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The steady consolidation of veterinary practices, increasing purchase prices and the proliferation of private equity and corporate consolidators has created a thorny question for independent veterinary practice owners. Do I sell or do I stay independent? As any animal hospital or pet clinic owner who is also a doctor of veterinary medicine (DVM) knows, deciding to sell a practice a difficult, multifaceted decision. A market-based valuation, like those available at VetValue.pet, helps frame one aspect of this question about practice sales – “what’s my practice worth now”.
However, more is required to really understand whether and when selling to a corporate consolidator or private equity makes sense. Financial concepts and models, while subject to number of variables, provide an excellent framework through which to do this analysis. Before plunging into the numbers, it is worth spending some time reviewing the qualitative factors that may drive a veterinarian to sell or not sell their clinic.
There has been a constant drumbeat in certain quarters of the veterinary community bemoaning the loss of independent veterinary hospitals and independent vets. Veterinarians who sell can often be faced with corporate directives that seem more focused on profit than on patients. There is a fear within the industry that veterinarians who practice as part of a corporate team will not have complete independence when it comes to their ability to make medical decisions. At the same time, selling a practice will take some business decision-making away from the selling owner. For example, decisions regarding significant medical or office equipment purchases may need to be approved by the corporate office. Finally, selling pet clinic owners will no longer be their own boss, instead, while still a professional, selling veterinarians who stay on will be just another employee.
Meanwhile, besides the potential financial remuneration, selling a veterinary practice can bring other benefits to the animal hospital owner. Many clinic owners feel bogged down by the business end of their practices. Selling to a larger organization can relieve owners of some of the managerial decisions and responsibilities they find so onerous. As an employee or partner, the selling owner can get back to practicing medicine without worrying about financial, technology or personnel decisions. This change can allow animal hospital owners to devote more time to both their families and their lives outside of work. In addition, becoming part of a bigger company can provide access to a host of additional resources. These include both financial resources that can permit the acquisition of real estate to the newest clinical equipment as well as managerial resources that foster the adoption of best practices.
Financially, selling owners often are trading potential future earnings coming from ongoing salary and ownership distributions for an upfront payment. This fact allows the modeling of different scenarios so that an animal hospital owner can gain a better understanding of the financial impact of the ownership decisions they might make. Indeed, by creating a simple financial model, albeit with a number of variables and assumptions, it is possible to provide a unique insight into the sell or operate decision. The model itself involves making assumptions that allow for the creation of 10-year financial projections for a generic veterinary practice. Once this has been done, the financial theory of time value of money, present value (PV), permits an apples-to-apples comparison of the different scenarios.
We created four different scenarios to be analyzed relative to a five- or 10-year plan to retirement:
· Stay independent, sell at retirement in an all cash deal.
· Sell to corporate today for all cash and retire in 5 or 10 years.
· Sell to corporate today, and retain a joint venture (JV) interest in the practice sold and retire in 5 or 10 years.
· Sell to corporate today, and acquire a roll-over equity interest in the acquirer and retire in 5 or 10 years.
We looked at "Sell Today" scenario from the standpoint of: i) the selling owner retiring 5 years after the sale, and ii) the owner retiring 10 years after the sale.
For each of these scenarios, we generated cash flows based upon a consistent set of assumptions. We made assumptions regarding everything from gross revenues, to profit margins, to prospective tax rates on income and capital gains, to expected yearly revenue improvements and sale/exit multiples. While these assumptions are realistic based upon our in-depth knowledge of animal hospital financial metrics, they are somewhat arbitrary. Nevertheless, and most importantly, they were applied consistently.
The analysis provides some interesting, but not surprising, results. The practice owner’s retirement timeframe is a significant factor in determining whether to stay independent or to sell, all other things being equal. Independent pet clinic owners who are looking to work for at least another 10 years, should seriously consider remaining independent. This longer time period permits independent animal hospital owners to capture the additional value generated from the distributions that come from ownership. This is particularly the case in situations where the practice owner believes a) that they can grow cash flow at a rate equal to or higher than that of their potential buyers; b) sale multiples will not decline materially in the future; and c) long-term capital gains taxes remain at the presently favorable rate of 23%
On the other hand, if a practice owner is contemplating retiring in five years, a sale to corporate or private equity now is the way to most likely to maximize long term career earnings. By selling now and retiring in five years, an owner can create significant additional value versus continuing to operate independently. Under our assumptions, the decision to sell added value ranging from +5% if a practice is sold for all cash, to more than 45% if a practice is sold and the practice owner is allowed to roll over a portion (30%) of the proceeds into equity of a well-run, growing acquirer. Naturally, given the fact that veterinary practices can sell for millions of dollars this is a significant consideration.
Now if the selling owner is looking to retire in 10 years, or more things change dramatically. The benefits of ownership coming from the distribution of cash flow over this longer period of time tilts the equation in favor of independence, all other things being equal. Staying independent increases value by 31% versus selling for all cash and then working as a salaried employee for another 10 years.
It should be noted that the selling veterinarian’s ability to rollover some of their sale proceeds can, in certain cases, change these dynamics for an owner 10 years from retirement. In our model, if the selling owner is able to negotiate a continuing interest in the form of a JV (joint venture), they will be essentially indifferent from a financial perspective. Moreover, a practice owner is still incentivized to sell if they can rollover some of their sale proceeds into equity of the company that acquires them, as long as the acquirer is a growing concern. In this case, the increased value coming from ownership in a corporation that is expected to itself increase in value provides an extra boost.
It must be stressed again that there were a number of arbitrary assumptions that need to be made in order to complete this analysis. Tweaking any number of these would change the results. Increasing the future capital gains tax or decreasing future sale multiples tilt the decision towards a sale now, for instance. While decreasing income taxes of increasing future multiples support a sale later. Nevertheless, we believe our base case is reasonable and provides a good starting point to spur a discussion regarding when is the right time to start the sales process.
Most such discussions seem to be focused more on the qualitative aspects mentioned at the beginning of this paper without doing the rigorous financial analysis to quantify this incredibly important decision. We hope by changing this conversation, we can help the owners of animal hospitals make better, more informed transition decisions.
Lastly, the creation of a model like the one we used requires both a thorough understanding of financial concepts and theory combined with model skills. So, make sure your financial advisor is qualified to do the work.
We encourage any practice owners who are interested in seeing what this analysis might look like for their individual practice to contact Carson Taylor at VetValue.