Leslie A. Mamalis
MBA, MSIT, CVA (Emeritus)
Leslie A. Mamalis is the senior consultant at Summit Veterinary Advisors and the firm’s former owner. She provides practice valuations, profitability assessments, feasibility analyses, and financial consulting to veterinary specialists and general practices. She is a past co-chair of the VetPartners Valuation Council.Read Articles Written by Leslie A. Mamalis
As a veterinary practice owner, you hopefully thought about your succession plan. When you’re ready to leave ownership, will you do it all at once, selling 100% of the business? Or will you gradually release the reins by bringing one or more partners on board and strengthening their leadership skills before you sell the remainder of the practice? Many decisions go into considering a partnership versus an outright sale, not the least of which is understanding the impact of each on the value of the business.
Asset Sale or Equity Sale?
When a practice owner sells 100% of a veterinary hospital, the buyer generally purchases the assets. They buy all the tangibles (inventory, equipment, computers, furniture and office supplies) and intangibles (business name, phone number and website). Upon an asset sale, the buyer typically gets everything on a cash-free, debt-free basis and starts with a clean slate — no payroll liabilities, no credit card balances and no cash from the practice. The buyer doesn’t get the money the seller accumulated over time and doesn’t have to pay off the seller’s credit cards, vendor account balances or bank loans. Someone buying 100% of the practice will transfer all the assets into a new business entity and establish new bank accounts, vendor accounts and credit cards.
In contrast, an individual who buys part of a practice obtains an agreed-upon portion of the assets and liabilities, including vendor bills, credit card balances and equipment loans. In other words, the buyer gets equity. The equity value is the asset value minus liabilities. It’s then increased by the cash in bank accounts and any rent or utility deposits.
No surprise that assets are usually worth more than equity. See the simple example in Figure 1.
Assume a veterinary practice’s asset value is $2 million. To determine the equity value, we add interest income to the net income and subtract interest expenses. We also add bank account balances since cash is another purchased asset. Finally, we deduct the liability balance to get the equity value.
The sample practice has an asset value for someone not assuming any debt and an equity value for someone obtaining only a portion of the business.
Who’s in Charge?
For fun, let’s take the example a step further. When I value a practice for an associate buy-in, a minority interest is usually at stake. On the other hand, anyone buying a majority stake, whether 51% or 95%, now controls the business.
Control of a veterinary hospital often relates to the quality of medicine practiced and the business hours, species treated and culture. However, when we look at control through the acquisition lens, it also means the ability to change the income and expense structure of the business, from the fee schedule to compensation, notably owner pay and benefits.
What can a minority owner control? Very little. Therefore, a minority partner has little influence over practice income and expenses. If you don’t control the business, you don’t control the money.
Practice owners can pay themselves as much as they wish, ideally based on advice from a tax accountant. If they pay themselves more than someone else would receive for the same work, the extra pay comes from the profits. The same is true with rent. If the practice owners also own the building, the rent might not be a fair market value (what a third party would pay to rent the property). The difference comes from the profits if the rent is higher than normal.
What about discretionary spending? Many business owners receive generous perks, from personal computers and home internet plans to continuing education travel and personal vehicles. Whether the expenses are small or large, business owners pull out profit dollars in many ways. Spending profits like that reduces the price a minority owner should pay for a slice of equity.
In the example in Figure 2, the owners earn $200,000 more than they would pay someone else to do the same work. The rent on the building they own is $50,000 higher than the market rate. They travel first class, and the practice pays for family cell phones. (I’m not judging anyone. Owners can take money out of the business whenever they like.)
IRS tax issues aside, nothing is inherently wrong with running personal expenses through the hospital. Still, the owners need to understand that less profit is available for the associate to pay for the buy-in if the spending continues. Those discretionary expenses are disguised profit distributions paid only to the existing owners, who must choose between continued discretionary costs and a higher practice value.
SHOW ME THE MONEY
Clean financial books are critical in any business. Most valuators won’t accept a seller’s word that business expenses are lower or income is higher than what the tax return shows. Valuators must verify the amounts before we include them in a practice’s value. Trust me, reviewing credit card statements and Amazon charges to identify personal expenses is time-consuming. My advice is this: Save yourself the trouble by recording personal expenses as owner distributions or in clearly labeled expense accounts.