In this episode, hosts Brad and Michael dive into the story of an OBGYN who entered into a “Wall Street” deal when he sold his growing fertility clinic to a private equity group. What initially appeared as the perfect opportunity for expansion soon revealed challenges post-sale. Learn the underlying obstacles sellers face in these transactions, from adjusting to someone else controlling your business to understanding your post-sale legal obligations as the seller. Tune in for strategies to help you adapt to “Wall Street rules” and protect the future of your practice.
Listen to the full episode using the player below, or by visiting one of the links below. Contact ByrdAdatto if you have any questions or would like to learn more.
Transcript
*The below transcript has been edited for readability.
Intro: [00:00:00] Welcome To Legal 123s with ByrdAdatto. Legal issues simplified through real client stories and real world experiences, creating simplicity in 3, 2, 1.
Brad: Welcome back to the Legal 123s with ByrdAdatto. I’m your host, Brad Adatto, my co-host, Michael Byrd.
Michael: As a business and health care law firm, we meet a lot of interesting people and learn their amazing stories. This season, we’re entering the most sophisticated AKA fancy season of a business. Our theme this season is buying and selling a business.
Brad: Well, for those that don’t know, Michael, buying and selling a business is just one of the four seasons. What are the other ones?
Michael: Yes. So we have the building season, starting a business, the operating season, you’re running a business, the scaling season, when you’re growing a business. And as we said, we’re here now at the buying and selling season.
Brad: All right. What do you have for us today, Michael?
Michael: Well, I’m really thankful with what I’m about to say is that we as [00:01:00] a law firm are out of the hourly billing world. We do have experience with that. We grew up as young bucks in our old law firm and even prior firms, billing by the hour. And even back then, no matter – whatever our hourly rates were as we went up, we always marveled at some of the rumors on what big law charged per hour.
Brad: Well, first off, thanks for letting me know. We’re not billing by the hour. I was not aware of that.
Michael: Okay.
Brad: Is that new?
Michael: Yeah, new as in like, I don’t know, like six years ago.
Brad: Okay. Good. I got that down. Thank you. Kennedy, can you just put that in loop because I’ll probably forget again. Yeah. Going back to hourly rates – I can remember a long time ago when we thought we’d hear someone like, “Wow, they’re charging like $600 an hour. That’s kind of crazy.”
Michael: Yeah and you’re basically admitting that you’re old like me. So that rate nowadays is pretty standard even for [00:02:00] associates in a lot of firms. But I’m curious because we still hear the rumors out there. What’s the highest rate you’ve heard about?
Brad: Yeah. Assuming we’re not talking about these plaintiff attorneys who have these huge mega cases and end up getting these huge hourly fees afterwards. I remember, and this is just a few years ago, thinking this was crazy that these two different divorce attorneys, the different law firms were charging $2,000 an hour for when their clients hired them. What about you?
Michael: Well, I can’t go that high. I’ve never heard of that. That’s pretty incredible. We did a health care deal last year where there was a health care attorney that does exactly what we do, and he charges $1,300 an hour. I got to the point in the deal because we were working together with the same client, and I was hesitant to reach out to him because I felt bad that my client was going to get that bill for [00:03:00] that hourly rate.
Brad: If I remember correctly on that particular guy, it actually was that and some change. It was like 1,396 cents or something bizarre like that.
Michael: Yeah, you may be right.
Brad: So just out of curiosity I know we’re lawyers and apparently don’t charge by the hour, but why are we talking about that today?
Michael: Well, a question for you. What do you think the record is for the highest hourly rate?
Brad: $100 billion.
Michael: Oh, wow. Okay, clearly you are not going to try today. It’s okay. To answer this, we have to talk about court awarded attorney’s fees, and you somewhat alluded to this at the beginning. In litigation, oftentimes depending on the type of claim you have in your lawsuit, you, the party, may be able to recover attorney’s fees. And when that happens [00:04:00] the lawyers go before the judge and prove what they claim they’re entitled to being reimbursed for what they call “reasonable attorney’s fees”.
Brad: And air quotes that baby.
Michael: Yes. So the record award in US history, according to an article I read, was $688 million in legal fees in the Enron class action lawsuit from 2008.
Brad: Wow. Okay. I was told there would be no math today. How does that translate to hourly?
Michael: Okay, I’ll get there because I’m not feeling the math either. So I have another question. Do you remember more recently, as in this year, 2024, when Elon Musk was fighting in court over his requested multi-billion dollar pay package?
Brad: Yes. I actually read a bunch of articles on it and actually [00:05:00] listened to podcasts on it. It was actually just fascinating to understand all the moving pieces.
Michael: So the lawyers who argued against they represented the stockholders and it was in Delaware, in their court system. And they were arguing against the pay package. I don’t remember how much it was. I want to say it was like 50 something billion dollars a year as compensation or as a pay package. I don’t remember exactly what it was, but when they were arguing against that, they actually won the case. The court denied the pay compensation package for Elon. And so, they’re wanting their attorney’s fees and they’re asking for their own piece of the pie. They requested legal fees, Brad, of $7.3 billion, and asked for it in Tesla stock.
Brad: Yeah. And for those that aren’t familiar with this case, I’ll give a little [00:06:00] more context because I know Michael loves it. So, Tesla shareholders that did file this lawsuit were challenging Elon Musk’s pay package or compensation package from 2018, which at the time actually was considered crazy because it was so built on the fact that Tesla had to do really well. Now the pay package that he or his comp package is actually valued at is $55 billion. And the Tesla, to the court case that you’re referencing, they said, “Well, that’s excessive and granted him too much money and control.” And then the argument that they initially successfully won with was they said that it was improperly scrutinized. It was unfairly enriching Musk. But the board actually came back and actually defended the package saying, “Hey, it was based on performance base.” And at the time when they came up with this targeted number, Tesla had to meet this incredibly high number just to get to that number. And so initially, as you said, the [00:07:00] Delaware judge ruled that Musk and the company failed to prove that the mass payout was fair. Hence, as you said, the shareholders actually did win. However, our Delaware court eventually did rule in Musk’s favor of holding the compensation as valid. And the court found that Tesla’s board acted independently in the company’s best interest.
Michael: All right, that’s helpful. And yet these lawyers still want to be paid, even though ultimately it didn’t prove fruitful. So, what I read about their claim for the $7.3 billion is that there were 37 attorneys and paralegals that were working on that case, and that they did this on a contingency basis. So vocabulary word, when you have a legal fee arrangement based on the contingency, it’s usually set at a percentage of the outcome. And so, the attorneys here are justifying the $7.3 billion because it was a contingency case. And instead [00:08:00] of the standard 33% fee recovery, they are only asking for 11%, which sounds great, except for the fact that 11% is $7.3 billion. The translation would be an hourly rate of $370,000 per hour. Can you imagine sending that invoice?
Brad: You talk about surprise bill. I actually sense future litigation just on the attorney fees alone.
Michael: No doubt. Well, definitely a battle is ensuing over that very large amount of money. But let’s dive into today’s story, Brad, which I’m just going to say it’s coincidental. Our main character in today’s story, we’re going to call him Dr. Elon. Yeah, we’re calling him that because he’s a serial entrepreneur and a serial in all sense of the words. He’s been starting businesses since high school. Dr. Elon [00:09:00] is an OBGYN who specializes in infertility.
Brad: Well, based on the real life story of Elon Musk who has sired a ton of different kids with different women, I don’t think he needs to go see Dr. Elon at the fraternity for fertility reasons.
Michael: Yeah. There’s a lot of news lately. He’s claimed that he’s trying to help the population problem that’s coming for America by I think he has 12 children. That’s the last I heard. Well, Dr. Elon, who’s different founded a fertility clinic called Baby Daddy Fertility.
Brad: Baby Daddy Fertility? Very immature of you, Michael. And I like it.
Michael: Yeah, I knew you would. I actually came up with that just for you.
Brad: Thank you.
Michael: So Dr. Elon has a flare for attention grabbing, much like his [00:10:00] namesake. And despite the unconventional name, Baby Daddy Fertility grew to multiple locations over six different states.
Brad: And audience members, we just finished an entire podcast season on that and covered what happens when you’re scaling, and for those who didn’t get to listen to it, super high level. When a business starts scaling, especially with multiple locations, this brings several different challenges across various different areas. No matter what speed you’re doing it in, what scale you’re doing it at, there are at least three elements we want you to focus in on. What kind of compliance impact are you going to have? What changes happen when you do this to your accounting, your tax planning, and then operational changes that occur as you kind of go like this. And as you add each new location, you will face these consequences. And obviously if you fail to at least stress these three elements, there can be a lot of headaches in the future for you.
Michael: Yeah, and that all was the issues that Dr. Musk faced. His [00:11:00] growth strategy was very specific. He decided to expand by buying businesses. And so he would go and locate a mom and pop fertility clinic in a market and acquire it to then kind of fold into the Baby Daddy Fertility empire.
Brad: Alright. I like it. So what was the biggest obstacle he faced while growing this fertility empire?
Michael: Well, there was few. Staffing was a big one. When you’re opening and growing multiple locations, hiring and retaining top talent is no easy feat. And kind of on top of that, as he acquired these mom and pops, sometimes long-term employees would leave after the acquisition or if they were staffed by the mom and pop, sometimes when he was acquiring them, it was because the mom and pop wanted to retire, and so he had to replace the team there.
Brad: Yeah. Again, going with the rapid growth you can outpace the ability to [00:12:00] hire and train staff leading to as you said, higher turnovers, unqualified employees. And additionally, a business expanding quickly may not have enough experience managers or leaders to oversee all these new locations effectively. As you can imagine, and I think we’ve talked about this in the last season, scaling, this can obviously lead to cultural mismanagement issues.
Michael: Yeah, for sure. And I’ll say this, Dr. Elon, his superpower was creating a cohesive, energetic culture across all of his clinics. Dr. Elon had a captivating personality and was a natural leader, so everyone would quickly get on board and drink the Kool-Aid, so to speak.
Brad: Nice. Well, having a powerful leader can be the benefit for when you’re scaling, and especially with scaling companies like this, especially bringing in all these new teams that he has to deal with. So, what did Elon struggle with? Sorry, Dr. Elon?
Michael: Yes, Brad, thanks for clarifying. Well, at the time, [00:13:00] Dr. Elon wouldn’t agree with what I’m about to say, but from our view of the world, and I know you remember this Dr. Elon’s biggest struggle was compliance. Staying in front of regulatory issues was a constant battle for Dr. Elon. And the reason he might not admit it is he was so focused on expanding his business that he often kind of just set it to the side. He forgot to reach out about compliance when acquiring new locations. And when you acquire a mom and pop business, things can get messy quickly if you’re not on top of the compliance paperwork.
Brad: Yeah, the classic grow now, ask questions later approach. Unfortunately, we’ve seen this derail many businesses over the years.
Michael: Yeah. And there’s two sides of the coin with this small business mom and pop acquisition strategy. One side is that the financial strategy can be great. I mean, you can get a deal from a valuation perspective because often these really small [00:14:00] businesses don’t have high expectations on what they’ll sell their practice for and you’re instantly in a new market with existing patients and oftentimes even with an existing team in place.
Brad: Okay. Michael that was one side of the coin. Please tell us the other side.
Michael: The other side of the coin is that there’s a reason you can get a good deal. Mom and pops are run like, well, mom and pops. This means that they’re not going to be sophisticated from a business perspective and often have a ton of unknown compliance issues.
Brad: Yeah. This I’m sure was complicated because Dr. Elon was a mom and pop business owner at heart. He’s still running this business the same way. He was running the businesses when he started in high school even.
Michael: Oh, yeah. I mean, Dr. Elon, I mean, it’s a great point. He fought and acted like a mom and pop [00:15:00] in so many ways. He would tell people in fact that he was the CEO, President, CFO, COO, Head of Sales, and Bookkeeper. He did everything himself, even when they were in six different states.
Brad: Yeah, sounds like a lot of titles carry around, or we say a lot of hats to be wearing as we discussed on other shows. And this, honestly for us, when we hear these words starts becoming a red flag when you’re wearing that many hats.
Michael: Yeah. And despite all of this, Dr. Elon decided it was time to take Baby Daddy Fertility to market. He had met an investment banker who helped him organize his financials and start preparing for sale. And now this investment banker, Brad, he had a side passion for employment law, so we’re going to call him Mr. Denny Crane.
Brad: Oh, of course, I love that you’re referring to the old TV show called [00:16:00] Boston Legal, played by William Shatner who was Denny Crane. But why Denny Crane in this particular case?
Michael: Well, Denny Crane was only a lawyer on TV and not a real lawyer. And so Mr. Denny Crane also acted like a lawyer, but was not real, at least for employment law.
Brad: Oh no, that sounds like trouble. All right. How did it go when they went to market?
Michael: So, a private equity group fell in love with Dr. Elon and his vision. They wanted to use Baby Daddy Fertility as the platform for a large scale rollout of fertility clinics nationwide.
Brad: Excellent and for context, again, when acquiring a medical practice, generally a platform, which Michael just said, refers to like a larger well established practice that serves as a foundation for future growth for expansions and subsequent acquisitions. The platform typically has a solid infrastructure, strong [00:17:00] management team, scalable operations, and recognizable brand. When investors acquire a platform practice, the goal is to use this base, acquire smaller practices, similar to what I guess Dr. Elon was already doing, integrating them in the platform to achieve an economics of scale, is I think the term they use in the street. And this platform approach is supposed to create increased market share and drives growth in a more efficient and strategic manner.
Michael: Yeah and the buyers here, were willing to turn a blind eye to some of the compliance concerns that we’d been screaming about for years because they were so impressed with Dr. Elon’s energy and leadership.
Brad: Yeah. Sounds like a dream scenario.
Michael: Well, as you remember, we were shocked that the deal did not fall apart over the compliance stuff that we had been harping on.
Brad: So Michael, what happened?
Michael: Dr. Elon ended up selling Baby Daddy Fertility for $50 million. But Brad, there was [00:18:00] a twist.
Brad: Here it comes, everyone get ready for it. What was the problem?
Michael: After the honeymoon phase post-acquisition, doctor Elon wasn’t used to having bosses and being accountable to anybody.
Brad: Yeah, and we talked about this, what it would be like when all of a sudden you’re – I’m sure they reassured that Dr. Elon, that they would still be the CEO even post acquisition, right because that was the platform.
Michael: Yeah, no, you’re right. And he loved the idea of the open checkbook so he could do what he’d been doing, except at a much faster pace. However, the markets started to change, and the people with the checkbook shut it. And the private equity firm decided that they were going to focus on starting new clinics from scratch or de novo as they say on the street, instead of acquiring existing ones, and so this is a [00:19:00] slower growth strategy.
Brad: Yeah and so that means these new clinics didn’t really probably live up to the projections of what they were trying to do.
Michael: Exactly and some of these compliance issues that everyone ignored started coming back to bite them.
Brad: Yeah. I remember they got some medical board and nursing board complaints and ended up having to change their staffing. This, of course, as you can imagine, would increase their overhead.
Michael: Yeah and then the new clinics didn’t perform as well as expected, and Dr. Elon never received his earnout.
Brad: Oh my gosh, another vocabulary word. For those not familiar with the word, “earnout” – in mergers and acquisitions a deal, the important part of a deal is that, and they’ll add this to the contract that allows a seller to receive additional compensation after the deal is closed based on the performance of these acquired business over a specific period of time. This performance is typically measured by financial metrics such as revenue, profit, and other key KPIs, as they say in the streets. [00:20:00] Earnouts bridge the gap between what the buyer and seller, when they have different views of the actual value of the business. For the buyer, it reduces the upfront risk as part of the purchase price in continuation of this futuristic or this success of this business. For the seller, it provides the potential of a higher and total payout as the business they believe will perform well post-acquisition.
Michael: Yeah. And about a year after the acquisition, Dr. Elon called us and he wanted to know if he could leave the deal.
Brad: And earnouts can be the source of post deal disputes if performance metrics, those KPIs aren’t clearly defined in the business facing these challenges of hitting these particular targets. And I’m starting to think this is probably one of the main reasons that Dr. Elon wanted to leave
Michael: For sure. Well, let’s go to commercial Brad, on the other side. Talk about the issues that arise when a seller wants to leave the business.
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Brad: Welcome back to Legal 123s with ByrdAdatto. I’m your host Brad Adatto, with my co-host, Michael Byrd. Now Michael, this season, our theme is Buying and Selling a business. And we’re talking about these stories that happen to our clients, sometimes good, sometimes bad. And today we’re talking about Baby Daddy Fertility. That’s the name you gave it. Not me. I’m too mature to have a name like that. And the growth it was going through and the twist that started happening, especially with [00:22:00] Dr. Elon who was wearing all these hats and growing their own company. And then about a year later, after being inquired by private equity, I guess the training wheels or whatever you want to call it, things started falling apart. So I think for our audience members that are hearing their story and wondering about them going their route, maybe you can start talking about some of the typical obstacles that someone faces when they are trying to exit a deal like this.
Michael: Yeah. And I think for purposes of putting yourself in the shoes of Dr. Elon, it’s important to understand the differences between, we use the term Wall Street deal and Main Street deal. And so, Dr. Elon, as we said, is a mom and pop at heart. Started businesses in high school, serial entrepreneur, wore all the hats, and then he acquired businesses that were just like that, so that was his world. And so, there’s a, a little less formality that goes with the mom and pop [00:23:00] world, the main street deals. Well, he sold for $50 million to private equity. That’s a Wall Street deal. And private equity transactions are sophisticated. There are layers of protections that are built to keep the seller, in this case, Dr. Elon tied to the company. And if you think about it, I said earlier, the number one thing they wanted was Dr. Elon. They fell in love with him to execute on this platform strategy, even to the point they were willing to ignore a bunch of compliance problems.
Brad: And we probably can get into this a little bit more in a second, but when it comes to these purchases, a lot of times inside these governing documents, the purchase agreements, there’s going to be a stick, so non-competes, and then there’s a carrot, which is the earnouts that protects the purchaser in this case, the Wall Street deal PO post-closing. And I think, Michael, for our audience, maybe we can kind of dive deeper into that statement because I think there are a lot of different components that go into this. So [00:24:00] again, going back to someone like Dr. Elon, who is thinking about selling, for them to start thinking about some things to consider after they sell.
Michael: Yeah. And we’re going to have to keep it high level for those who have not been involved in a buying or selling of a business, the volume of documents that you signed is probably more than you’ve ever signed in any legal situation. And so there’s a ton that goes into it that’s trying to you know, memorialize the transaction and include these protections that we’re talking about. So the first, and you just alluded to it, is non-competes and other restrictive covenants are going to be a part of every acquisition. They’re built to prevent the seller from starting a competing business for a set period, and oftentimes that set period is going to be longer than you would see in an employment agreement because the buyer is buying the [00:25:00] business and they don’t want the person that they’re writing a check to go out and start competing.
Brad: Yeah, that’s a good point. And a lot of people, first off, I think just going to that statement in general, that non-compete could be up to five years, so just be prepared for that. Second a lot of people are just like, “Oh, well, if the FTC rule does come through, doesn’t that make non-competes invalid? Or, are my state non-competes invalid?” That’s generally speaking for employment agreements, not for the purchase of business. So don’t hang your hat that it won’t be enforceable, because generally speaking, courts are like, “No, they bought your business, of course you can’t compete with them after the fact.”
Michael: Yeah. And so, another area that you’ll see these restrictions put in place is an equity role forfeiture. And so we’ve talked about this in prior episodes, but in a transaction, oftentimes a portion of what the seller’s going to receive, so a portion of this $50 million transaction would’ve actually been equity [00:26:00] in the buyer’s company, so stock. And so, what they will often put in place is, yeah, if you leave or you violate some other provision, you lose that. So you’re walking away from a huge portion of the transaction. And in this particular case, the equity role was 30%, so it was a big equity role that Dr. Elon took on.
Brad: Again, this is one of those perfect carrot stick moments. It could be either or, right? It’s the carrot is…if we grow this thing and we sell it down the road, you’re part of it, but if you leave before certain markers are met you’re forfeiting this right, and in this case, it was a lot of the overall purchase price was tied to it.
Michael: And then another area that is designed for a couple of reasons is the earnout. So the earnout we mentioned before was not met, and so those are built partly for the buyer’s perspective, [00:27:00] to make sure that what they’re buying is actually what they think they’re buying, so that the company’s going to perform based on a certain level that they expect with the check that they’re writing. Another reason they have it is a further financial disincentive for the seller to leave, because the seller has to be there to execute on those earnouts. And if they were going to leave, they would lose the ability for those future checks to come in.
Brad: Yeah. And this is the part where they want that leadership team that they’re acquiring to stay there and be motivated to help grow it. “Hey, we’re buying you for this, you’re supposed to hit these goals every year and going forward, even though you don’t completely own this anymore, we need you to still hit this for you to get the full value of that purchase price.” And for us, the buyer should get the full value of that purchase price going into the future. So again, it’s another one of those perfect carrot and stick situations. And where the frustrations that we see with a lot of these owner [00:28:00] operators, is someone comes along and they don’t know how to run it correctly, or they switch, in this case, course, and now the CEO is stuck with a process that they’re not used to.
Michael: Yeah and then the last area of how private equity will, or a buyer will, protect against the seller trying to leave is just flat out damages. You breach the contract, and so there are going to be significant financial penalties associated with it. And so, you may get popped with all these different restrictions and financial losses and face the possibility of getting sued.
Brad: Yeah. And this is why, and we’ve talked about this in other shows about reps and warrants and about why what you’re going to do and what you promised to do is so important because if you leave and it turns out that you knew about a lot of these things, they may come back and say, not only do you have to pay us back A, B, or C, we [00:29:00] have damages because of that, that’s outside of scope of this. So these are all important elements to understand what will happen to those who stay afterwards and the issues they will face. So Michael, let’s just keep rolling. Let’s get back to Dr. Elon here. As it relates to Dr. Elon, he wanted out. He obviously, there is, I’m assuming, non-competes and financial penalties that could lock him up. What happened then?
Michael: Yeah, he had all of those things in place and so Dr. Elon stayed the financial impact and these restrictions on trying to start a new business were too big of barriers. Now, Dr. Elon is to this day, still not happy with this situation.
Brad: Till today, right?
Michael: Yes.
Brad: Let me check my watch…
Michael: Yes still, and that’s despite having 50 million reasons to be happy.
Brad: Yeah. It’s a tough pill to swallow for someone who’s used to being the boss. You know, after selling this business, many sellers face challenges and adjusting to this new dynamic, Dr. Elon [00:30:00] in this case, no longer is truly in control. And the struggle with losing this decision is making authority, or especially when you have to reduce your advisory role or to this new ownership. And it can be frustrating, especially again, going back to the mom and pop mindset. And now you have this different purchaser, or in this case, their vision versus your vision, right? And finally sellers may experience this emotional void or loss of who they were because they’re mom and pop. They have all these hats they wear. And that’s a major part of that life decision for a seller. Michael, were almost, almost near the end. And even though Dr. Elon, had 50 million reasons to be happy. Any final thoughts?
Michael: Well, in Dr. Elon’s case, it was a reminder that when selling to private equity, you’re not just selling your business, you’re also committing to staying engaged for the long term under new rules, Wall Street rules.
Brad: Ooh, Wall Street rules. All right. Well, Michael, we’re back [00:31:00] next Wednesday where we get to discuss the types of M&A deals, and we have our rockstar, Jay Reyero, joining us again to discuss Main Street deals. Thanks again for joining us today. And remember, if you like this episode, please subscribe, make sure to give us a five star rating and share with your friends.
Michael: You can also sign up for the ByrdAdatto newsletter by going to our website at byrdadatto.com.
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