One day we are going to have to retire, whether we want to or not. It might be due to health, changing interests or family, but at some point, we will hang up our stethoscopes and call it a career.
The same thing applies to an owner of a veterinary business; one day he or she going to want to let it go and ease into retirement. In both situations, the question remains whether one is going to retire on his or her own terms, or whether retirement is going to be forced upon that person.
In the case of an equine veterinarian, the wear and tear of the profession might force retirement while the mind is still sharp, curious and not quite ready to quit. The same physical limitations will affect the business owner, but running a business is easier on the body, so that person might have a few years to transition out of ownership. In other words, owning a business can buy you some time before the inevitable retirement day. That extra time allows those of us who own businesses to have more control of our careers, our retirement plans and the sale of our businesses. We have the time to plan for our succession.
Business succession means different things to different people, so for our discussion, it will be defined as the process of transitioning out of an ownership role by selling one’s ownership stake to another entity. Much like the “when” and “why” questions that anyone facing retirement will have to answer, we will also ask about the legacy of the business, how the value of a business is determined, how to transition in new owners and what the change means for the staff of the business.
The reasons why we decide to sell our businesses are fairly straightforward and personal. Everyone has his or her own reason for wanting out of a situation. Regardless of the reason, the overall goal needs to be closely examined. It is one thing to say you want out because you’re tired, bored, need the money, etc., but what is the next step?
Perhaps someone loves being a veterinarian, but just doesn’t like owning and operating a business. By getting rid of the stresses related to business ownership, that person can fully embrace what he or she loves about the profession. On the other hand, a person might need money for medical care of a family member or want more time to spend with a spouse who has retired. Each of these reasons to sell a business will have its own goals for the next stages in the lives of the sellers.
Owners of veterinary practices often have the advantage of having time to plan for moving on from their businesses. Yet, even if retirement is decades away, the sooner they begin planning, the more they can ensure that they will sell on their own terms. It is an industry standard that it takes five to seven years to prepare a business for a sale in order to maximize the sale price, have a smooth transition of staff and ensure a desired legacy. Imagine what could be done with more years.
At What Price?
There are two main formulas for determining the selling price of a veterinary business, and both involve the free cash flow that is produced each year. Free cash flow is the money that remains in a business after all expenses and investment activities are accounted for. In other words, it is the money that is left over each year that the buyer of a business can use to pay for the purchase over time. These formulas are very intricate with numerous advantages and disadvantages, so our discussion will focus on their general use as valuation tools.
The first formula for business valuation is based upon a multiple of historical annual free cash flow over an average of three previous years. Typically, the multiple in equine practice is three to five times the average cash flow. For example, if the average cash flow is $200,000, then the business is valued at between $1- 1.2 million. Higher multiples are used when there is less risk associated with a business. It is worth paying more for the business because a consistent profit is to be expected. Increased risk could be due to the following reasons:
• The majority of the sales in a business come from the person selling the business. Once the person is no longer involved, there is an increased risk that sales and free cash flow will decrease.
• The equine market is very volatile (unstable). We see this in the equine world with racehorse practices because the success of racehorse industries is often due to funding models that are legislated by state governments. If the laws are changed for whatever reason, there could be a negative impact on the success of a veterinary practice. A recent example of this was when the government of Ontario changed the funding model for horse racing, resulting in the industry contracting by 50% within just one year.
• The local economy is weak or depressed. It stands to reason that the equine market will reflect the local economic circumstances.
The second valuation method is called the Discounted Free Cash Flow Method.1 It also uses historical free cash flow and risk for valuing the business, but it incorporates estimated future earnings less current debt. It is more time consuming to calculate, but it is becoming the preferred method of valuation because it based upon time-tested principles of the value of money over time.
Regardless of the method used, it is imperative that the business maximize its free cash flow. This can be difficult with small businesses because they tend to show minimal profit for several reasons: Lower profit equals lower taxes, family members are on payroll or some personal expenses are run through the business.
Another significant reason for a business to show decreased profit is because it partakes in cash or bartered exchanges. All of these factors have a direct impact on the cash flow a business generates. Although there might be some short-term advantages of showing a lower profit, when the business is for sale, any valuator or potential lender is going to look at what is demonstrated, and not what could have been. This is why it is important to prepare in advance for the sale of a practice so that the business can demonstrate a consistent historical record of maximized free cash flow.
Many sellers of veterinary practices are surprised when they see valuations that are not in line with what they thought they would get for their businesses. Often these sellers are relying on older standards of valuating a business, or they already had sums in their heads with regard to its value.
Historically, one of the more common, yet recently disregarded, methods to determine a selling price was based on the previous year’s total revenue. The key thing to remember is that any business that is being sold has to demonstrate a consistent cash flow that is sufficient to repay the principle and interest associated with the loan to buy the company. Even if a business is showing 10% annual growth for the past three years, the value is based upon some variation of the free cash flow that remains.
Hiring the right professionals to assist the business owner in planning for a sale is not just an option. Lawyers, accountants, certified business valuators and financial advisors are essential. They will more than justify their cost in the benefits they offer. Understanding the legal and tax implications of a sale now will help in the plans for a sale later. Furthermore, the right team behind the sale will offer excellent advice on the terms and financing of a sale.
Getting a bank loan for the purchase of a veterinary business is very rare, so many sellers are obliged to finance the purchase themselves. If that is the case, it is important to develop strong contracts for the sale of the business. At the same time, having the business valued now will give the seller an idea of what they need to do, and how long it will take to reach the financial retirement goals as determined by a financial planner. If someone needs $1 million to retire and the business is worth half that amount, it is better to have figured that out now and work to improve the value of the business over the next five years than be in the position where your health is forcing you to sell at half the money you need.
Who Are the Buyers?
Another key factor in the sale of a business is determining who might be the prospective buyer(s). Is there an associate or a group of associates who want to buy in for a little bit now, then buy all shares at a future date? Is there a neighboring business that would want to acquire your business, or are there outside corporate veterinary groups that might swoop in to buy your business? Depending on the buyer, there will be different expectations to manage the transition.
Typically, the easiest sale process happens when an existing associate (or group of associates) purchases the business. They know the factors that contribute to the success of the business, and clients should have a relationship with them, ensuring continued loyalty. The key phrase in the previous sentence is that “clients should have a relationship.” Unfortunately, this is not the case in some equine veterinary practices where there is often a main veterinarian who is the driving force of the business, or the reason that clients use that business. Without that person in place, there is little loyalty to the practice and future sales would likely fall if that person left.
Again, that is why a planned transition is best: because that leading vet, usually the owner, can spend time working with clients and the associate veterinarian(s) to make sure the clients accept the “new kid on the block” as well as they have accepted and trusted the doctor who has always been there for them.
Another consideration for an “inhouse sale” is creating a plan to evaluate the prospective owner(s) to make sure he/she/they are the right ones to buy the business. It is one thing to have to means to buy the business, but it is another to succeed at doing so.
Not everyone is meant to be a business owner. What looked easy on the sidelines might be too stressful in reality. If the seller has to carry some of the loan, that person wants to ensure that the business will thrive so that he or she will get paid in full.
Nothing dampens a retirement dream more than having to take the business back a couple of years down the road or not getting what is owed because the business goes bankrupt. If the buyer has what it takes to be an owner, then a business training program should be developed. It could be as simple as mentoring the aspiring owner by including him/ her/them in current business discussions and decisions, or finding external business training for the new owner to improve overall business acumen.
If the buyer is another business in the area, then other considerations come into play. The buyer will want to perform some due diligence to make sure that the purchase is a good investment for him or her. The person will want to make sure that the two businesses have a similar pricing model, have similar veterinary compensation models, have similar styles of customers and that the medical philosophies between the businesses are aligned.
Answering these questions to the satisfaction of the buyer is the buyer’s concern, but that person will expect the seller to be transparent when answering those queries. Why should the seller care? Consider it another form of a pre-purchase exam. If the buyers do their jobs right, they will find out about the issues that limit performance now rather than later, so it is better to be up front about things before the buyers find out and other opportunities were not explored.
Consider the legacy of the business that the seller has developed over the years. Does that person want his or her great reputation sullied or long-standing clients and their horses left adrift because the buyer(s) didn’t buy the business they thought they were buying?
Again, preparing for the sale will help reduce these risks. Here is a real-world example we experienced when a seller misrepresented the business we were trying to buy.
When we made our inquiries, we were told that their pricing was similar to ours and that the clients were very knowledgeable and wanted the best care for their horses. We were also told that everyone was on board for dentals. The reality was that most people expected to pay cash, or wanted some form of discount; they wouldn’t let us use dental power tools because the selling vet hated dentistry and would just perform perfunctory hand floating; and the selling vet told the clients that horses didn’t need their teeth floated on a regular basis!
The end result was that we soon gave up on those clients because they were not a fit for our practice and the selling vet developed a bad reputation in their area when the horse community was left without a vet. If the seller had planned ahead, he/she could have trained those clients to pay full price and accept modern dentistry. The end result would have been that the veterinarian would have been able to sell that business for much more than he/she eventually did, the clients would have been happy with the transition, and the practice’s reputation in the community would have been upheld. Planning is essential.
Corporate Practice Ownership
Although we don’t have nntional corporate veterinary groups in equine practice like they do in companion animal (CA) veterinary businesses, there are some murmurs in the industry that they are coming. What do they want? If they are like CA corporate groups, they will pay a high multiple of free cash flow, and they will want the owner to stay on for a number of years to ensure a smooth transition.
We have already discussed the need for excellent free cash flow, but the latter request (to stay on) will be a challenge for many independent equine veterinarians. Now retirement has been delayed and the seller has to work for someone else, which means following orders and accepting changes. That is easier said than done for anyone who has owned his or her business for a while. Often the reason that person had a solo business is because the veterinarian liked being his or her own boss and creating the own rules.
A different mindset is needed for corporate businesses. That is something to be evaluated in advance, and if the increased monetary gain is not worth the extra years working, then selling to an associate or a neighboring practice might be a better option.
What About Staff?
Finally, we are left to consider the remaining veterinarians and the support staff that will remain with the business. This is an often-overlooked aspect of succession planning. Most people do not like change, and having a new boss can be very stressful. Managing this change is essential. At the same time, most buyers will want to see the employment contracts for all vets and staff to see what they are on the hook for when they buy the practice.
For example, the buyer might not want to keep what the seller considers key staff. Maybe those staff are being paid too much for their positions, or the new owner might want to consolidate some jobs with another location if another group is buying the business.
When it comes to staff, the seller has to decide how far to go to protect the jobs of people who have been with the business for years. It is a fine line between doing what is right for people and the dollarsand- cents decisions that need to be made for a sale to go through.
Some veterinarians have refused to sell their businesses because they didn’t like what the sellers wanted to do with staff. Everyone has his or her own opinion on this, but it is a question that needs to be addressed ahead of time. When it comes to the veterinarians on staff, do they have non-compete clauses in their contracts? In those states that enforce non-competes, that could be a significant request by the buyer. The new person or group doesn’t want to buy your business and have all of the associate veterinarians quit and set up shop in the same town. All of a sudden, the business could be worth a lot less.
Finally, it is a good idea to involve your staff in the selling process. They know that eventually the business will have to be sold. Having them understand your succession plan will give them confidence that the best future is being prepared for the business and for them. Unfortunately, some people might not want to be part of this new future and will leave. Again, if there is a lot of planning time, employee considerations can be addressed to help maximize the value of the business.
Plans are always evolving. What was a great idea two years ago might need to be adjusted with the new economic reality or professional/lifestyle changes. The five- to seven-year succession plan should be reviewed annually to make sure that the ultimate goals are still on track. The timeline might be delayed or it might come sooner than expected, but that won’t be known unless the plan is regularly evaluated.
Also consider a contingency plan in case the expected future can’t happen for whatever reason. What would you do if you had to retire much sooner than expected? Could you sell the equipment or facility quickly to get some cash? What if the promised purchase from a junior veterinarian in the business can’t happen— are there alternative buyers? Having a plan of alternative measures will prepare the seller for life’s surprises.
Succession planning is not something that is done overnight, or even in a couple of years. It is best done multiple years in advance to prepare the business to sell for the maximum potential. An excellent plan is consistent with personal goals and is mindful of the employees and legacy that the seller will leave with the business.
We spend years building up a business, and often we don’t give it the attention it deserves to fulfill our retirement dreams. But with careful planning, and the use of outside professionals, we can transition into a comfortable and fruitful next stage of our lives.
This article was first published in the Fall 2016 issue of EquiManagement magazine.