Will Your Practice be One that Sells or Gets Passed Over – PART 2

Stanley R. Creighton, DVM, Diplomate, ACVIM, Internal Medicine
CEO, National Veterinary Associates, Inc.
&
Dick Goebel, DVM
President, Simmons Great Lakes

There is a direct relationship between practice value, the magnitude of the adjusted net earnings and the risk factors associated with the practice. The value of the practice is determined by the following formula:

Adjusted Net Earnings X Risk Factor (multiple, cap rate) = Practice Value

Let’s look a few examples:

Example 1:

This is a very nice practice, in a good location, with a long-term staff that is well trained. Numerous systems are in place allowing the practice to run smoothly and the owner veterinarian sees clients 4 days per week. The revenue has grown 6 % each of the past three years and was $1,000,000 in the most recent period. There is very little risk to a buyer of this practice so we can assign a multiple of 4.5 to this practice.

Adjusted net earnings = $150,000

Multiple =4.5

Practice Value = $150,000 X 4.5 =$675,000.

Example 2:

Now let’s take the same practice but change its risk profile. It is now in a bad location, the building is in disrepair, there is high staff turnover and it has been difficult to retain veterinarians. The revenue has been flat for the last three years at $1,000,000. The selling doctor is working 60 hours per week in order to maintain a high level of adjusted net earnings. In this case it might be fair to assign a multiple of 2 because of the very high risk to a buyer.

Adjusted net earnings = $150,000

Multiple = 2

Practice Value = $150,000 X 2 = $300,000.

Example 3:

Now let’s take the same practice in EXAMPLE 1 again, but change only its staffing profile. This practice still has revenues of $1,000,000, but has two more staff than before, with a total cost to the practice of $40,000. This reduces the adjusted net earnings to $110,000. The risk profile is the same so we assign it a multiple of 4.5.

Adjusted net earnings = $110,000

Multiple =4.5

Practice Value = $495,000

Note that two extra staff members not only cost this owner veterinarian $40,000 per year in additional personal income, but they reduced the value of his practice from $675,000 to $495,000, a decrease of $180,000 in purchase price.

Example 4:

Now let’s take a really well run practice. This owner is careful about costs and staffing levels. He is able to consistently increase the revenues each year by adding new services, regularly increasing fees and using his lay staff to free up the doctors so that they can see clients. His fees are the highest in his community but the service culture in the hospital is outstanding so clients feel like they are getting value. He has regular staff meetings to discuss ways to improve client service. The building is well maintained and has all the equipment that the doctors need to provide the best care possible. The revenues were $1,000,000 in the past year. The adjusted net earnings in this hospital are $200,000. The risk to a buyer is minimal so we can assign a 5 multiple to this practice.

Adjusted net Earnings = $200,000

Multiple = 5

Practice Value = $1,000,000

Note that in these four examples each of the hospitals had revenues of $1,000,000. But because of differences in the level of the adjusted net earnings and in the risk factor related multiple, the practice values ranged from $300,000 to $1,000,000. The practice values ranged from 30-100% of the last years revenues. Clearly it pays to have a well managed practice with low risk because it has more value to a buyer than one that is poorly managed and has more risk.

Hospital MANAGEMENT MISTAKES and Other Errors Leading to Lower Valuations

  • skimming cash
  • excessive or difficult to document personal expenses that are paid by the practice on the owners behalf
  • letting staff costs get out of control (“But I need the extra staff in order to provide the level of service I give”)
  • failing to regularly raise fees (“But my clients are different” or ” But in my part of the country, clients won’t pay what they do elsewhere”)
  • excessively worrying about what the competition is doing
  • waiting until the growth has stopped before deciding to sell the practice
  • putting the practice on “cruise control” because you are at the stage of your life where you do not need all that income
  • failing to charge for services
  • waiting until you are emotionally ready to leave the practice before selling it
  • failing to get regular appraisals or to know what your practice is worth

MERGER AND ACQUISITION: A STRATEGY FOR SHAPING UP AND THEN EXITING

Practice ownership transition occurs in a variety of ways. Outright sale to an unrelated party, internal incremental or complete sale to an associate or partner, sale to a regional or national corporate are several ways in which ownership may be transferred. Occasionally and unfortunately, some practices are not salable and are liquidated and closed. One additional exit strategy will be discussed in this session: merger or acquisition. This strategy may also be used to expand an existing practice.

Merger and acquisition (M&A) is a concept used extensively in larger businesses and has been for years. It is an emerging and useful tool in veterinary medicine. Let’s look at some of the ways in which it is applied:

  • Strategic positioning
  • Financial efficiencies: cash flow, adjusted net earnings, utilization
  • Quality of life issues
  • Quality of practice issues

Strategic Positioning

Acquisition of a neighboring practice can be the strategy of a practice owner seeking to expand his/her existing practice, can be used to increase the presence of his/her practice in the community, can be used as a method to upgrade the facility, equipment and/or staff of the existing practice, and can also be used as an important step in positioning the practice for future sale.

Financial Efficiencies

Financial efficiencies can be achieved through M&A in two major ways. The first is a matter of efficiencies of scale. As practices grow from smaller ($<300K) to larger (>$600K), staff salaries drop as a percent of gross, rent expense drops as a percent of gross and equipment costs drop as a percent of gross. Total documented efficiency amounts to 4.5% ($30K in a practice grossing $670K)*.

More significant efficiencies are experienced when facilities are physically merged; redundancies are eliminated in facilities, equipment and staff. Fixed expenses are reduced by 25% resulting in overall efficiency of 7.5%. Net is increased by 5-7% ($34K to $47K in a $670K gross practice).

The potential for greater efficiencies clearly exists. Fixed expenses amount to about 20% in many practices. When merging facilities, this duplication can be virtually eliminated making the revenue from the merged practice’s clients 20% more profitable than they were before.

Quality of Life Issues

By merging the solo practice with another practice, the isolation of solo practice (including leadership and management) can be ended and responsibilities shared. Scheduling coverage for client service, continuing education and vacations can be coordinated and optimized for continued smooth practice operation.

Financial security is increased, as larger practices are more likely to sell. At least 10% (30% in some regions) of all practices have no buyers; most of these practices gross $300K or less. From this perspective, larger is better. In addition, larger practices sell at higher prices (as a percent of gross). Ownership succession may also occur within a larger group of veterinarians within a practice…..and added option for the exit strategy. Enhanced cash flow makes the practice sale agreement attractive for commercial lender financing.

Quality of Practice Issues

Patient care is often enhanced in a larger, merged practice as the larger practice can better afford a broader array of equipment, more and better trained staff, internal consulting among doctors and expanded professional services.

Client service is enhanced in a larger, merged practice as hours can be more readily expanded, services can be added (house call or delivery services), and a broader array of services in the practice can mean “one-stop shopping” for the client.

The critical mass of personnel achieved in a larger, merged practice can support the development of a versatile and talented health care team. Effective staff meetings, effective training programs, enhanced benefit programs, cross training among team members and the synergy of team thinking and problem solving can be implemented and utilized.

Typical Merger Scenario: Dating, Engagement, Marriage**

Dating

The initiating practice owner(s) do their own strategic planning to determine the need and purpose for proposing an M&A transaction. They contact the neighboring practice to invite discussion. Confidentiality agreements can be exercised as appropriate. Brainstorming should sort through the advantages and disadvantages for both parties/practices. Deal breakers should also be identified in this process. At the conclusion of the exploratory exercise, a vote is taken. Proceed with a letter of intent or scuttle the deal!

Engagement

Next steps include obtaining legal opinion on feasibility and best route for accomplishing the objectives. Financial feasibility should be accomplished by owners (with accountant) to determine affect on all owner doctors if merger occurs and if merger does not occur. Governance must be addressed. Who will lead? What will the organizational structure look like? What will be the distribution formula? What will the new owner benefit look like?

It’s time for another vote. Hire the preacher……..or scuttled deal?

Marriage

Decisions must be made regarding form of medical records, computer system, billing system, employee pay and benefits, employee positions, authority and title. Corporate culture and values must be determined. Agreement must be reached and philosophies developed that drive the management of staff, professional practices, client service and financial management. Teambuilding must be addressed to achieve “buy-in” by key staff members, to plan and accomplish a smooth transition, to address staff redundancy, to reconcile compensation, retirement, profit sharing and other benefits. Logistics of tax, accounting, insurance, etc. must all be addressed and solutions implemented.

Legal contracts that may be necessary include: purchase and sale agreement (acquisition) or merger agreement, employment agreement for doctors and key staff by the new entity, restrictive covenants, and buy-sell agreements to be exercised as owners exit. Exits by way of death or disability can be financed through insurance product.

Practice valuation of both entities must occur to determine relative value brought to the table. This becomes the tool used in establishing the pro rata ownership in the new entity.

Costs Incurred:

  • Legal, accounting, facilitation and valuations: $15-30K
  • Upgrades: computer, phones, medical equipment
  • Reconciling the incompatibilities (e.g., compensation and benefits)

Clients must be notified and assured that the new paradigm will serve their interests effectively. An assembly of your best clients (advisory board or focus group), newsletter, direct mail and an open house celebration are ways in which you may choose to deliver your message to clients.

Conclusion

If you would like to increase the size of your practice or your presence in your community, or to enjoy greater financial efficiency and utilization of practice resources, or to enjoy improved quality of life, or to improve practice quality, the M&A strategy may be the avenue for you.

Proceed carefully through each step of dating, engagement and marriage with a vote (yes or no assessment) taken at critical stages along the way.

The result can be very gratifying and rewarding.


*Simmons & Associates Sales Database.**Model adapted after method developed by Dr. Richard Hoerl, medical practice merger consultant.

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