David Gerber, DVM, Simmons Northwest
For the entire transcript visit: Avoiding Practice Purchase Pitfalls
Tonight we will be discussing some of the most common pitfalls we see time and time again surrounding the purchase or sale of a practice. By identifying them here and discussing solutions, it is my hope that you will be able to avoid some of the frustrations we see all too often. We will likely not be able to cover all of the material, but I will make a full handout available after the session for anyone to download as a reference.With that, let’s get started.First, I would like to get a sense of how many of you are owners or associates, and how many of you are anticipating purchasing or selling all or part of a practice in the near future. Please answer the survey.
- 1. Owner or associate
- a. Owner
- b. Associate
- 2. If owner, anticipate full or partial sale in:
- a. <1 year
- b. 1-3 years
- c. >3 years
- d. Not sure
- 3. If associate, anticipate full or partial purchase in:
- a. <1 year
- b. 1-3 years
- c. >3 years
- d. Not sure
Pitfall #1 – Practice sale price does not account for all of the following:
– Normal practice expenses
– Loan payments for the practice purchase
– Loan (or rent) payments for the real estate
– Income needs of the buyer
If a practice is properly priced, it should “buy itself”. In other words, the profits of the practice must be sufficient to pay for all of the normal operating expenses, any rent or real estate mortgage payments, the loan payments for the practice, and still provide a reasonable salary to the buyer. If it can’t, the price is too high. In owner-occupied practices, the owner often does not pay himself/herself a “rent” for the building, and, thus, incorrectly calculates the practice’s profits. The buyer will need to pay an actual rent or mortgage for the building, but, either way there is a cost to the practice for the facility, which leaves less for the buyer and to pay for the practice. So, when figuring how much will be left for a buyer in a particular practice, one must look at the gross revenue, and then subtract the normal operating costs, a rent or mortgage cost for the facility, and finally the payments to purchase the practice. What is left is the amount available for the buyer’s personal needs. Is it enough? If so, the price works. If not, it is priced too high.
Pitfall #2 – Improper pricing
As I follow the VIN message boards I frequently see owners who have their practices “on the market” at an admittedly high price with the thinking that if someone will pay that much, then they will sell it. In reality, most buyers are now sophisticated enough to not grossly overpay. AND, lenders need to know that the income is sufficient to justify the price.
So often we are asked, “What is the average price as percentage of gross?” There is no good answer, and, if you price your practice based on “average” you are sure to lose. The same applies to the real estate and let’s use that as an example.
I have a practice and real estate each priced at $300K. You offer me full price for both BUT contingent upon financing. The lender will require a real estate appraisal. Let’s say that it appraises at $250K. What will be your negotiating position? Might you want to reduce your offer by $50K to the $250K? I think so. OK. How about if the appraisal comes in at $350K? How interested will you be in offering me the extra $50K? Likely, you will simply say, “Thanks for the great deal.” You lost both ways because you did not have the real estate valued ahead of time. You can apply similar logic to the practice.
Pitfall #3 – Indecision of the seller
All too often sellers simply are testing the water, not really motivated to sell and they haven’t given thought to what to do next. Until you are deadly serious, it is best not to test the market because you may hurt your chances in the future as the word gets around that you don’t really care if you sell or not. It REALLY aggravates buyers who are willing to spend time, energy, and money researching a practice, only to find out that it really isn’t for sale.
Pitfall #4 – Inadequate preparation
Buyers – Credit is king. Do whatever it takes to keep your personal credit as good as possible. A huge pitfall is entering into a transaction with marginal credit, high charge card debt, a couple car loans, and a few late payments. It’s wise to know, as you begin your search to figure WHERE you want to practice and what TYPE of practice fits well (high volume and low cost, boutique, exotics, mixed, etc.) Then when the right practice comes along, you are ready to move on it.
Sellers – Nothing is more upsetting during the stressful negotiating process than finding out that the roof needs replacing, the property line is incorrect, there is a buried fuel tank, or that there are unknown liens. It would probably be a good idea to have a building inspection done prior to marketing in order to find and repair deficiencies early on. It will also show the buyer that you care about keeping things in good shape. “Creative accounting” will destroy the trust between you and your buyer. If you are willing to cheat the IRS, might also be willing to cheat me? Trust between a buyer and seller is always tenuous anyway, and anything to damage that will often send the buyer into the sunset.
Pitfall #5 – No non-compete agreements with associate doctors
To the extent that they are legal in your state (for instance, they are not in California), this is very important to buyers. As an owner, even if YOU are sure your associates would never compete, either as a practice owner or by moving to a nearby practice, buyers don’t know that. We have seen many sales fall apart because of a lack of non-competes with associates. It is hard to implement these after an associate has been hired; they should be a part of the initial employment agreement. Here is an area where GOOD legal advice is necessary. Are non-competes fair. Absolutely, as long as they are reasonable and not overly restrictive.
Pitfall #6 – Thinking that you can buy only a small practice due to lack of financial resources
Actually, a small practice is higher risk than a large one. Even if the cash flow PERCENTAGE is smaller in a large practice, the actual dollars available to the buyer will generally be more. Therefore, if the practice has a hiccup or a temporary drop in revenue, there is usually a lot bigger cushion and margin of error with these larger practices.
Remember, if priced properly, the practice should pay for itself out of its own profits. So, a $200K practice will buy itself, but a $1M practice will also buy itself.
Pitfall #7 – Thinking you can do it all yourself
This may well be the largest purchase or sale you make in your entire life and you need to have advisors who are experts in their fields. Early on, it is wise to assemble your team so each can contribute what he or she does best. Your attorney will make sure you don’t enter into a transaction that will haunt you legally for years to come. Your accountant will help with the tax consequences and how to structure the purchase or sale to minimize that impact. Your broker will help you to identify a buyer (if a seller) and a practice (if a buyer), and he/she will orchestrate the negotiations and keep your team all moving in the right direction. All too often we are called in to help with a transaction that has been smoldering for many months or even years because both buyer and seller are busy and simply don’t spend the time and energy to keep the details moving forward.
Pitfall #8 – Retain the real estate in order to collect the rent
On the surface, this makes sense, but the problem is that the majority of buyers want to own BOTH the practice and the real estate. For those of you who do, I am sure you understand. Here is some of the rationale that owners use to justify retaining the real estate.
1. They want the rental income,
2. Future investment to sell later at a higher price,
3. Defer taxes by not paying on the entire sale at once,
4. No one can afford to buy it all at once.
While rental income may be a valid reason to hold onto the real estate, the others have little merit. As to future investment, veterinary practice real estate often has limited use and is probably a poorer investment than would be a property with a broader use. Moreover, the gain on the real estate sale is taxed as a capital gain. Unless there is a change in our tax structure, capital gain tax will always be with us and maybe at a higher rate. So why not take a 1031 exchange and roll over the real estate ownership into a more desirable property? This would defer the taxes and more effectively achieve the same investment goal. Your accountant can tell you how a 1031 works, but it is really neat tool to use.
Probably the greatest fallacy is that the buyer “can’t afford to buy it all now”. While this may have been true a decade ago, it definitely is not today. There are many commercial lenders who are very aggressive in our profession, so that loan funds are readily available for buyers to purchase the real estate along with the practice, and usually with a very small or token down payment. Moreover, with the relatively low interest rates and favorable terms available today, the mortgage payment on the real estate is typically less than a rent payment would be.
Bottom line is that many buyers will “walk” if they can’t buy both practice and real estate. And, there aren’t a lot of good reasons for owners to balk at that.
Pitfall #9 – Unreasonable demands
You can’t have it all your way. Remember, if you BOTH leave the closing table feeling a little bit “taken advantage of” and that if you had held out just a little bit longer you could have gotten a better deal, it probably was fair to both parties.
The Seller may be willing to act as the bank and hold the note, but he/she often wants (justifiably) 20-25% down for security. For a $750,000 sale that is at least $150,000. This will reduce your pool of possible buyers by well over 95%. Best to have them get outside financing for a much lower down payment. Most buyers have little or no collateral, so asking for liens on all of their worldly goods really doesn’t get very far. Again, using an outside lender is the solution-one who does not require collateral beyond the practice assets. Another pitfall we see is sellers who refuse to release financial data until there is a signed offer presented. We have also seen sellers who demand to stay on part-time, even if there isn’t sufficient business to support the extra DVM.
Buyers also can have unreasonable demands. They may ask the seller to stay on for an extended period for a transition with little or no compensation. They may even want the seller to guarantee the practice’s income. Really, I have had that happen!
Bottom line is that the purchase and sale must work and be fair to BOTH parties or it really isn’t a good transaction. Neither party should end up with “all the marbles”.
Pitfall #10 – Inaccurate list of assets
Although it is not critical the every single hemostat be listed, the asset list should be pretty complete to include all the medical equipment (don’t forget the stuff on walls and ceiling such as surgery lights), office furniture, and office equipment. Again, listing each stapler isn’t necessary.
Even more important than what IS listed, is the exclusion list of IS NOT included. The best approach is to remove any items from the building before the practice is shown. If that is not practical, then the buyer should be told, as he/she tours the clinic what is NOT included. Then these items need to be written on the equipment list as exclusions. Be sure to be specific about any leased equipment. Our recommendation is to pay off any remaining balances at or prior to closing so this is not an issue.
We actually saw a dispute over $50 lawn ornaments that involved both attorneys due to a simple misunderstanding. Yikes!
I hope this has been helpful so that you can avoid some of the more common situations that will destroy a perfectly good transaction, and things that can often EASILY be prevented. Good evening.
Dave Gerber owns and operates the Northwest regional headquarters of Simmons & Associates, Inc., the nation’s largest and oldest veterinary practice brokerage and appraisal firm. He received his DVM from Colorado State University in 1978, and, in 1980, he opened the Animal Medical Center in Coeur d’Alene, Idaho, which he operated for 14 years. It received the Veterinary Economics Hospital Design Award. In 1991, he was the first recipient of the Washington State University Small Animal Practice Award. He was President of the Idaho Veterinary Medical Association in 1998 and has served as Idaho’s Alternate Delegate to the AVMA. Dave has been a frequent speaker on management topics at AVMA, AAHA, WVC, and AAEP, as well as in Mexico and the Dominican Republic.