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Veterinary industry consolidation has made understanding basic business valuation methodologies critical for independent veterinary practice owners. The demand for veterinary clinics has increased the values of these businesses to unprecedented levels. In order to protect, grow and eventually realize this value, animal hospital owners must know how potential acquirers will determine what their hospital is worth.
Owners typically complete a veterinary practice valuation when they are looking to sell all or a portion of their animal hospitals. A valuation can be described simply as the process of determining what the practice is worth by using objective measures. A valuation also should not be confused with an appraisal that would be done by a veterinary practice appraiser.
Since most veterinary practices are private businesses, we will only discuss valuation methodologies that apply to non-public companies. We all also assume that we are valuing a business that is a going concern.
Before reviewing the methodologies, it is important for our readers to understand one point. A large veterinary practice can be viewed as essentially a series of future cash flows. In other words, animal hospitals produce net cash flow that could theoretically be distributed to its owners.
Most veterinary practices do not have publicly traded stock. In addition, most practice owners are not looking to liquidate their businesses. As a result, we will focus on three common approaches used to complete going concern business valuations.
The first, the Discounted Cash Flow (DCF) method, may be the most rigorous. But, it is not often employed in the pet care service industry. This valuation process would require the practice owner to create a complex financial model.
This model would generate a practice's expected future income statement and net cash flows. The net cash flows would then be discounted back using a Present Value (time value of money) calculation to arrive at a valuation. Doing this calculation would also require the selection of a Discount Rate that would reflect the business’ cost of capital.
The second, the multiple or percentage of revenues method, is typically used for single doctor or very small practices. This methodology is essentially a type of comparable company analysis. Purchase prices are calculated as a percentage of, or a, multiple of revenues.
This methodology greatly simplifies the valuation of the business. This is accomplished by removing the need to distinguish between what is a personal versus a practice expense. It also limits the need to create detailed financial projections and select an EBITDA multiple (more about this in the next section).
The third methodology, the typical private equity multiple of cash flow model, is another form of comparable company analysis. This is also used for private (and sometimes public) businesses that are considered going concerns. It is appropriate for larger, multiple doctor practices since these hospitals can be viewed as going concerns even if the owner leaves after the sale.
The private equity model calculates a practice’s value by first determining a normalized version of its operating cash flow. The most often used cash flow measure is EBITDA, which equals Earnings Before, Interest, Taxes, Depreciation and Amortization. EBITDA, as the name suggests, is pre-tax operating income with depreciation and amortization, non-cash expenses, added back.
A savvy financial advisor will also adjust their client’s EBITDA. This is done to remove expenses that would not be incurred if the practice was operated by a corporate entity. For example, many clinic owners will use a vehicle leased by their business. Obviously once the practice is sold, this expense would not carry over to a corporate owner.
EBITDA is then multiplied by a number or “multiple” that is determined by market as well as practice-specific factors. Multiples reflect both the demand for this particular asset (veterinary practices), plus the demand of operating assets (businesses) in general. The multiple also will be impacted by the availability of financing and the current level of interest rates.
The product of EBITDA times the multiple will provide a gross value for the practice in question. Now, all debts must be subtracted and accounts receivable vs accounts payable must be netted to arrive at a final valuation.
VetValue suggests bigger clinics use the Multiple of Cash Flow method in most instances. Indeed, this methodology is the basis of the valuation tools available on the VetValue.pet website. It is also the most accepted way of valuing veterinary practices in the market today.
We believe most veterinarians have a limited understanding of how to value their businesses. To make matters worse, consolidators often use this ignorance to buy clinics at less than their true worth.
Veterinary hospitals enjoy a number of the characteristics that has made using time tested private asset valuation methodologies applicable. As such, independent veterinary practice owners need to understand the different valuation methodologies. We recommend that multiple doctor practices use the multiple of EBITDA methodology in most cases.