Normalized EBITDA in Veterinary Practice Valuation

March 2, 2021

Normalized EBITDA in Veterinary Practice Valuation

We define a single corporate Buyer's Valuation of a specific veterinary practice as follows:

There are two inputs into a Buyer Valuation
  • Where Buyer Valuation1 is how Buyer1 values the Practice. By implication, Buyer2 (another potential buyer) may generate a different valuation (Buyer Valuation2) for the same practice with the same information

This articles provides a simple 2-step framework for how a buyer determines a target veterinary practice's EBITDA. This Normalized EBITDA is a key input into the Buyer's Valuation.

Note that a single Buyer's Valuation is not the same as the "True" value of a practice.  Also, the Buyer Valuation may be much higher than the purchase price offered.  Sellers only see the buyer's offer price, which may differ from the Buyer Valuation.  We discuss the reasons for this in several articles on this site.

Buyer's Determination of EBITDA

This analysis is relevant to valuation in the context of a practice sale.  *Veterinary Practice EBITDA stands for Earnings Before Interest Taxes, Depreciation and Amortization.

A buyer, particularly one with private equity backing, wants to estimate the current, stable, annual cash earnings power of your veterinary clinic in a corporate setting.  This estimate is the  Normalized EBITDA. Right away you should see that there is subjectivity in deriving this important metric.  

It is a two-step process:

  1. The easy part: calculate Last Twelve Months EBITDA (an industry proxy for cash earnings or cash flow) of the practice by adding interest, income taxes, depreciation and amortization to operating earnings.
  2. The hard part: Normalize the EBITDA so that it is stable, and reflective of a certain corporate environment.  This is the input a buyer needs to determine what your practice is worth. Each potential buyer is likely to get a different answer at the end of the "normalization" process.

A buyer generally considers three types of adjustments to EBITDA in order to “normalize”:  

  1. Smoothing adjustments to address one-time expenses or benefits that cause variation which is not expected to re-occur. Nearly any expense is a candidate for one-time adjustment depending on the circumstances.
  2. Acquisition adjustments to eliminate expenses, or benefits in the EBITDA that won’t carry over to the buyer’s organization. Here the buyer is calculating: “what veterinary hospital-level EBITDA could this practice generate if I dropped it into my corporation?”. This is where the buyer strips out personal or practice owner expenses. It is also where a buyer may estimate the impact of corporate buying programs, or process efficiency technology.  
  3. Pro Forma adjustments are adjustments to reflect the current earnings power of the business. These adjustments can be diverse depending on the practice so here is an example:

If a doctor joins a practice two months before the practice is sold, only a portion of that doctor’s annual production will be included in the last 12 months of EBITDA. Without a normalizing adjustment last twelve months EBITDA will under-state the annual earnings power of the practice. There are many other potential adjustments in this category

What does a buyer need to calculate normalized EBITDA?  

Detailed information. Not only financial statements but also explanations and reasons.

No potential buyer can determine a Normalized EBITDA, and subsequently the valuation of a veterinary practice without access to financial statements.   Of course, these statements have no context if the buyer does not also have the ability to ask questions of the veterinary practice owner. If you have received an offer letter from a corporate, you should ask: what information did he use to get the valuation implied by the offer?  

Unless the buyer has seen your financial statements and had a chance to discuss them with you, the offer is based on very little, and likely worth very little.  Any valuation multiple suggested by the offer should be taken with a grain of salt.

Unless you go through the process or normalizing your EBITDA, you won’t know what the buyer is concluding with respect to his normalization process. If a buyer identifies a potential adjustment that increases your Normalized EBITDA, he may choose not to include it in his valuation, or “give you credit.”  

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