Since 1977, we’ve been the business advisor and broker to thousands of veterinarians, and it’s been our pleasure to be part of their career journeys. Our team of experts specialize exclusively in veterinary practice sales, appraisals, and brokerage.
We’re passionate about providing the best service, honest guidance, and education about profitable practice ownership and valuation to those in the veterinary field. Take advantage of our article library to learn more about Simmons and feel free to reach out to us if you have any questions.
Be notified instantly when new veterinary practice listings hit the market.
For veterinary practice owners reviewing laboratory agreements, the most important section of the contract is not the pricing schedule or the equipment list. It is the termination provision. Owners should clearly understand how termination penalties are calculated, whether previously granted discounts must be repaid, whether future expected purchases are included in the damage’s calculation, and how equipment subsidies are valued if the agreement ends early.
Most laboratory agreements include liquidated damages clauses that apply if the practice ends the contract before the agreed upon term expires. These provisions are designed to compensate the laboratory for what it considers lost value from the partnership. The calculation frequently includes multiple components. First, the practice may be required to repay the value of any equipment subsidies that were provided when the agreement was signed. The diagnostic analyzers placed in the hospital are rarely truly free; their cost is generally embedded within the long-term purchasing commitment. If the contract ends early, the remaining equipment value may be charged back to the practice.
In addition to equipment repayment, some agreements require practices to reimburse the laboratory for discounts previously received on testing. Under these provisions, the laboratory may calculate the total value of discounted testing provided over the life of the agreement and require repayment if the contract is terminated early. What initially appeared to be a pricing incentive can effectively become a retroactive financial obligation.
Another factor often included in termination calculations is the practice’s minimum purchase commitment. If the agreement required the hospital to purchase a certain amount of laboratory services and those volumes were not met, the difference may be billed as part of the termination cost. The most surprising component for many veterinarians, however, is the inclusion of projected future revenue that the laboratory expected to receive during the remaining contract period. In some agreements, the laboratory calculates damages based on the practice’s historical monthly laboratory spending multiplied by the number of months remaining in the contract.
Ironically, the practices most affected by these contract liabilities are often the most successful ones. Growing hospitals frequently upgrade diagnostic capabilities and expand their services, which may involve entering into new vendor agreements. Yet if the practice later sells sooner than expected, joins a larger hospital group, or simply wishes to change laboratory providers, the remaining contract term can become a serious financial obstacle.
Consider a practice that spends approximately $12,000 per month on laboratory testing. The hospital signs a six-year laboratory agreement and receives diagnostic equipment valued at $75,000 along with discounted testing and a modest signing incentive. Three years later, the practice owner decides to sell the hospital. During the sale process, the buyer indicates a preference for a different laboratory provider or has been given the opportunity to enter into a new, much more lucrative contract. This is common when buyers are planning to switch providers. To complete the transaction, the existing contract would need to be terminated.
At that point, the laboratory calculates the termination obligation based on the remaining term of the agreement. If three years remain on the contract, the laboratory may begin its calculation with the practice’s average monthly laboratory spending—$12,000—multiplied by the 36 remaining months. This alone represents more than $430,000 in projected revenue. The final buy-out figure may then incorporate adjustments for equipment value, discount recapture provisions, and other contractual formulas. Even after negotiations, the resulting termination cost could still approach $300,000 (or higher!).
When this occurs during a practice sale, the impact can be significant. Buyers routinely review vendor agreements during due diligence and treat termination costs as financial liabilities tied to the business. If a buyer won’t accept the contract, the seller must pay a substantial buy-out to exit an existing laboratory agreement. If a buyer does accept the contract, but it’s not as financially favorable as a new one, the buyer may subtract the difference and require a reduction in the purchase price. For example, if not terminating the current laboratory contract creates a future increased cost of $100,000, the buyer may simply reduce their offer by a similar amount. In effect, the contract reduces the value of the practice.
In some situations, buyers may choose not to pursue the acquisition at all if the contractual obligations are too restrictive or expensive to resolve. Corporate veterinary groups, in particular, often maintain standardized vendor relationships across their hospital networks. If a newly acquired practice is locked into a competing laboratory provider under a restrictive agreement, it can complicate integration and purchasing efficiencies.
When you are considering signing a laboratory agreement, ask for an example of a buy-out calculation for your contract for two periods of time, two years into the agreement and two years before the agreement ends. Get it in writing! You can use this to help you see the costs before you commit, and it may be valuable later if the buy-out calculation is different than what you originally received.
A veterinary practice is often the largest financial asset a veterinarian will ever build. When the time comes to sell the hospital, every contractual obligation attached to the business can influence its value. Unfortunately, laboratory agreements are sometimes treated as routine vendor relationships rather than long-term financial commitments.
As a result, some practice owners discover—often during the final stages of a sale negotiation—that a contract signed years earlier now carries a six-figure termination cost. In extreme cases, that cost can approach $500,000 or more. The lesson for practice owners is straightforward: Before signing any long-term laboratory agreement, it is essential to understand not only the pricing and incentives offered today, but also the financial consequences of leaving the contract in the future. In many cases, the most important number in the agreement is not the discount on laboratory testing, but the cost of the exit clause. As always, the devil is in the details.
Before signing or exiting any laboratory agreement, understanding the financial implications is critical. An experienced Simmons advisor can help you evaluate contract terms, assess potential liabilities, and protect the long-term value of your practice. Contact Simmons to start the conversation.
This article was originally posted on www.simmonsinc.com. Any reproduction on any other site is prohibited and a violation of copyright laws.
