We work with successful veterinary practice owners who are contemplating the sale of their hospital. In many cases, they are considering a sale because of the significant growth in corporate consolidators who pay multiples as high as twice the historic valuations. A general feeling exists that the bubble will inevitably burst and that practice values will revert to a historic mean. Of course, predicting if and when that will happen is impossible, but many practice owners have an overriding fear that the failure to sell at today’s high valuations will mean leaving money on the table and a lifetime of regret.
Does failing to sell at a high valuation today mean you will miss out? Receiving top dollar for the practice you’ve built over the decades is important, but a high valuation from a corporate consolidator is certainly not the only consideration.
A Case Study
Here’s a common scenario we see:
- 50-year-old owner-veterinarian
- Four-plus doctor practice
- $3 million in annual revenue
- 15% EBITDA ($450,000)
- Practice valuation of five times EBITDA (earnings before interest, taxes, depreciation and amortization), or $2.25 million
As you know, well-run veterinary practices are a great investment. They are among the few businesses that are relatively recession-resistant and even considered “Amazon-proof.” Receiving a valuation of 10 times EBITDA from a corporate entity is not uncommon. The practice above could be sold for $4.5 million.
So, the decision is easy, right? Sell for $4.5 million to a corporate consolidator, sign a two- or three-year employment agreement with the buyer, become an associate doctor, collect your salary and ride off into the sunset. This is clearly the best deal available. Or is it? Some sellers regret not factoring in other considerations.
The process often starts with you receiving an unsolicited offer from a consolidator, leading to a strong sense of urgency — “Don’t miss out on this golden opportunity!” The prospective buyer highly values your future profits, and so should you.
Not So Fast
Your first step should be to look at all the factors besides price that are driving your decision to transition the practice. The decision should be based on the following criteria:
- Lifestyle and family: Your “why.” Carefully identify why you are contemplating a sale.
- Emotions: Are you ready to transition into the next phase of life, or does working fulfill and energize you? You might move away from the business, but what are you moving toward? This is critical.
- Legacy: What about your family, the co-workers left behind, and your clients, patients and community? Will a sale to a corporation help you attain your legacy, or is selling to an individual better?
- Timing: If you are not ready professionally and emotionally, then why sell? In many cases, the best time to sell is later, even if practice values revert to historical norms. (See option four.)
- Financial: How much money your family needs will answer the question “How much is enough?” Does taking the most money today result in the best long-term financial outcome?
Let’s consider the math in the following four options.
1. Sell 100% of your practice today to a corporate consolidator at 10 times EBITDA, or a total pre-tax payout of $4.5 million over one year.
- Pros: Take all the money now. Avoid future business risks.
- Cons: Taxes are due in Year One. You have no incentive to grow the business given that all control and decisions rest with the acquiring company. Your legacy is out of your hands.
2. Sell a controlling interest to a corporate consolidator today and maintain a minority interest to be sold later.
Many deals are structured so that the buyer purchases a majority stake in cash, perhaps a two-thirds interest, and the seller keeps one-third for sale later. A two- or three-year employment agreement commits the seller to work as an associate doctor, run the practice and produce revenue. Typically, an annual salary is guaranteed — for example, $120,000 or 22% of production, whichever is greater. For the minority interest held back, a valuation will be spelled out in the contract and is often the same EBITDA multiple as the purchase multiple. The seller is incentivized to grow the practice and maximize the value of the remaining interest.
Assuming a 10-times multiple and a two-thirds initial purchase, the seller receives $3 million upfront. The remaining one-third, or $1.5 million, is held back, but assuming 6% annual growth, the value is $1.79 million in three years. Over three years, the seller realizes profit distributions of $506,000 and compensation of $360,000. The total pre-tax payout is $5.65 million over three years.
- Pros: You get a greater potential upside and take some risk off the table. You ease into retirement without the burden of making all the business decisions.
- Cons: You are now an associate doctor. After decades of running your business, you might find it difficult to follow directives, especially if you disagree with one. You have wealth but not control. You’re a minority shareholder.
3. Do not sell equity for five years but instead set up 20% profit-sharing with your purchasing associate veterinarians. You improve EBITDA to 20% and sell 100% of the practice in Year Five at a historically normal five times EBITDA.
Assuming 6% annual growth and 20% EBITDA, you receive 80% of profit distributions over five years, or $2.87 million. Your associates get 20% of the profit, or $717,000.
Your associates attend quarterly meetings with a certified public accountant to prepare them for ownership. You include them in important decisions and treat them as future owners. This strategy creates cash for the associates and helps them become the buyers beginning in Year Six. Assuming a 6% growth rate, the practice has annual revenue of $4 million after Year Five, and EBITDA has grown to $800,000. Your owner’s compensation is $600,000 over five years, and the sale proceeds are $4.02 million.
The total pre-tax payout is $7.48 million over five years.
- Pros: You have complete control and the ability to take as much money out of the business as is possible. Your tax-preferred strategy might include a Safe Harbor 401(k) profit-sharing plan or a cash balance pension plan, both of which drive higher levels of retirement investing and income tax savings. You have the opportunity to develop one or more associates to take over the practice and help improve EBITDA. You have the flexibility to sell to a consolidator and, if so, the associates would profit.
- Cons: You maintain all the current risks for five years and share some of the profits. You must maintain your energy level to work at your current pace or similar.
As this option shows, increasing EBITDA should be a top priority.
4. Sell to an associate veterinarian over 10 years.
A lot of owners want to practice for another decade, aren’t ready to sell, and need to retain one or more productive, valuable associates. Some transactions are structured for an owner to sell 10% in Year One, 10% in Year Five and the remaining 80% in Year 10. This is often financed by a bank at a five-times multiple, or $2.25 million in this case, with a new valuation each period and assuming 6% yearly growth.
Figure profit distributions to you of $5.3 million, practice sale proceeds of $3.76 million and compensation of $1.2 million. Your pre-tax payout is $10.26 million over 10 years.
- Pros: You have a huge monetary upside, complete control until Year 10 and better odds of achieving a positive legacy.
- Cons: You must commit to growing the practice value and mentoring your associate.
Discuss this last option with your CPA to ensure the best tax-handling strategy for you and your associate veterinarian. If you want to practice for another decade, giving up much equity today, even at a high valuation, is generally not advisable.
Final Thoughts
While quantifying each of the four options is essential, the most important step is to define how much money you need. In other words, how much is enough to achieve your living, giving and wealth-transfer goals over your lifetime? The amount must include enough margin to allow you to deal with unexpected circumstances.
All this can be accomplished with a team of professionals fully invested in your success and succession. You’ll want a comprehensive financial life plan developed by a certified financial planner practitioner who serves you as a fiduciary. Also, be certain to include a CPA and a certified valuation analyst (CVA) who have experience with veterinarian succession plans. Guidance and counsel from this team can add measurable value by helping you to improve EBITDA and grow wealth.
Once the target and strategy options are developed, you will have the proper context for evaluating your choices. Ideally, your personal and unique objectives and preferences will determine the path forward, including the timing and buyer identity.
Take the time to explore all your options. The math matters, but so do all the other considerations. This likely will be the biggest financial decision of your lifetime, so don’t rush.
Financial Wellness co-columnist Robert A. Sparrow is a partner with Triune Financial Partners LLC. Co-columnist Jason Castner is the managing shareholder at Lacher McDonald & Co., CPAs & Consultants. Co-columnist Fritz Wood is a veterinary industry veteran with a special interest in finance. He serves on the Today’s Veterinary Business editorial advisory board.
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