David F. King, DVM, AVA
Planning an exit from practice takes time and effort. If getting money for your practice at the end of your career is important to your retirement funding, proper planning several years before a sale can make a huge difference in both the time required to sell and the final price you are able to receive. Knowing the elements that create value, and knowing exactly what your market of buyers are looking for, increases the chances that you will have a successful and profitable exit from your practice.
As with selling anything, the highest price can be attained by presenting the asset as attractively as possible. That entails not only physical appeal, but also, if it is a business, having financial appeal. Any problems need to be remedied prior to the sale and the business needs to be a “well oiled machine”. The closer it is to a “turnkey” operation, the easier it will be to market and sell and for the best price to the owner.
The physical improvements can be performed close to the time of sale, but, since buyers will want to examine the business operation for the most recent 3-5 years, it is important to begin the planning as early as possible. Simply telling a buyer what might be will not work. They want to see the results, and justifiably so.
Therefore, it is wise to develop an exit strategy several years before the need arises so that, when the time comes, everything is in place and the business is operating efficiently and profitably.
What is Profit?
What is profit and why do we care about it? Profit is the amount of money remaining after paying all normal operating expenses for the practice. Those expenses include a reasonable veterinary salary for the owner, management compensation for the owner, and fair rent on the facility if owned by the practice owner. What remains is the “true profit”. Profit is the return on your investment for taking the risk and headaches of ownership. Profit is the basis of practice value. Without profit, there is no (or very little) value in a practice.
In the published booklet by VetPartnersTM, The No-Lo PracticeSM: Avoiding a Practice Worth Less, there is a good introduction to understanding how to view profit. It says, “To determine this, you must step outside your practice and examine it as a potential investor. Pretend you are a silent partner. What amount of money would flow to you while sitting at home if the practice continued to use your money but without your active presence? All the functions you perform in the practice would have to be done by someone else who is fairly compensated for this work. All the expenses would have to be paid before you, as an investor, could get any reward. Your return from the practice is what flows to you sitting on your sofa at home while the practice carries on without you.”
An owner should be paid four ways: 1) pay for producing income, 2) pay for management, 3) rental income (if practice owner owns the facility), and 4) profit simply for being an owner, and it is THIS final piece that is the basis for practice value. If there is nothing left for #4, the practice has little or no value because there is no money available for a buyer to use to pay for the practice loan.
Gross = $1M
Owner’s production is $450K, pays 20%
Management compensation = 2-3% of gross
RE value = $1M. Fair rent =10% of value.
|Owner’s “Take home”||
|LESS salary for being a doctor||
|LESS management compensation||
|LESS fair rent (if Px owner is RE owner)||
The Two Components of Value – Profitability and Desirability
All high-value practices have high profit BUT not all high-profit practices have high value. To get the maximum value, your practice should be profitable AND have a high desirability.
Profit can be increased by only two ways, either increasing revenue or decreasing expenses. Most practices that are struggling with profitability have trimmed costs about as much as it possible, but oftentimes not much attention is given to increasing revenues. Certainly everyone is hammered daily about increasing fees, and that DOES need to be done a few times annually in small increments. But, often more important are the subversive “give-aways” and excessive “discounting that reduces profit dollar for dollar since all of the costs remain in place, so each dollar not captured in charges is one dollar lost profit. Give-aways and discounts “feel good” and are often started by the practice owner with the staff following and changing can be very difficult.
Remember that for every dollar of revenue that makes it to the “bottom line” as profit, benefits you 2 ways. First, you get the dollar, but, more importantly, you get and added 3 to 6 dollars in practice value!
Even if two practices have exactly the same level of profit, they rarely have identical values because of the intangible qualities that make one practice more desirable than another. Some of these can be “tweaked” to increase desirability and some cannot.
Long term, loyal, skilled employees add value, as does a reasonable transition period by the selling doctor. A small, “high touch, boutique” practice has more loyal clientele than does a high volume, “low cost” practice. A practice in a permanent location as opposed to a mobile practice will have more transferable goodwill because the clients will more easily remain with a fixed-location practice, hence, more value. And, what about competition? Is it more advantageous to be in a market with several other practices or few? The answer is not as simple as it sounds.
Location is probably one of the most important factors contributing to desirability, but often not possible to change. Other “intangible” qualities that contribute are growth rate, competition, staff quality and longevity, transferability of the goodwill (difficult in a specialty practice), quality of equipment, demographics, and associate non-competes, etc. Some of these you can alter, some not. Some of the important ones you CAN improve upon are:
- Practice Appraisal – You cannot figure out where you need to go if you don’t know where you are presently. An appraisal will set a baseline of your practice value and help you set a future goal. It may also illuminate certain areas of your practice that need attention. It is the first step you must take to seriously begin exit planning. The appraisal will give you a current market value of the practice and decisions can be made based upon this. If the market is good, and your practice is at a premium, it might be the best time to sell rather than in 3-5 years when the market may be different. However, most of the time you will find areas of improvement that will increase the practice value before the planned exit. VetPartnersTM also has another good publication entitled “Valuation Essentials for Veterinarians” which describes what to look for in both a good practice valuation and a good appraiser.
- New Facility or Major Remodel – This is a large capital expense and is sometimes necessary due to practice growth. However, though rapid growth is usually seen after construction, it takes at least 5 years (and probably closer to 10 years) to see a return on investment based upon practice value. Prior planning is key for this type of investment. Professionals need to be hired to calculate the demographics and psychographics to determine if spending money in this manner is wise. Expanding or remodeling is not an option a lot can be done to improve a facility with a good cleanup crew and a bucket of paint.
- Adding new equipment – New equipment needs time to produce income for the practice. The first question before making an equipment purchase is, “Will this equipment not only pay for itself but will it increase profit?”. If the answer is not a strong yes, then the equipment is probably nothing more than a high-priced toy. Toys depreciate and do nothing to contribute to the value of the clinic. Useful, income-generating equipment will provide a tax deduction AND contribute to the bottom line and thus to the practice value.
- Establish an Emergency Clinic or Call Rotation – Buyers today are not only looking for a profitable practice but a life outside of veterinary medicine. Unlike we older practitioners who KNEW we would need to take emergency duty, the new generation of veterinarians NEVER agreed to night or weekend calls. And, they don’t need to with so many emergency practices available now. They do not want to put in a 60-80 hour work week and take after-hour emergencies. Therefore, having an emergency facility to handle after hour calls is a huge factor when a buyer is deciding on a practice. If one is not available in your area, now is the time to contact your neighbors and establish one or at least organize a call rotation schedule. Your life will improve instantly AND your practice will become more desirable. As a bonus, you might even get some added income from the profits if you are one of the owners.
- Staff Training – A well-trained staff is the single most valuable asset in any practice. Not only will a good staff make money, it can be a huge selling point to a potential buyer. The reverse is also true; a staff with no direction can easily kill even the most solid of deals.
- Bookkeeping – It is very important to manage your expenses closely; it is of extreme importance that you have your CPA provide you with financial statements that are designed for you to not only understand but can use to track your expenses. Financial statements are not something just to look at a bottom line but should be studied carefully to help manage a practice. Like with most things you get what you pay for with CPAs so ask for this service. It can be an eye opener. Now is also the time to begin to clean up the books. While it is important to take every legitimate deduction to minimize taxes, it is also important to maximize the bottom line in order to create value. Paying personal expenses through the business, or taking cash out of the practice, only robs the equity at the time of sale. Every dollar added to the net income may increase the value of the practice by 3-6 dollars. Most proper deductions won’t affect value because the appraiser may add them back to cash flow, and they will not be contested by any potential buyer or advisor. Clean books help support your asking price and show there is nothing to hide.
- Timely fee increases – Again, this is just good business practice but it is imperative that proper fees be maintained. The last thing a buyer wants to do is come into a practice and be forced raise fees significantly in order to maintain cash flow. Fee increases often insure at least some growth, and almost all of the increase goes to net; thus you can greatly increase the practice value.
Proper planning of your exit can pay big dividends when the practice sells. Even very small, inexpensive plans can have a huge impact to your retirement nest egg. It is important to stay passionate about veterinary medicine and the business of running a practice. Stay focused on the goal of selling your practice for maximum value. You need to continue to strive for growth and high profits. After you sell, you will have plenty of time to look back on a very successful career and exit strategy.