How to make a practice purchase with reduced risk and capital requirements (Proceedings)

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How to make a practice purchase with reduced risk and capital requirements (Proceedings)

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Nov 01, 2010

A lower risk practice purchase means the buyer and seller both win and the practice sells. It may be obvious that win-win is best, but sales are made that are not win-win or low risk. The practice sale may be to an independent third party or to an inside person, usually an associate doctor. The practice sale can be 100% cash out from the buyer's cash savings or cash from financing. Even with cash from financing, it could be 100% cash out with no down from the buyer. This is because some of today's specialty lenders are willing to make those 100% loans even when veterinary practices generally have a sale price including 60% to 80% goodwill. The reason lenders make these high leverage loans is because veterinarians are good credit risks. Losses nationally are only in the 1% to 4% range. In general, if sufficient due diligence is done, risk is reduced.

A practice sale can be a partial sale to an associate or a 100% sale to the associate or a third party. If the sale is a partial sale, unless the buyer has cash, the seller will have to finance the sale. Only if the seller will subordinate 100% of the practice as priority security to the bank, will the bank lend on a partial sale. Most banks will not lend for a partial sale.

Other than financing issues, the main win-win (lower risk) issues have to do with the sale price and (if it is a partial sale) with the timing of when the partial buyer may be able to purchase more shares or even to purchase controlling interest.

Another main area of issue for a buy out win-win is: was the price fair? To have a fair price the price should be the fair market value (FMV) based on a practice valuation by a practice valuator or appraiser. This person should have experience with the valuation methods used in the current market place to arrive at a practice value based on earnings. A practice valuation is to be based on the excess earnings or a prediction of future earnings of the practice after the seller's (and any other veterinarian's) compensation has been adjusted to a production basis with earnings set at about 22% of their production for small animal practices.

Another (one of many) important adjustment that is commonly needed in the practice profit and loss statement, before the valuation is complete, is that the rent for the physical facility must be imputed, if needed, so that it is at fair market rent. This market rent adjustment is based on other commercial buildings in the same geographical area, as determined by a third party person in the real estate field.

Other adjustments for the valuation will require the valuator to look at non-recurring costs and other expenses sometimes listed as private expenses for automobile or excess continuing education travel or personal items taken from the practice and paid for by the practice.

The records are reviewed on a cash basis. Non-cash expenses like depreciation and equipment amortization are removed. Leases for equipment are removed because it is presumed the buyer would be a cash buyer unless it is an associate buying only a minority interest. After all the adjustments are made, an excess cash earnings calculation is made. There is usually a deduction for return on the investment in capital that is to be invested for the tangible assets. The final excess earning is usually calculated in a growing practice by giving more credit to the more current years, by using a weighted average method for calculating the excess cash earnings that predict future earnings.

After these future cash earnings are calculated, there is an analysis of subjective risk factors made by the valuator to determine what a potential buyer's return on investment should be as compared to the risk factors. This return on investment rate, after also considering the growth rate of the practice, will allow the valuator to arrive at a capitalization rate usually in the 33.3% to 20% range resulting in a multiplier of the excess earnings being 3 to 5 for the calculation of the good will.

If the non-win-win practice sale occurs, because the practice value was not properly determined, there is a much higher likelihood that the buyer may fail or not be able to pay for the practice from proceeds of the practice earnings after paying himself an adequate compensation for being the onsite or one of many veterinarians.