As a consultant, I get nervous butterflies each time I prepare to review a veterinary hospital’s valuation with a friend or client. The video calls summarize the individual’s ability as a practice owner to build a legacy and sustainable business. Many of the conversations end in virtual high-fives as the transitioning owners achieve their retirement dreams and cashout numbers. Unfortunately, I’ve shared bad news with owners who failed to generate significant financial value for their life’s work, whether due to a lack of intention, knowledge or planning.
Having made countless numbers of such calls over the years, I break the practice owners into three subgroups:
Those able and excited to successfully transition their “baby.”
Those who must recommit to additional years of work as they build their hospitals’ value.
Those who realize the hospital won’t support their next life stage and resign themselves to a Plan B.
This begs the question: What can practice owners do to ensure their decades of hard work and commitment result in a business bigger and better than just themselves?
As I write this article, I am partnering with one of my consulting firm’s team members, certified valuation analyst Dr. Sarah McFadden, on a project focused on how hospital owners can best align their exit strategies with their practices’ value.
The worst outcomes for a valuator occur when owners without an exit strategy expect a certain (unattainable) value and, when they don’t achieve it, leave practice as soon as the ink dries on the sales contract. That combination means they’re unable to work on improving the valuation. The best-case scenarios happen when owners plan an exit strategy years in advance. If a surprise comes, they pivot and make changes quickly enough to still achieve their goals.
With all that in mind, let’s explore tips and tricks for helping current practice owners develop an effective exit strategy.
Start With Your Why and Goals
What are your financial and personal objectives for retirement? If you’re not familiar with the concept of “your number,” it’s what you need in income-producing assets to hit your annual cash-flow goals upon retirement. For example, if you assume a 5% return on all your investments (stocks, bonds, real estate, etc. ) and want $100,000 in annual income upon retirement, you need $2 million in income-producing assets. If you want $200,000 a year, you need $4 million in income-producing assets.
Keeping that in mind and thinking about when you want to retire, discuss your goals with your significant other and family. Check in with your accountant, certified financial planner, estate planner or attorney to make sure you’re on track. What adjustments, if any, do you need to make?
Money aside, where would you like your practice to be in one, five and 10 years? Do you want its mission, vision and core values to continue under new ownership? Is a potential buyer aware of those goals? What changes would a possible owner make, and how could you help implement them?
Funny Numbers
When it comes to practice value, our profession still banks on myths sometimes. For example, your hospital is not automatically worth its annual gross revenue or a set percentage. Instead, veterinary valuators will examine and adjust your earnings before interest, taxes and depreciation (EBITDA) (usually over three years, although some corporate consolidators look at shorter periods). In other words, while year-over-year revenue trends likely make your practice more or less appealing, EBITDA (cash flow) determines the value.
Similarly, I’ve had practice owners tell me their hospital was worth more because “We have great clients,” “We’ve been in the community for a long time,” or “I’ve got a great team.” Similar to gross revenue, those attributes can be important, but their value is only significant if they’re leveraged to produce cash flow.
Gross, growth and intangibles matter, but only if your profit-and-loss statements demonstrate how you created cash flow with them.
Time Is of the Essence
Ideally, you should start exit planning at least three to five years before you intend to retire or sell the practice. Most valuators require three years of financial information, if not five, to accurately reflect the value of the business. The last years of financial data should show the strongest growth in revenue and EBITDA. If they don’t and you start planning early, you have time to address the issues.
I recommend reviewing your financial statements monthly. Consider using the AAHA/VMG Chart of Accounts at bit.ly/3NfmYAV to identify where your practice excels and has room for improvement. After you organize the financials, evaluate the revenue and expense categories.
The simplest revenue metric is usually production per full-time equivalent DVM, with most published ranges varying from roughly $550,000 to $700,000 per FTE. For example, if a hospital with two full-time veterinarians brings in less than $1.1 million a year, room for revenue growth is likely.
When it comes to expenses, cost of goods sold (COGS) and payroll are the largest categories at most hospitals, regardless of size, type or location. If your EBITDA is low, I suggest starting there. As a general rule of thumb, payroll should represent roughly 44% of your revenue, COGS should range from 23% to 25%, and your EBITDA, after all other expenses, should be at least 12% of revenue.
After reading the story your financial statements tell, consider completing a valuation at least one year before you look to sell. If the value disappoints you, you have time to improve your hospital’s financial situation. On the other hand, if the practice valuation hits your target and meets your retirement needs, continue on your current path until the sale date.
If the valuation isn’t what you expected or need, ask yourself:
- What can I do to improve my practice’s worth?
- Are expenses such as COGS and payroll under control?
- Is my staff fully trained and leveraged to help the doctors produce as much as possible?
- Are the doctors providing optimal patient care at every visit?
If the answer to some or all of those questions is “no” and a retirement or sales date looms, now is the time to bring in outside help.
Proper Planning Prevents Poor Outcomes
I recently spoke to a former practice owner who told me the best business decision she made was to start planning for retirement early. She knew her practice’s value at one point wouldn’t support her goals, so she sought outside expertise and learned to manage expenses better, improve operations and leverage the staff appropriately. As a result, her gross and net income doubled within five years. Not only did she sell her practice for more than she ever dreamed, but she could retire seven years earlier than anticipated. She now works because she wants to, not because she has to. All of that was because of proper planning.
Most practice owners speak with a valuator eventually. However, the outcome, whether a celebration or a rude awakening, is in their hands.
We all probably know colleagues who needed to sell sooner than expected due to unfortunate health or family matters. The takeaway? As a mentor once shared with me, never get into a business without a plan to get out of it.
Whether you’re an aspiring owner or have owned a veterinary practice for a year or decades, remember to run the hospital like a business. That advice doesn’t mean it’s all about the money. The money (revenue) will come if you focus on sustainably serving those around you. Once the money comes in, you need to be a steward in managing expenses to build a business that achieves your mission and continues to serve your community and team.
TIME TO YOURSELF
A gradual transition from practice ownership allows you to step into retirement slowly and spend more time outside the hospital. Perhaps you have a significant other or family member who helped you breathe the practice into existence years ago. If so, celebrate together as you approach the last steps, and do something special together. Let that be the final to-do on your checklist.