This is the third article in a series on internal GP practice buyouts. The series began with Why internal GP practice buyouts fail more often than they should by Dr Chris Mitchell AM, FAICD, and continued with Valuing a GP practice for an internal sale. This article addresses how the transaction should be structured and documented.
What bank finance covers and what it does not
A lender will fund hard assets at reasonable loan-to-value ratios. Equipment, fit-out and purpose-built infrastructure are tangible and retain residual value if the transaction fails. Goodwill is different. Its value rests on the practice's patient relationships, the consulting arrangements with the selling doctor, the branding and other intellectual property, and the staff and management systems that make the practice function. None of these transfers automatically at settlement.
A lender who has funded the goodwill component cannot recover against it in the same way they can recover against a tangible asset. Depending on the transaction structure, standard bank finance may cover only a portion of the purchase price. The balance needs to come from the buyer's own capital, vendor finance, or a staged equity structure in which the acquisition proceeds in tranches. In most internal buyouts, the buyer's capital is limited. Vendor finance is therefore not incidental to the transaction, it is usually central to it.
Vendor finance mechanics
A vendor finance arrangement for a GP practice sale typically involves the buyer paying a deposit at settlement, with the balance of the purchase price remaining as a debt owed to the seller. The deposit percentage and repayment period vary by transaction, but a typical structure involves 40 to 60% paid at settlement, with the balance repaid over two to five years at an agreed interest rate. The seller becomes a creditor of the buyer entity for the duration.
This is the source of both the structure's flexibility and its risk. The seller's risk is real: the buyer now controls the practice and its cash flow. The seller's ability to recover the outstanding balance depends entirely on the quality of the security taken at settlement and whether that security is enforceable against the buyer's assets if the buyer defaults.
Security: what to take and why
Security over the vendor finance debt should be documented and registered at settlement, not deferred. The minimum adequate security package for a GP practice internal buyout typically includes:
- A General Security Agreement (GSA) over the assets or shares of the buyer entity, registered on the Personal Property Securities Register (PPSR)
- A mortgage over any real property the buyer holds or acquires
- Personal guarantees from the individual buyer where the purchasing entity is a company or trust
- Security over third-party assets, companies or trusts the buyer controls outside the practice
Why PPSR registration matters
Under the Personal Property Securities Act 2009 (Cth), an unregistered security interest is unperfected and ranks below perfected security interests in insolvency. If the buyer entity enters external administration while carrying an unperfected vendor finance debt, the seller stands behind every secured lender and alongside unsecured creditors. ASIC reported 11,053 companies entering external administration in 2023-24, a 39% increase on the prior year. Default risk is not theoretical.
The registration window is also time-sensitive. A security interest registered after insolvency has commenced can be challenged. The documentation needs to be prepared before settlement, signed at settlement, and lodged on the PPSR immediately. Delays create gaps that cannot always be repaired retrospectively. The date of registration, not the date of the agreement, determines priority under the PPSA.
Earnout structures
An earnout defers a portion of the purchase price and ties payment to the future financial performance of the practice. In an internal GP buyout, earnouts are typically used to bridge a valuation gap: the seller believes the practice will perform well under the buyer's ownership, while the buyer is uncertain and unwilling to pay at settlement for performance that has not yet occurred. The structure is common, and the rationale is legitimate. The disputes that arise from earnouts are also common.
The definition of the earnout metric
The definition of the earnout metric is more important than the earnout amount. If the metric is revenue, the parties need to establish precisely what revenue means: gross billings from all sources, or only billings generated by the buyer's own consulting? Does the selling doctor's continued billing at the practice count toward the metric, and if so, what is the weighting?
If the metric is EBITDA, are the add-backs consistent with the normalised EBITDA used to price the transaction? A formula that appears clear at the heads-of-agreement stage may reveal a fundamental disagreement when the first earnout period closes and the parties apply it to actual numbers.
The selling doctor's clinical behaviour after settlement
The selling doctor who continues to consult after settlement creates a structural complication in the earnout design. That doctor's clinical decisions, roster, billing patterns and patient retention all affect the earnout metric, and they retain some control over the outcome. This raises the question of whether the earnout measures the practice's performance or the selling doctor's continued effort. The buyer has paid for a business. If the earnout is effectively measuring whether the seller keeps working, the earnout period and the seller's consulting arrangement need to be designed together, not separately.
Earnout disputes arise most often when the baseline data used to set the targets was not properly stress-tested before settlement, or when the formula did not account for the selling clinician's post-settlement behaviour. The earnout period and earnout amounts are the single most consequential structural decisions in an internal GP practice buyout.
Tax treatment of earnout payments
The ATO's earnout look-through rules (Income Tax Assessment Act 1997, Subdivision 118-I) treat certain earnout payments as part of the original sale price for CGT purposes rather than as separate income events in the year received. This affects how the seller's CGT concessions apply, including eligibility for the small business concessions. The earnout structure needs to be confirmed with the seller's tax adviser before the agreement is finalised. A formula renegotiated post-settlement to address a tax problem creates its own risk.
Staged equity
Staged equity structures, in which the buyer acquires a portion of the business at first settlement and the remainder through subsequent tranches, are a common bridging mechanism for internal buyouts. The documentation requirement is a pre-agreed formula for each tranche, with a clear mechanism for resolving disputes if a tranche settlement is contested.
A staged equity structure without a pre-agreed valuation formula defers the valuation dispute rather than resolving it. These critical terms must be set in the sale agreement, not left to be negotiated at the time of each subsequent tranche.
The documentation failures
The vendor finance and earnout arrangements that arrive as disputes have usually failed in one or more of the same ways.
Common documentation failures
- The GSA was not signed or not registered. The date of registration, not the date of the agreement, determines priority under the PPSA. A delay in registering the seller's interest can impact their priority ranking.
- The earnout formula was not tightened. Often set at the heads-of-agreement stage and not revisited when the sale agreement is drafted. By settlement the parties have moved on to other issues, and the formula has not been updated to reflect the practice's actual financial structure. Additional data that comes to light during the period between execution of the heads of agreement and the sale agreement can dictate how the earnout formula should be drafted, this is commonly missed.
- No acceleration clause. A vendor finance agreement without an acceleration clause on default leaves the seller chasing individual missed payments rather than the full outstanding balance. The seller's commercial position deteriorates with each payment cycle.
- No restriction on distributions. There is no restriction on the buyer entity distributing profits or paying dividends before the vendor finance is fully repaid. A buyer who draws down the practice's cash reserves in the first year of operation, then faces a shortfall in the second earnout payment, has done nothing technically impermissible if the agreement is silent on distributions.
- The parties used the same adviser. Where one legal adviser has acted for both parties, neither has been advised from their own starting position. The general legal and commercial terms have not been separately stress-tested, and neither party's best interests have been properly advocated, including the seller's security position and the buyer's remedies in the event of default.
Closing the structure before settlement
No two transactions are the same. The specific issues in a GP practice internal buyout differ from those in a pathology acquisition, a multi-site roll-up or a radiology business change. What holds across all of them is that the legal structure and the legal and commercial terms need to be agreed and documented before settlement, not repaired after it.
The final article in this series covers the full document suite for an internal GP practice buyout: the shareholders' agreement, the sale agreement, the restraint-of-trade provisions, the post-settlement consulting arrangements, the facilities and services agreements, and the employment obligations that transfer with the business.