in third-party over-payments and clawbacks, notes Fanburg adding that in a stock sale, the buyer inherits those liabilities.
“In that instance, indemnification is the best way to minimize risk,” Fanburg says, adding that pitfalls remain.
“The indemnification has the risk of if something happens three or four years from now… the seller may not have the wherewithal to provide indemnification.”
The buyer, he advises, can also ask for indemnification enhancements that can include holding some money in escrow. “If I’m doing $50 million maybe I hold 10 percent in escrow,” Fanburg says.
Ultimately, Fanburg says, the seller’s lawyer is going to insist that indemnification does not exceed the center’s sale price.
Smith says another advantage to selling stock to raise funds is that if the business fails, the owners generally do not have to pay that money lost to the investors because the investors assume the risk of both gain and loss when they decide to invest. Smith says this issue also touches on the distinction between equity and debt.
“If you take on additional debt to raise funds, then that is a debt that needs to be repaid through debt service on the loan that ultimately repays the principal due. When a sale of stock or equities is made, there are also representations that are made. Whether it’s through a private placement memorandum, or in a public sale through a detailed securities document, there are representations made regarding the operation and risk of the business. When you are selling equity to raise funds, the new stock owners are coming on and they are made aware of the risks of the underlying business and are assuming those risks,” He says.
“Yes, in some respect you are spreading the risk of failure or loss. If I own 100 percent of the stock today and I sell 25 percent of that stock to raise funds, then I have pushed off some of that risk. At the same time, when I make that sale of stock, I am also going to be making certain representations that are protected through the securities laws to the purchasers of that stock. These representations will show what the business is all about and what the risks and other issues are that may come forward with regard to the business. It’s not just a lazy transaction where you lay off some of the risk and raise some easy money. It’s a serious transaction with serious implications regarding those securities laws that have to be complied with as a part of that whole transaction.”
If you have an interest in learning more about the subject matter covered in this article, the M&A process or desire to discuss your current situation, please contact Blayne Rush, Investment Banker at 469-385-7792 or Blayne@AmbulatoryAlliances.com.