Terry O’Neil CPA CVA, an accountant and certified valuator from the firm Katz, Sapper, and Miller, spoke on valuation at the 2021 AAEP Convention held in Nashville, Tennessee. O’Neil concentrated his presentation on larger practices, particularly those that are considering selling to a corporate veterinary firm.
O’Neil began by discussing critical items to consider when preparing for a valuation, and he explained the different items that a valuator will request. These include how any real estate will be handled (sold or leased to the buyer), whether debts will be assumed or subtracted from the purchase price, seller and buyer tax consequences, what type of financing will be needed, and what method of valuation will be used. He suggested that sellers should be prepared to share five years of financial data, including the current year-to-date data compared to the previous year, as well as tax returns.
In addition, practice owners will need to gather associate veterinarian contracts, management reports, fixed asset schedules, inventory reports, an employee census, summary of benefits, fee schedule and revenue production history for all veterinarians working in the practice, he said.
Other information needed includes an accounting of any owner personal expenses being run through the business, as well as any unusual non-recurring income or expenses that occurred in the last five years.
When a high-producing owner will leave the practice after a sale, O’Neil suggested that a “claw-back” clause might be added to the sale contract if the retention of the revenue of the retiring person is questionable. This is common in transactions with corporate entities, he added.
Because minority shares have no control over decision-making, these shares are worth 30-40% less than controlling shares, he stated, so if you do not wish this to be acted upon, you need language to state that there will be no discount applied for minority shares.
A management assessment, including interviews with the staff, is needed to determine if the practice is “turn-key,” the culture is positive, and the management is competent, the speaker stated. This includes assessing risk in the practice, such as the degree of compliance with regulations related to OSHA or for controlled substances.
In addition, the valuator should look for unusual and possibly non-recurrent causes of increased or decreased revenue as well as differences from industry norms to determine if adjustments are needed. “Risk is the heart of valuation,” O’Neil stated.
Normalization of earnings is part of the process of valuation, the presenter explained. The owner’s (and possibly the owner’s family’s) compensation must be adjusted to 22-23% of their revenue production. Any discretionary expenses and/or fringe benefits might need to be reduced or eliminated.
Evaluation of the rent to make sure it is within the fair market value is another item to consider, he said. A handy formula for determining an appropriate annual rent is to multiply the value of the property appraisal by 13.3, which allows for appropriate adjustment up or down. Depreciation and amortization is added back.
If cash sales have not been recorded, they are not added back, O’Neil emphasized.
After explaining the earnings, market and asset methods of valuation, including Discounted Cash Flow, the speaker expanded his discussion on the capitalized return method. He stated that, “If a bank won’t finance the acquisition at the asking price, that’s a clue that the price is too high.”
His recommendation for buyers is that after paying the loan principal, interest and taxes that there should be a 10-20% “cushion” to protect against unexpected shortfalls in revenue. This accounts for the risk that revenue could drop sharply after the departure of the current owner(s), which could lead to business failure.
The speaker added, “If the loan doesn’t cash flow over 10 years, the practice is overpriced.”
In discussing sales to large corporate entities, O’Neil stated that they are paying extraordinary multiples of earnings as much as 10-18, due to large sums of available investment funds. These multiples are impossible for associates to pay.
He went on to say, “No one typically enjoys working for a corporation” but they offer large signing bonuses (typically 1/3 cash and 2/3 stock), make student loan payments after graduation, and are starting to pay expenses for some veterinary students from their first year in school.
In closing, O’Neil recommended that practice owners delay selling to corporate until they are ready to retire and will not need to worry about money again in their lifetime.
For younger owners, the return of profit for the remaining years of their career will far exceed the gain of a sale now, and they will still have the practice to sell at retirement.