Veterinary Practice Value
Doyle Watson, DVM, Simmons Southeast
Simmons responded to a VIN thread regarding an article on practice value printed in a leading veterinary magazine. We thought it may be of interest to our readers as well!
The Author stated: “If an owner’s net income has never exceeded 25% of his gross, he’ll never find a buyer… Doctor owned practices should net at least 30%”.
There two basic definitions of “net” or “profit”. One is the “free net cash flow”, or simply “cash flow”. This figure represents the total money pot that an owner is able to pull from its practice (exclusive of rent in event he/she is also the landlord). This includes compensation, perks, fringe benefits, personal expenses run through the practice, capital improvements and purchases, interest, amortization, some depreciation, some normalization where appropriate, etc. In a well-managed practice we like to see cash flow in the high 20‘s to low 30‘s percentage of gross. This figure also drives the maximum price a buyer can afford to pay and the maximum price at which a lender is willing to lend—two very important aspects of the entire transaction. In other words, the price must “cash flow” from the buyer‘s and lender‘s perspective in terms of affordability and lendability criteria.
“Earnings” is another tier of “net” and represents the remainder from the cash flow after the chief of staff doctor (typically the owner) has been paid a fair market salary for being the doctor and manager (not for being the owner). The remaining earnings are the return on the investment as if it were a cash investment with no debt. In a well managed practice it will typically range from the mid to high teens as a percentage of gross. This is the figure that is generally capitalized by a rate of return (inverse of a multiple) to arrive a practice value. In some cases the price may vary from the value.
Therefore the value and price as a percentage of gross will fluctuate from practice to practice depending upon the earnings and cash flow, the higher figures generally valued higher and selling at a higher price. It is not uncommon for a high grosser to value and sell considerably more than gross, or the No-Lo or low grosser to value and sell at below 50%.
Nevertheless, almost all practices are sellable at the right price, especially the higher grosser‘s. Actually a 25% cash flow in a high grosser may pull a very attractive price to the seller.
I try to structure price and terms so that the buyer will have personal after-debt income from cash flow of at least $100K and 15% of gross. The former is not always possible in the low grosser and the latter with the high grosser with highly leveraged terms, although after-debt income may well exceed $150K or more.
As to doctor-owned, I believe he (the author) is differentiating between private doctor and corporate ownership.
VIN Participant comment: So more corporations will buy practices instead. This really is sad! I just cannot believe what these financial experts say.
The market is as rampant today with eager, private buyers as I have ever seen in over 30 years in this business. That could be because commercial funds and terms are so attractive.
VIN Participant comment: Most practices I know fit into the No-Lo category. Corporations aren’t interested in buying No-Lo practices either. Why would they?
Actually relatively few practices fit the No-Lo category. However I believe these practices have always been around. There are just more of us pros appraising them now vs. the local CPA; so we are just recognizing more of them. Some corporate buyers may not be interested in the cash flow or earnings, but only in revenues, which they will blend with the mass and operate at its own level of profitability.
VIN Participant comment :________ wouldn’t it be wiser to purchase a No/Lo practice with much potential for income increase, rather than a high priced, high profit practice?
Although maybe not as much sense as a well-managed one, yes it does make some sense to buy a No-Lo at the right price considering the opportunity to improve on value and personal income by improving revenues.
VIN Participant comment: What is hard for some people to understand is that there are practices grossing 2 million dollars and can only be sold for the value of the assets. The overhead is just way to high.
I don‘t recall seeing a grosser of $1.5 mil and above that did not earn at least 5% and cash flow at least 12%. At $2mil gross and 5% earnings with a cap rate of 20% (5X earnings), the value could be $500K, well in excess of tangible assets. The price could exceed that.
The Author stated: “—-as practices typically sell for less than a third of the last year’s gross revenue.”
This is absolutely not so. Some will sell for that. However our statistics of 30+ years indicate that 80% to 105% is not uncommon in high-grossing, well-managed, average earnings and cash flowing practices. The range is actually 15% to 153% of gross with a wide range all over the board in between. Coincidentally the median and mean are both at 73%. In well-managed practices grossing in excess of $800K, my personal experience is typically 80 to 105% of gross, all driven by earnings and cash flow.
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