Stanley R. Creighton, DVM, Diplomate, ACVIM, Internal Medicine
CEO, National Veterinary Associates, Inc.
Dick Goebel, DVM
President, Simmons Great Lakes
Who Are the Buyers?
It was not that long ago that the typical transition of ownership occurred when a young associate joined a practice, worked there a few years and then bought into the practice in a deal that was financed entirely by the selling veterinarian. Practice owners had little concern about selling the practice because most young associates wanted to be owners. The challenge for the seller was to find someone he liked and who shared the same practice philosophy. Things have changed. The landscape facing practice owners today is impacted by the following powerful forces:
- There are fewer buyers today than ever before. Generational issues are causing people to make lifestyle choices that value family and free time more than practice ownership. Many young veterinarians, both men and women, do not ever want to own a practice. There has been a significant gender shift in most of the professions, including veterinary medicine. In 1967, 95% of practitioners were men. In 2000, 70% of all veterinary students were women.
- The number of practices for sale is increasing and will do so at a faster rate as the “baby boomers” approach retirement age. The oldest boomer is 59 years old today. Most veterinarians in the boomer generation are male practice owners. The number of practices on the market is expected to increase as this group tries to exit from practice and retire. Only about 50% of practices are sold as part of the seller’s retirement plans. The others are sold as a result of a career change, illness, relocation needs, or divorce. With more practices available to choose from, all sellers will be impacted by the oversupply regardless of the reason the practice is being sold.
- Buyers now include the large national corporations. They include VCA Antech, National Veterinary Associates, VetCor and Healthy Pet.
- The absolute dollar value of practices has increased over the past thirty years as practices have become larger. However, the dollar value as a percentage of revenue has decreased because the overall profit margin of most practices has declined.
- The methods used to value practices have become more sophisticated and all use an analysis of adjusted net earnings and buyer risk in determining the sales price. Practices are not being valued today solely based on a percentage of the revenue.
- Cash flow is low in practices with revenues of $500,000 or less, which makes it difficult or impossible for a buyer to pay all the expenses, himself and the selling veterinarian. Approximately 25% of all practices in the country are in this category.
- Practice mergers are being considered more frequently now in an attempt to make the combined practice more attractive to buyers.
- More practices will be closed and liquidated as buyers become more discriminating and knowledgeable.
How Much Will a Buyer Pay You?
The days of expecting someone to pay you a percentage of one year’s gross revenue are gone. Most practice values today are determined by its adjusted net earnings and the risk to the buyer. High adjusted net earnings and low risk lead to favorable valuations. Low adjusted net earnings and/or high risk have a negative impact on the practice’s value.
Lenders have a major voice in the purchase price as they finance 90-100% of many transactions. They work with the buyer to make sure that the value implied by the price is actually there. They also look at adjusted net earnings and risk as a basis for value. Like lenders, the large national corporations use similar economic and risk assessments to arrive at a fair purchase price.
Buyers often engage their own accountants to review the price versus value equation. While buyers are not always financially sophisticated, increasingly they are hiring sophisticated advisors.
The bottom line: to be paid for value, you must deliver value.
Adjusted net earnings
Are adjusted net earnings and the taxable income that appears on your tax return or the net profit that appears on your financial statement the same thing? No. Tax return preparation typically is done with the idea of minimizing tax obligations. When attempting to find earnings (as the basis for value), one must take a different perspective.
Adjusted net earnings (the basis for value) are calculated by making certain adjustments to your taxable income or net income. We calculate the adjusted net earnings by starting with the taxable income on your tax return or net profit on your year end financial statement. To that number we add any unusual, non-recurring expenses, depreciation, interest, any rent that was paid to you that is beyond a fair market rent, any compensation that was paid to you in excess of the going rate for another veterinarian if you were replaced, and any personal expenses that were paid by the practice on your behalf. In other words, your year end financial statement or tax return is adjusted to make it look like it would if the practice was owned by someone else for the entire preceding year and you, the owner, were paid like a regular associate veterinarian. This adjusted net earnings number represents what would be left over for a new owner after all practices expenses were paid.
Practices have less risk to a buyer if they have the favorable characteristics listed below. If some of those characteristics are missing, then the risk of ownership increases. When comparing different practices with different risks, a buyer should be willing to pay more for a practice with low risk.
We quantify the risk by assigning a number to it called a “multiple”. In the veterinary industry the multiple can (usually) range from 3 to 5. Practices with low risk command a higher multiple. Practices with high risk command a lower multiple when quantifying the risk factors. The term “multiple” is sometimes referred to a “cap rate” or “capitalization rate” and we use the terms to mean the same thing in this discussion. The “cap rate” or “multiple” is increasingly being determined using objective criteria. This is done by using a risk matrix that assesses multiple risk factors. The “cap rate” is then derived from this risk analysis.
The value of a practice is determined by the adjusted net earnings and the multiple using the following formula:
Practice Value = adjusted net earnings X multiple. For example, a practice with adjusted net earnings of $200,000 and a risk factor of 5 would be worth $1,000,000.
Thus there is a direct relationship between the practice value, the amount of the adjusted net earnings and the risk factors associated with the practice.
Favorable Practice Characteristics That Buyers are Looking for and That Lead to Higher Sales Price
- The practice must generate enough cash flow (adjusted net earnings) to enable the buyer to pay all the expenses, his/her compensation and the debt incurred when the practice was purchased.
- There should be systems in place that minimize the risk of purchase to the buyer. These* include:
- o The practice should practice high quality medicine and surgery.
- o The practice revenue should be growing each year.
- o There should be low staff turnover and wages should be fair.
- o There should be an ongoing commitment to staff and doctor training.
- o The practice culture should be transferable to a new owner. Niche practices have higher risk.
- o The management responsibilities should be delegated to others and not be solely dependant on the selling veterinarian.
- o The revenue mix should be at least 85% professional services with the balance from boarding, grooming, food sales and other ancillary services.
- o The facility should be clean, well equipped, attractive and with room to grow.
- o The practice should be located in a community where one will be able to recruit veterinarians and staff.
- o Night and weekend emergency care should be available in a nearby emergency practice.
If any of the above characteristics are missing in a given practice, then that practice may be less attractive to a buyer because of the increased risk. Increased risk usually translates into a lower purchase price.
*This list is not intended to be all inclusive.
OWNERSHIP TRANSITION FOR THE SOLO PRACTICE: PLANNING THE EXIT AHEAD
When considering all business listed for sale, only 20% actually sell. The remainder are taken off the market or liquidated. In veterinary medicine, the picture is more encouraging as two thirds of the practices that are advertised on the open market do, in fact, sell. The remaining one-third does not*.
Practices sell for a variety of reasons, the principle one being retirement of the seller. However, this number comprises only half of the total with other reasons being cited such as career shift, gaining liquidity, geographic change, health issues, spouse career issues, personal and family reasons, and partnership dissolution (business or marriage).
When practice owners consider selling their practice, many questions come to mind:
- Are buyers available, who are they and what are they looking for?
- Should I try to hire an associate and sell to her?
- Should I try to sell to my current associate? In one transaction or in an incremental sale?
- Should I consider merging with another practice or being acquired as an exit strategy?
- When should I sell?
- Should I do it myself or get some help? If so, who do I call?
- Will a sale fund my retirement? When should I know the answer to this question?
- Can this process occur confidentially or will it become a “public forum”?
- Can I give up control?
- What will I do after the sale? Am I ready to retire?
- What are the tax implications?
- How important is a restrictive covenant with my associate?
The typical (and traditional) buyer is a veterinarian who has 3-8 years of practice experience as an associate. Less typical is the veterinarian who is looking for an additional practice (2nd, 3rd or more) to buy, two veterinarians seeking to buy their first practice together, and the regional or national corporate buyer.
The recent graduate buyer is looking for independence but with safety and security, that is some assurance of professional and financial success. Lifestyle preferences are a major factor in making a purchase decision. With most new veterinarians coming from a large metro environment, small animal practices located in large metro areas are in highest demand. In addition to location, the availability of after-hour emergency services is an important criterion. Access to specialty referral and the lifestyle comforts provided by a multi-doctor practice are also appealing.
Once the species and geographic parameters are satisfied, the buyer looks at the financial success of the practice (including the anticipated ability to service a new practice acquisition loan) and the ability to “get a raise” from the associate salary level of compensation. Roughly 50% of practices listed for sale have the ability to provide a 6-figure income (after debt service) to a new owner in their first year of ownership. These are obviously more attractive than other 50% of practices that will produce less.
It is extremely important in states where restrictive covenants are enforceable that they be used in conjunction with associate veterinarian employment agreements. Without them being in place, the transferable good will of your practice may be at risk. The only time that a practice owner has any leverage in obtaining a restrictive covenant agreement is PRIOR to hiring the associate. Buyers often ask for a contingency that provides for the employment and new restrictive covenant be negotiated between the associate and the buyer in order for the sale to be completed.
Buyers have their own set of questions:
- What about price? How high is too high? Is cheap a good deal?
- What about financing?
- What about cash flow, debt service, my income, my educational debt re-payment?
- What about employing existing associates and staff? Will they stay or not?
- What about restrictive covenants? With seller, with associates?
- Should I buy or lease the real estate? Any zoning issues?
- What are seller’s future plans?
When should start planning for a sale? The day you buy the practice … or sooner.
One should always consider how one will exit a business opportunity before committing to ownership. In addition, one never knows for sure when the exit will occur. It may not be planned, as occurs with illness, disabilities or accidental death. The best advice is to ALWAYS have your practice prepared for sale.
Since good financial performance (profitability in the 12-20% range) during the last 3 years prior to the sale is a precursor to optimal practice value and pricing, an important question is raised. If the practice can perform at this level for the 3 years prior to sale, why not tailor the practice to perform at this level throughout your career as a practice owner and make a significant annual contribution to your retirement nest egg? Surely, building a retirement fund throughout your career would provide more peace of mind than waiting for a “roll of the dice” at the end of your career when it comes time to sell the practice. It would seem much wiser to annually fund your retirement and look at the proceeds of the practice sale as an added bonus, rather than an essential dollar requirement.
Because your practice and the real estate it occupies are valuable assets in your investment portfolio, they should be valued periodically much like your periodic stock portfolio report or your bank statement. A professional appraisal of value should be conducted periodically (every 1-3 years) for the purpose of financial and estate planning, for communication among partners, for potential internal sale, and for other reasons, an appraisal of business and real estate valuable is essential. Veterinary practice consultants who provide this service can be identified with the help of the American Animal Hospital Association (AAHA**) Consultants Directory and also by the American Veterinary Practice Management Consultants Association (AVPMCA***).
* Simmons & Associates sales database** www.aahanet.org*** www.avpmca.org
For a PDF, click here: Will your Practice be one that sells – D. Goebel, DVM
This article was originally posted on www.simmonsinc.com. Any reproduction on any other site is prohibited and a violation of copyright laws.