BLOG: Equity: Buyback rights, forfeiture and vesting
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Key takeaways:
- Physicians and legal advisors will want to closely review and negotiate all sales documents.
- Sellers must be aware of terms and conditions related to buyback rights, forfeiture and vesting of equity.
In our last post, we saw how rollover equity fits into the overall consideration paid to a selling physician owner of a physician practice.
We also discussed how a management service organization platform’s capital structure can impact the realized value of that rollover equity through allocation of proceeds among private equity sponsors, physician owners and third parties. Today, we’re digging into the less pleasant topic of some of the ways that physicians can lose some or all of their rollover equity and future grants of equity.
As a selling physician, you will be asked to sign a substantial stack (most likely an electronic one) of agreements for your sale transaction. Along with the sale agreement itself, a physician typically receives an employment agreement, a rollover agreement (sometimes called a contribution agreement) and a platform partnership or limited liability company agreement (or a joinder to one) — all of which are related to your rollover equity. (In the future, you and your colleagues, including associate physicians, may be granted additional equity, which will likely tie to these documents.) You and your legal advisors will want to closely review and negotiate these documents before you sign them because these will include economic terms and obligations for all parties. The agreements will likely include terms and conditions related to buyback rights, forfeiture and vesting of equity, and it is important for you to understand how each of these provisions might stand between you and a full payout for your equity.
Repurchase/buyback
The first type of provision is buyback (or repurchase) rights, where the platform can exercise a right to repurchase some or all of your equity in exchange for money. These rights typically give the platform the right to buy your equity from you if certain events (or triggers) occur. Buyback triggers vary by platform and deal but typically include breaches by the physician of restrictive covenants (eg, noncompetes), terminations of employment and indemnity claims under the sale agreement. While you might expect that buyback provisions would work both ways and give both platforms and physicians exercisable rights, these provisions are usually drafted to be at the option of the platform — not the physicians. If a buyback would result in a high sale price for the physician’s equity, the platform might not exercise its buyback rights against the physician at all.
The one-sided structure of buyback rights makes valuation mechanisms critically important. A platform-friendly buyback provision might give the platform’s board of directors discretion to determine the value of the equity. Physicians can negotiate for explicit requirements that give a physician some comfort that the platform will price any buyback fairly, such as a right to a third-party appraisal or a useful and efficient process for resolving disputes over value.
Buyback provisions also vary in the repurchase price. Some buyback provisions base the value of rollover equity on its original purchase price (that is, the value of the shares exchanged for the rollover equity at closing). Others use the current fair market value of the equity. Others may use the greater or lesser of two or more formulas, depending on the circumstances of the buyback.
The process that a platform must follow to exercise its buyback rights can also affect how those rights will work in practice. For example, a buyback right that must be exercised by the platform within 30 days of a triggering event might favor a speedier resolution and more evenhanded compromise than a right that gives the platform months to decide (or that doesn’t even have a deadline).
Forfeiture
The most draconian way to lose your equity is forfeiture, which requires a physician to forfeit his or her equity for no compensation. In the case of rollover equity, this essentially means that the buyer is taking back part of the purchase price originally paid to a selling physician; in the case of equity that was granted to a physician (partners or associates), this means that you lose your equity and any value that you may have hoped to gain. Many platforms — but not all — reserve forfeiture for the most severe misconduct, such as termination of employment for cause.
Vesting
A third type of provision, vesting, delays the date on which you fully own some or all of your equity, usually subject to meeting certain conditions. It is common to see vesting terms when equity is granted or awarded by a platform to physicians (partners and associates alike) at no cost to the physician, although in some instances you may see vesting provisions tied to rollover equity as well. For example, you might receive a portion of your awarded equity on each anniversary of the sale closing for several years — so long as your employment isn’t terminated by the practice for cause and you don’t terminate your employment without good reason. (The definitions of “cause” and “good reason” tend to be deal- and platform-specific, so you should expect to discuss them closely with your advisors.) For example, if you quit without good reason 2 years after an equity grant, the platform might allow you to keep the amount of equity that vested during the 2 years but then you lose any equity that has not yet vested. You might walk away with only a fraction of the ownership interest in the platform that you would have had you stuck it out for the full vesting period.
Given the unpleasant ways that a physician’s equity can be taken away, it is important to discuss the terms and conditions of your equity with your advisors.
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