What Creates Veterinary Practice Value?

David Gerber, DVM, Simmons Northwest

Strictly speaking, a veterinary practice’s value is a function of its profitability. It is profitability that determines the maximum amount for which a practice can sell and still satisfy the financial requirements of buyers and lenders. But there are other intangible qualities that make one practice more “valuable to buyers than another one of equal profitability. It is all of the other factors that determine how close the actual selling price can be to this maximum. In rare circumstances it may sell for even more than this amount. Do the two practices have different values, or is one simply more desirable?

FINANCIAL QUALITIES

True profit is what remains for simply being the owner. It is what you might take out of the practice (not including rent) and you were living in Acapulco and simply receiving a check every month, simply because you are the owner. This is very, very different from considering all the money that you may take home. Remember, if you own the building, you now have two separate investments; one is a veterinary practice that RENTS from YOU, the real estate investor. So, even if you do not actually pay a rent check to yourself, it MUST be calculated in order to find your true profit.

Thus, in creating value, the higher the TRUE PROFIT, the higher the value. As a general rule of thumb, (oh, don’t we love/hate rules of thumb), figure that for most practices, the value will be 3-6 times the profit (earnings). In the stock market this is the P/E (Price to Earnings) ratio.

Increase profitability. This is the most obvious way to maximize value. More profit equals more value. Simply, it results from lower expenses or higher revenue. Many practices we observe show very low profits. Clearly, many do not watch costs carefully, but more and more, we are seeing practices that can’t cut expenses and have low profits due to insufficient revenue to support the practice culture. Either the fees are too low or a great deal of services are not being charged for appropriately or even at all. In these cases, 100% of these lost fees are 100% profit. The costs are already in place, so every dollar in lost revenue is a dollar in lost profit. This means that, not only is the dollar lost, but so are three to six dollars in practice value!

NON-FINANCIAL QUALITIES

One definition of value is “that quality of anything which renders it desirable or useful, so we can make the case for non-financial aspects contributing to and creating practice value. There is one factor that, in my mind, stands out way above all the rest. It has nothing to do with profit, but will make a practice salable or unsalable, in many cases.Geographic location. This is probably the single most important factor contributing to a practice’s salability! We find that no matter how good a practice is and how attractive the building, if it is in an area where nobody wants to live, it can be almost impossible to sell. These can be in cities or tiny rural towns. On the reverse, if a mediocre practice is located in a “hot area, it will often sell at top price. Then, within a particular city, buyers are looking for practices in growth areas with strong demographic characteristics. So, good location creates value.Buyer demand. Geographic location is actually a part of this, but, overall, ask yourself if this is a practice that will have a wide appeal. For instance, an old-school, rural mixed practice, with no availability of an emergency clinic or a specialist is becoming VERY hard to sell, regardless of its profit margin. High percentages of exotics, avian work, alternative medicine, behavior, or other special-interest niches have small audiences and lower demand. Mobile practices are difficult to sell because the perception is that it is very inexpensive and easy to set up a brand new competing practice. So, how can you make YOUR practice more appealing?

Geographic location can’t be changed, but much else can. The closer a practice is to a typical “dog and cat urban or suburban practice, the larger the market will be. If a small portion of the revenue is from exotics, large animals, alternative medicine, or other “specialties, it would be wise to at least carve out this part of the practice, both income and expenses, so that you can show a buyer the “standard practice without this difficult-to-sell component. If you are in an area with no emergency service, consider getting together with your colleagues to start one. We did just that three years ago in my town and it has been a wild success. In addition to ending night calls, it makes the area much more desirable for associates or buyers. If that is not possible due to size or lack of collegiality, at least try to arrange a call schedule with a couple other practices to lighten the load. This can be a BIG factor for the younger grads looking for jobs or for a practice to purchase.

Practice growth (or decline). As practitioners begin to reach the time when they are looking toward retirement, the growth of the practice often suffers. Certainly this is understandable. The practice and real estate are paid for, as is the home. The kids are finally through college, and with some planning, there is likely a comfortable nest egg in place. So, more important than continuing to drive the practice hard, is time on the golf course, with your spouse, on the lake, or traveling. But, as the revenue stagnates and even drops, in some cases, the practice value is impacted dramatically. Granted, the profits may not change appreciably, but there is a huge psychological negative as viewed by a potential buyer. “So, the practice revenue is down by only 5% now, but if the trend continues, it will soon be bankrupt. Realistic? Probably not, but it is all about perception. It is crucial not to mentally retire before the actual time you exit.

Non-compete agreements with associates. This seems to be more and more of an issue with many potential practice buyers. In reality, it is probably much less of an issue than most of us think. But, it is all about perception. If I have an associate who has been with me for ten years as a part-time doctor and he has no intention of owning a practice or of leaving, he is not much of a threat to a buyer. However, if you are a buyer from across the country and don’t know me, the associate, or the community, you justifiably will be concerned.

In most cases, it is more of a negotiating point if there are no non-compete agreements in place. Buyers will use it to reduce an offer. Interestingly in California, North Dakota, and several other states, these agreements are illegal for associates. In fact, it is crime to include one in an employment contract in California! If the threat is real, then, why wouldn’t practice values be much lower in these states? They are not.
So, what to do about it? First, it is good business to include a non-compete agreement as a part of the initial employment contract. It needs to be fair and not overly restrictive. It cannot (and should not) be designed to place a hardship on the associate, but only to protect the business. Second, if it is not signed PRIOR to employment, it may not be enforceable at all. Every state is different and it is of critical importance to consult with a well-qualified attorney about the laws in your state.

This is not the forum to discuss the legalities or ethics of associate non-compete agreements. That is for another time and VIN has several excellent discussion threads about it. But, suffice it say that with good, reasonable, and legal non-competes in place, the practice will have a better value.

Transferability of goodwill / Owner’s transition. Unless goodwill can be transferred to a new owner, it has no value. We like to say that goodwill value is worth one visit. It is the seller’s responsibility to do everything possible to encourage the clients to continue to use the services of the practice after a transition to a new owner. After that, it is up to the buyer. More goodwill value can be created by an owner who has less of a public role in the practice (he/she won’t be missed as much). It is more difficult to transfer clients in a single-DVM practice than in a multi-DVM practice. If the owner is willing to continue to work in the practice AFTER the sale and assuming there is sufficient business to justify it, that can be very helpful. But, the change in culture with a new owner can be difficult for the selling doctor.

Equipment. In most veterinary practices, the vast majority of the value lies with the intangible assets (goodwill, name, signage, phone number, staff, reputation). For practices with normal profitability, this usually comprises 80-90% of the total value, leaving 10-20% for equipment and consumable inventory. Remember, the basis of value is profit. If my practice has $100K profit, I purchase a $30K laser surgery and the profit does not change, the practice may change a little, but certainly not by $30K. That being said, it is necessary to have a reasonable amount of equipment that is current and functional. A practice without an X-ray machine, computer, and that is still using halothane, will clearly be “dinged by a buyer because he/she will need to purchase some new equipment right away just to get to reasonable standards. But, if the laser surgery is purchased just before a sale and there has not been sufficient time for that piece of equipment to generate additional profit, then it will add very little additional value. Although a new anesthetic machine, cages, surgery light, microscope may actually add new value (since it is expected that these are included), up to date equipment makes a practice more appealing and more salable. In general, it is always smart to keep equipment current, but to buy higher-end, more specialized pieces long enough before a sale so that the additional profit is shown. Otherwise these are merely expensive toys.

Facility. Much the same as equipment, the facility does not directly affect the practice value. But, it has a significant impact on the salability. A practice housed in an old, out of date, small, poorly located building is much harder to sell. Often a little minor remodeling, painting, and new countertops would completely change the appearance and give the impression of an up-to-date practice that would be a pleasant place to work. Simply deep cleaning, putting things in cupboards, and clearing all the towels from that top row of cages can make a huge difference! Sharpening the landscaping, restriping the parking lot, updating the sign go a long to way to make a striking first impression and you have only one chance to make a good first impression. Will all of this actually increase the value? Not necessarily, but it will certainly make it much more appealing and salable.

Date Published: October 6, 2006

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