Joint Ventures at Scale

‍Text Version of the Interview

What Makes the Vet Industry so Attractive? 

It's a very highly fragmented industry. 80% of the vet clinics are still owned independently by the veterinarian. Even though there's a lot of competition in our space, there's also a lot of clinics for consolidators to buy. 

It's a high-margin business. The EBITDA margins for a typical good veterinary clinic are in the mid-twenties. And it's a very low-risk business.

There is also a lack of strategic buyers in the space. Typically most of the people buying the clinics are PE-backed consolidators like ourselves. 

It has a private pay revenue stream. Unlike human healthcare, where you have the government or the big payers are setting your prices. Here, veterinarians can set their own prices. It's a cash pay service model; the industry is proven to be recession-proof compared to other industries. 

It's even pandemic proof. The vet business thrives throughout COVID. Millennial research is showing they're delaying starting families. They're buying pets instead of having kids, at least putting that off, which has obviously been a positive for the vet industry. 

It offers good returns for your financial sponsors. Obviously, anytime a private equity firm invests in that portfolio company, they have an exit in mind at some point and all of the recent recapitalizations in this space. They've all been North of 20 times EBITDA. It's a very nice return for your financial sponsors. 

Cons of the Industry

It's highly competitive. When you're going to talk to a veterinarian about buying their clinic, many of your competitors are also talking to that same clinic.  

Ultimately, we can still buy the clinics at a much lower multiple than we hope to exit at, but it's highly competitive. So make sure your close rate is a lot lower than you would like to because of the competition. 

There is also a shortage of veterinarians. They are your revenue producers. So you're always trying to recruit. Recruiting is a huge part of that consolidator's organization.

Joint Venture Consolidation 

We were one of the first joint venture consolidators in the space. A lot of the competition in our space is buying a hundred percent of the clinics. The former owner then just becomes an employee practicing medicine instead of a part-owner in the space.

We wanted to differentiate ourselves in the market when we entered. We do the JV model; we're buying a minimum of 51%. But what we do is, allow our partners to retain or have rollover equity in their own clinic. So we have a controlling interest.

It aligns with our goals that they're focused on driving their own clinic's performance cause that's what's going to benefit them at the end when we exit. 

And we also are going to give them the same multiple that we get at the exit. That's a big pitch of our strategy is we're going to pay you X upfront, but, if you retain 30%, when we scale and bring a lot of operational efficiencies and help you grow your clinic.

When we sell this large group of clinics down the road for a much higher multiple, you'll get that same high multiple on your rollover equity. 

Why take this approach?

It was really due to the competition in the space, you have to find a way to differentiate yourself when there are 20 other players doing the same thing. Some are better capitalized than others, which is obviously an important thing.  

If somebody gets better leverage in their credit agreements or debt package, they can afford to pay a higher multiple. So you just have to find a way to differentiate yourself. 

And also show a good value prop to that veterinarian of, Hey, in addition to paying you this competitive multiple upfront, you can make a lot more under our model.

They get profit distributions because they're retaining their interest in their clinic, but it just aligns us, so we're all working towards the same goal. 

They help refer deals to us because the more clinics we can buy-in, the more EBITDA we can acquire. That's going to help us sell at a premium multiple down the road. 

We're a service organization. We have a big acquisition team, our core business. Still, we're also trying to help drive same-store sales, introduce operational efficiencies, take advantage of our procurement synergies, and things like that. 

JV Model at Scale

There is a lot of uniformity when you're doing this many deals and a tight timeline; whether it's with our legal agreements or deal structures, we want things to be as similar as possible. 

Today we've got 85 clinics, and they all have very similar legal agreements and operating agreements.

I don't want to have a nightmare where I go off and do have 85 different structures. That will also make us less attractive to the next sponsor that comes in when our private equity firm just chooses to exit in the future. 

That's key to keep track of everything, the uniformity, a lot of it though, with us wanting to do 40 plus acquisitions a year. Communication is key too. We have to have a lot of cadences. 

Whether it's between the law firms we're working with or accounting firms with the quality of earnings, our different internal teams, the integration teams, the ops team.

That's key is having a regular cadence because there's a lot of activity going on. I have over 20 deals under LOI right now. They're all being closed over the next couple of months. There's not much time to pause and take a breath. 

How to Communicate the Model

Obviously, a hundred percent acquisition is a lot easier to understand. We're going to pay you X versus when I'm showing someone a term sheet; it's going to include some different components.

I have to do a lot of coaching for our business development people. It's not just a relationship job; they have to understand M&A. Explain some complex things to a doctor.

They practice medicine. They're not thinking about multiples and exit recaps and things like that. So it's something that you have to walk them through, but to show the value in our model and how it could be a lot more beneficial versus taking a little more upfront,  and there's risk involved.

Asset Sale

So they're all asset deals. So we set up a legal entity for each of the clinics we acquire, and there's some structuring involved too, and not just in the vet space, but certain states prohibit the corporate practice of medicine. 

So you have to structure around that, where you have a veterinarian own the actual legal entity that employs the veterinarians. And then you have some inner company agreements and things like that. Each of our acquisitions sits in its own LLC entity.

Exiting the Portfolio

We have to address complicated things in our operating agreements. It's one thing when you're negotiating an agreement, but you're also having to contemplate what's going to happen in the future as well, which is unknown.

So it's really all defined out, based on what their EBITDA is at the time of exit. If they can grow their clinics, they're going to do better than they would if they don't grow the clinics. That's all laid out in the operating agreements. 

And it is something that we usually get involved with the other side's legal counsel on, and the veterinarians don't get too involved in it. They want to know when they're going to get their money and when they'll get the next big check down the road. 

Equity Splits

So most of our JV space competitors are setting up the clinics in individual entities. But a lot of them are doing TopCo equity. Yes, where you're getting equity in the overall parent company versus equity in your individual clinic. 

We set ours up purposely this way because that way, everyone controls their own destiny, right? You get some people that want to rest on their low rolls and just let all their other partner clinics pick up the slack. 

Here, you control your own destiny. 

Integration

Integration happens in pre-closing. Once we go live, we can close a clinic. They're on our benefits, they're on our payroll. So the last 30 days before we close our integrations and ops teams really get involved in meeting with the staff, like answering all the questions they may have and getting them on board for payroll and benefits and things like that. 

Because at the end of the day, we're a people business. So we really want to make sure that the employees are comfortable because really nothing other than a name of who their payroll check is coming from. Nothing really changes on a day-to-day basis. 

We need to keep the culture of the clinic we're buying. We don't go change their name; all of our clinics keep their names or really this, there in the background to help and assist them grow their clinic and kind of take things off their plate.

We even let them choose their own suppliers they've always been doing business with; we have contracts with all of the suppliers in this space and obviously can get better pricing that they can take advantage of once they come under our umbrella. 

So there are always some immediate cost synergies from the procurement side. 

Challenges of the JV model at Scale

Starting off, I think it's always that tough decision on spending all the money to invest in the infrastructure that you know you're going to need at some point before you actually have the clinics under your umbrella and their profits and revenue to justify spending all that money.

JV model's complex. There's a lot of cooks in the kitchen. You have a lot of interaction with your partners because they're co-owners of the business. An owner of a business acts a lot different than just an employee, as far as the information they want to see and their involvement in decision-making. 

There's also a lot of tax returns to file, so there's just a lot of administrative stuff. It has to take place in a JV model. So it's one of those things, too, that most people want to slowly build the team and the infrastructure, making sure the revenues are there and justified. 

It's a big leap of faith to go spend the money and then hope it works out. But luckily, we've been successful, and it's worked out for us.

Size of your M&A team 

When your team can't keep up with the deal flow, and you start identifying bottlenecks in the process, I'm looking to add to the team if a person could solve some of those problems.

Sometimes it's changing a process, but if I say this is just a bandwidth issue, I just need another person, which is obviously a key time to add someone.

Just getting the daily vibe of your team, too, you can tell when people are overworked, they may be keeping up. It's just probably working more hours than they are. You would like them to work so everyone can have a balanced lifestyle. 

So it's something, as a leader of a team, you just have to keep your eye on to make sure your team's still productive, but also is happy with the work they're doing is getting challenging work and not just having to do monotonous activities. It's not helping them grow as corporate development professionals. 

How to Adjust Team Size?

A lot of corporate development teams are one or two people. I think it's different when you're a consolidator because, in many companies, the corporate development group or person is opportunistic. 

We need to add to this business segment or here's a new technology that you make the buy versus build decision. You don't need a big team when you're opportunistically doing one or two deals a year. 

But for us, that's our core business. We want to go do 40 deals a year. But in a competitive market, if you're going to do 40 deals, you can't just issue 40 LOIs.

So a lot of your team's work is spent on deals that will never come to fruition. It takes a lot of effort to do the evaluations, produce the LOIs, and even negotiate them sometimes. And then you never actually win the deal. It's a constant challenge.

Evolution of your Process

We have three distinct teams. We have the business development team, which is in charge of sourcing the deals. When they're sourcing their own deals, you're not necessarily deals coming in from bankers or brokers but actually out there pounding the streets meeting the veterinarians. 

Through there,  a lot of our BD team has a history in the animal health space. Like they were product salespeople in the veterinary space, selling drugs or different products.

So they have a lot of connections in the vet space and in working those connections, in addition to cold calling too, going off of lists of the veterinarians in their markets where they're the right size that we would like to approach. 

But also have my corporate development team, which handles from an identified opportunity all the way through closing the transaction. We have an integration team as well. 

So obviously, that's an important handoff later in the process between my Corp dev team, who has most of the knowledge on this particular clinic since we're the most heavily involved in handing that off to the operation of the integration team.

Do You Use Bankers?  

We do. So we get a lot of inbound stuff from a lot of business brokers in our space. Not necessarily as many, I wouldn't say true investment bankers because the typical veterinary clinic is just a little on the small size for a big bank. Still, you'll see groups of clinics come to market together.

And then you'll see more traditional investment bankers get involved. So a lot of business brokers specialize in the space. So yeah, that's a deal source. Then you rely on your team to go out there and source their own deals.

Then they can find deals that may be the seller or the future partner we're talking to that is not shopping around and taking it to every competitor out there. Maybe you get it at a lower, multiple, with less competition, which obviously is good for us.

For some of this stuff, you can outsource some of these functions as well. Obviously, we use third-party AUV firms to do that.

We have outside legal counsel and staff. We do have a lot of interaction with the third-party, but ultimately, my team and I are the ones making the decision and working with our internal teams and some external parties. 

Owner's Equity

On average? It's 30%. 

We have some that are at 49%. Most of our deals are between 20 to 40, but we have some outliers there. We have a majority interest in all of our clinics, but 30% is the average for the retained interest for the veterinarian.

Efficiency in Integration

You learn from every deal. It's amazing how they're all still unique. 

So constantly, whether we're negotiating employment agreements, working with our HR team and our future partners is figuring out the right timing. And we face this on every deal, just like anyone selling their business.

They're always a little apprehensive about bringing everyone over the wall on their side until they know the deal will happen. There's always that risk of disruption to your own business. So that's a challenge with our integration teams, too, is getting the seller comfortable informing the staff instead.

So we really can make sure we have a smooth close and smooth integration. 

Typically, let's say in a vet clinic, they may have three or four veterinarians. Only one of them is a partner who's going to be getting proceeds from this sale.  So you have to spend some time with those associate veterinarians, the ones who are getting any equity. 

Make sure they're comfortable and know that, Hey, nothing's going to change in your day-to-day life. Other than there's a new partner that's there to help make your job easier for you. Retaining our veterinarians is really key and having a successful acquisition. 

Retrospective

A lot of it gets discussed after a deal closes. We call it a budget handoff call. That's a call to recap everything. We have our finance team there, the ops team, and the integration to ensure that everyone's we can have that knowledge transfer. 

We're also talking about making sure that they understand our first 12-month forecast. Talk about any intricacies and things like that. A lot of it's via communication too.

We also do a lot of surveys too. We'll send out surveys after deals close to our new partner. 

Managing Multiple Deals

For one, you have a very good team underneath you that you trust because I'm the one responsible, so I can't make all the decisions. You teach and train them to make sure they're flagging the appropriate issues up to you or where I need to get involved.

Also, I keep them as involved as I can. So ultimately, I push and delegate more stuff to them so I can focus on other things. 

If you've got 20 deals under LOI, obviously, you have to address any issues that pop up immediately. If it's an issue of equal importance, I probably need to focus on the one deal that will close the soonest. 

 You have to keep those deals on track to hit their close dates, or it becomes a nightmare for your integration team of deals constantly shuffling around the close dates.

So you try to find ways of centralizing the communication where it's not just all via email and stuff. I could spend all day just answering emails. It's not the most efficient use or best use of my time.

Surprises During Diligence?

One thing that comes to mind at a prior company, we were looking to do an acquisition in Spain, and we went over to spend some time with the owners of the business. We went to dinner with him.

It was in a Harbor in Barcelona. In his broken English, he basically said, if you do good diligence, you can have one of these boats. We ended up not doing that acquisition because of the foreign corrupt practices act and bribery.

But that was interesting. Obviously, in different parts of the world, various things are accepted. 

Dealing with unsophisticated sellers from a financial M&A perspective, some deals, especially during COVID where you have some valuation gaps, do earn-outs on certain deals. 

These earn-outs are negotiated at arm's length with both sides represented by counsel. At the end of the earn-out period, when you have defined metrics, they achieved none of the metrics and still want their money. 

One thing that's unique about the JV model too.  Here I'm partnering with these people. So you had to explain to them, and you want it to make it a fair deal for both parties. 

Because if you come in too buyer-friendly, you may get the deal closed, but you're just going to create headaches for yourself, post-closing when they may realize things that they didn't understand at the time the deal was negotiated. 

As a consolidator, we heavily rely on our partners as referrals to buy more clinics. 

Causes of Seller's Remorse?

We use our partners heavily. They would all say it's a fair deal. But sometimes, to no fault of anyone, the business may not work out. 

Sometimes they lose a veterinarian. You may have a high-producing veterinarian who decides to move to a different state or decides to stop working for family reasons. And then you gotta go find a replacement. That's going to affect your profitability.

Sometimes, when you have earn-outs involved, anytime someone agrees to do an earn-out in their mind, they're going to achieve that whole earn-out.

Obviously, when you get to the end of that period, if someone hasn't earned all that additional purchase price they thought they were going to get, there's always some disappointment.

You have to walk them through that. Not really set seller's remorse because I think the vast majority of our partners are very happy that they partnered with us. 

Especially during the pandemic, everyone's been through in the last year because it was really a great time to have a partner.

Advice for First Time practitioners? 

In corporate development, it's really about getting in a place where you can do deals. That's how you learn in this space. It's just doing lots of deals. 

Whether it's doing Corp dev work for a company, where you can really focus on just doing deals for that company, or coming at it through the transaction services space, where you get to work on a lot of deals to learn that way, or from the banking side.

There are obviously many different avenues for getting deal experience for someone who doesn't want the same thing every day.

It's a great line of work to get into. Always offer to help your bosses. Go sit in on the management meetings.  You may not be able to talk on a call, but go and sit in your boss's office and kind of just absorbing as much as you can. 

Just be a sponge and absorb as much information as you can because you'll learn on every deal. I've never done a deal that's the same; everyone's different. 

Which do you prefer? Consolidation Strategies or Traditional Approach?

This is my first time doing it from both a PE-backed company and in a consolidator space. It's definitely challenging. And the deal flow is pretty aggressive. I like it. I definitely like the PE-backed space. 

I've done it for a public company before because sometimes you can have competing priorities within a public company. That's having to manage their profitability a quarter at a time for the street and stuff. 

So one year, you may be focused on acquisitions, and then the next year, we're, Hey, we're going to use all of our available cash to buy back shares and things like that. 

The one thing that I like about the consolidator PE-backed company is that they're always going to be aligned with what I want to do because a consolidator will do deals. That's the point of why they exist. 

So you're going to have plenty to do and not have any kind of months where you're maybe sitting around or working on. Some different projects because the company is not currently focused on and making any acquisitions.