June 3, 2007
For the full transcript visit: Alternative Exit Strategies For Low-Grossing Practices
Tonight we will be discussing Alternative Exit Strategies for small grossing veterinary practices and some of the more common elements and issues that affect a practice’s successful sale and financing in the marketplace. Certainly, profit is of paramount importance, but there are many other factors as well. We won’t be able to cover all of the material, or touch on all of the information you’ll need to plan a successful exit strategy, but I have made an Exit Strategies handout available for anyone to download as a reference. With that, let’s get started.
Here is what I hope to accomplish this evening:
- 1) Briefly what drives practice value, salability, and its corresponding price
- 2) What factors influence the success of a sale
- 3) What characteristics are of importance to a small grossing practice
- 4) What options exist for your exit
- 5) Get you thinking a bit creatively about alternatives to a simple open market sale.
Take home point:
Exiting ownership will take planning on your part, preferably well in advance, and likely a bit of creativity.
In order to set the stage for tonight’s discussion I’d like to describe the “Average Practice” Although it may have many meanings to each of you, KPMG completed a study indicating the following:
22,400 veterinary practices studied
+/- 2 full time equivalent veterinarians
Average Gross Revenue $478,355
Average Expenses $303,584
Average Cashflow to Owner $174,771 (36.5%)
Average Earnings after Owner is paid $74,145 (15.5%)
The reason I’ve included this table is to satisfy everyone’s curiosity about what is a “small grossing practice”; after all it was not so long ago that $300,000 was a pretty sizable gross income. For discussion purposes, let’s agree that tonight, small gross income practices will be those that gross less than $350,000.
Let’s also define the following in general terms, and my apologies in advance to any combo MBA-CPA participants.
Revenues – money in the front door
Expenses – all NECESSARY expenses and costs, REQUIRED to perform the veterinary services (drugs, supplies, ads, utilities).
Cashflow – money available to the owner BEFORE the owner pays him/herself at least three compensation components (DVM compensation, management stipend, ROI)
Earnings – The profit left AFTER the owner has paid everyone, and every necessary invoice (but not inclusive of the frills, perks and benefits that are un-necessary such as golf membership, $4500 Europe CE trip, convertible, etc…) and paid him/herself a reasonable level of compensation commensurate for the doctor work being done (typically a production based calculation) and the management duties being performed (typically 1-3% of gross, adjusted for any other managers in the practice).
Why is it important to have a clear understanding of a practice’s profitability? A practice’s value is a function of its profitability AND its salability. In short it’s partly influenced by the dollars at the bottom line but also qualitative characteristics like location, equipment type and condition, facility style, floor plan, age and condition, competitive pressure, growth potential, and current momentum.
The profit portion is important because profits a seller currently receives are the same funds that a buyer redirects to a bank in the form of a loan payment. There must be sufficient profit in a practice to pay for the loan payment.
The salability characteristics are what make one practice more “valuable” to buyers than another one of equal profitability.
Let’s also define the Life Cycle of a Practice.
Origin: Gross $0.00 1 DVM new practice
Growth: Add DVM’s and Staff 1, then 2, then 3 DVM’s
Steady State: +/- match inflation annual growth in revenue 3 to 5%
Decline: Drop staff, Drop Gross Was a 3 DVM practice, now 1 DVM
Terminal: Limited hours & procedures Referrals, limited equip. or hours.
Euthanasia: Nothing viable left A professional hobby business
It’s helpful to examine where you might be in the lifecycle, since the only thing they share in common might be a small gross income. One can have a start-up, a satellite, or what once was a busy 3 DVM full surgical service hospital that is now a 1 DVM practice with part-time hours, or a part-time doctor. The exit strategies are often different for each.
Here is an alarming trend that should concern us all. Lower grossing practices are increasingly harder to sell, there is a rapidly rising trend in the US that these practices are becoming un-sellable at any price, and the supply of practices for sale is increasing.
Do you have any idea why?
Too many facilities per community
Not enough DVMs
Reduction in “ownership” desire of new graduates
All of the above
The answer is e) all of the above. In many areas, the business model of today’s industry has changed making it increasingly difficult to adequately equip and staff all of these redundant practices in the same geography. In the US, there are approximately 27 DVMs per 100,000 consumers. In California that is 17:100,000. If we adjusted only California to the US norm, California would need 3,367 veterinarians this year, more than all that will graduate. The largest group of 60 plus year old retiring veterinarians EVER in the history of US veterinary medicine is starting right now with the baby boomer retirement. And finally, new graduates have less ownership desire.
What about the buyers? Who are they, what do they want?
Interestingly we are now seeing statistics in enough volume to report that women are buying practices nearly at an equal level to men, so the gender equation doesn’t fully explain the issue. Student debt is at an all time high. In 1990 student debt was <$40,000, in 2007 that number climbed above $100,000 in many vet schools, and out of state tuition at KSU recently jumped $27,516 in a single year, up 16%!
In 1990, more than 50% of recent graduates polled desired ownership AND they wanted it sooner rather than later, stating independence as a primary driving factor. When repeated in 2000, slightly more than Â½ reported they NEVER wish to own a practice, and the majority that did, were in NO particular hurry to do so, stating the desire to own a peer-style MULTI-DOCTOR, URBAN practice as a primary factor in choice.
Today, one questions whether graduates may have to look towards ownership as a means to pay-off student debt using the profits of strong performing practices to retire the enormous school and personal debt accumulated.
Now let’s look directly at the financial issues of small grossing practices.
Since profits pay the practice loan payment, I want to be sure everyone looks at the cashflow through the eyes of a buyer and lender. Let’s use an example, and adjust for owner perks, one time expenses, etc. to gather a view of the cashflow available to a buyer.
Let’s use a Sole Proprietorship example
Expenses as reported $155,000
Seller’s Draw(s) $65,000 (seller’s take home)
Now let’s adjust this for true profitability –
2006 Gross as reported $220,000
Expenses as reported -$155,000
Less perks, benefits +$ 15,000 (auto, IRA, new flooring)
Plus oversights -$ 24,000 (rent value of owned building)
Cashflow available to new Owner $56,000
Let’s assume the buyer needs $48,000 a year to live a very simple lifestyle, used car, small condo, and paying student loans.
This leaves $8,000 available for the annual loan payment. Borrowing at 9% for 10 years, that would service a total loan amount of $52,000!
That would only be 23.6% of the gross revenue, and well below what many of you might suppose to be a reasonable price. In fact you may be right to some degree; however one must ask where will the buyer get the money to pay for the higher “asking price”?
Recall the profit that is present is all that can be used to make the payment at the time of purchase. Yes, potential growth can play a factor, and often does, however there are limits to the optimism of any banker or buyer.
Who thinks this is only a problem for small practices?
The answer is that although it’s known to be common in small grossing practices, no or low profits are now being seen in multi-million dollar grossing practices too. In fact, not long ago a number of my appraisal colleagues began seeing this no/lo profit issue develop and started digging deeper. Today organizations like AVPMCA are studying its effects on the industry, and developing tools to use to analyze it. One of which is the No-Lo Practice Threat Advisory Worksheet. Download and review at your convenience. It’s setup with some example cases, but you can fill in your practice’s numbers as well.
So what do you do? Close shop and go home?
Many owners of small grossing practices have been frustrated by the lack of interest from buyers. Seemingly otherwise good practices, with nice clients that pay their bills, and a loyal staff, aren’t being purchased. Why?
Here’s what you MUST have to be successful in an ownership transition today.
- 1) A good location. That is the most important factor for smaller practices. That means geographically AND the right side of town. Moving a practice to a new location may be a necessity. If it’s in a specific state or region that is of little interest to most veterinarians, you may need to consider other alternatives.
- 2) Updated equipment. If you have older, outdated equipment it will certainly be met with resistance. Now usually isn’t the time to buy digital radiography, but it most certainly is the time to send the methoxyflurane vaporizer to the crusher.
- 3) Computerization. Once a luxury, it’s now a requirement. All savvy practice managers will use data from the clients, pets or patients, and economic trends and percentages to manage and grow a practice. Non-computerized practices are often ridiculed as “hiding something” even when they are not.
- 4) Dress it up. First impressions are killer, and a requirement. You won’t have high profits to woo your buyer, but there is no reason to have old paneling, yellow counter tops, peeling paint, and a dilapidated sign detracting from a solid and useful practice.
- 5) Profits. Bottom line, cashflow funds practice purchases. Profits need to be sufficient to pay the loan payment, pay all the necessary bills, albeit devoid of frills and perks, and pay the buyer a REASONABLE after debt income. No one is suggesting that the buyer makes $200,000 a year in a smaller 1 DVM practice, but most buyers are resistant to an income that requires a night job to feed the family. It’s simply easier to remain an associate or purchase a larger more profitable practice.
What are your alternatives to an open market sale? (One where a buyer comes in and pays you cash-on-the-barrelhead to replace you as the owning and working DVM)
If you aren’t successful finding an outside buyer consider the following alternatives.
- 1) hire an associate, at least part-time to build up the practice, go back to work yourself and then encourage the associate to purchase the practice (historically successful, however DVM shortages may prevent it today)
- 2) Expand hours, services, raise fees. Of the three, the last might be most achievable. Use NCVEI.org, and other data from AAHA and AVMA to help you determine appropriate fee schedules. Do you already call around? That may not be sufficient, especially if all of your local colleagues are pricing incorrectly.
- 3) Become an acquisition target. Your 800, 900 or 1200 clients are good clients. After all they provide the annual revenue you report. That revenue is equally useful to the practice down the road. AND when a practice purchases your practice/records/clients and merges them into their own, many of the overhead expenses (yellow page ads, utilities) and redundant expenses (equipment and some supplies) are either reduced or eliminated.
- 4) Buyout someone else. This could be either a small practice OR a larger one. You will have the same benefits as they would have buying you.
- 5) Merger. If it’s structured as a true partnership, Practice A + Practice B = new Practice C, you’ll need to do a lot of planning and soul searching. It’s hard to teach old dogs new tricks and some of us just don’t play all that well together. Although useful, I’m a bigger fan of one acquiring the other rather than becoming two captains on the same ship.
6) Aggressive Retirement Funding. Ask your financial planner to review your funding strategies. Using tools like a defined benefits style pension plan may allow you to put away a lot of profit very quickly. In a sense you may be able to buy your practice from yourself, funding the pension plan, avoiding post-sale taxes, etc.
7) Give it away. Get creative. Most would agree that a 1 DVM equine practice is hard to sell nowadays. Dr. B will certainly attest to this after failing for a number of years. We structured an associate “gifting plan” for him. In essence the hired associate earns credits for each month she works at the practice, up to the full purchase price of the practice. He owns the building, so he’ll have rent income while this is progressing, earned DVM income while he’s still working, and will be able to sell the building to her as well. Perhaps not as clean a process as getting a check all at once, but that hasn’t worked so far.
8) Close it down and walk away. For some this can be a sad event, especially for the seasoned owner who may have spent more than 30 years at a location. If you truly have tried to sell, and you were 100% realistic and motivated to do so, not selling shouldn’t be taken personally. It happens. It does nothing to undermine all of the years of service and good work you’ve done as a veterinarian.
Here is your Do’s and Don’t List to help guide the process.
- DO report ALL income
- DO document all discretionary expenses
- DO increase gross income
- DO decrease expenses
- DO computerize
- DO stabilize staff
- DO offer full selection of services
- DO keep your fee schedule current
- DO keep the facility neat, clean, and painted
- DO expand client base
- DON’T play too much golf
- DON’T retire further mentally before a sale or merger
- DON’T let the equipment deteriorate
- DON’T over-refer if you can bring a sDVM in-house (specialist)
- DON’T let your ego interfere
- DON’T take it personally
I’ve made available to each of you an Exit Strategies Checklist.
(It’s lengthy, so download and review later.)
This jointly developed product was developed utilizing the tools and experience of some of the most experienced companies in our industry, spanning over 30 years of “in the trenches” trial and error. This was first issued to attendees at the 2006 WVC conference. Please feel free to use it in your planning. It was designed for practices of all types and sizes, so you may need to focus on applicability to the smaller practice, but before dismissing anything that doesn’t seem to apply, ask yourself “what would need to change in my practice to make it fit”. That sometimes helps you vision-cast your plans and ideas.
Lastly, I think we all must be cognitive of what closures of practices means from a social responsibility in our industry. In order for consumers to receive pet services, livestock producers to gain nearby and affordable access to veterinarians, and strong and resilient food safety, we are going to have to re-think how we practice medicine and the business models in use. There is a lot of discussion that the mom & pop, jack-of-all trades, James Herriot practice has no future. From a business view, I might generally support the notion that management by the seat of your pants doesn’t fly anymore, however I’m not quite ready to see our industry compressed to multi-doctor megaplexes found only in dense urban areas. Or practices that refuse to offer any services to larger species or small animal services to the budget strapped client that is otherwise a very dedicated pet owner.