How the Valuation of a Veterinary Practice Works
How the Valuation of a Veterinary Practice Works - updated 03.02.2021
As a veterinary practice owner, your life is filled with immense responsibility ranging from patient care to client relations and finally, making important business decisions for your practice.
Entrepreneurs and business owners also have the vital task of ensuring their business’s success and longevity, and one of the most critical areas of concern as a business owner is placing a dollar value on your enterprise.
Day in and day out, a practice owner may not worry about how much their business is worth as long as they can pay their bills and continue serving their clients and patients.
However, veterinary practice owners should get into the habit of performing a valuation of their practice.
Healthy veterinary practices are valuable businesses and attractive investment opportunities or private equity firms, veterinary networks, and associates looking to purchase their own practice.
Today, we will cover various veterinary practice valuation methods to introduce the topic of valuing your practice and preparing to sell it if the opportunity arises.
Why do You Need a Practice Valuation?
There are many reasons why you might want to determine how much your veterinary practice is worth. Here are four of the most common reasons:
- Practice sale. The most common reason to value a veterinary practice is if you plan to sell. You want to know how much profit you can get from selling the practice and its evaluation is the first step.
- Sales management tool. Terminal cash flow will define how much your practice is worth when you decide to sell. Knowing the value of the practice helps to see whether you are taking steps to enhance the value of the clinic and improve its profitability.
- Partnership insurance. Partnership insurance plays a vital role when one of the partner’s leaves, retires, or dies. The insurance helps the practice owners secure their share of the total value of the practice. A valuation is needed to accurately determine each partner’s share.
- Qualify for a loan. If you plan to apply for a business or personal loan, some or all of your practice may be assessed or used as collateral. That’s why it’s important to know the fair market value.
Understand the Standard of Value
Before we delve into valuation methods, let’s get familiar with the basic legal concept that is called the standard of value. You will need to understand and use the proper standard of value to accurately determine the value of your veterinary practice, and it will influence which valuation method will be used. Fair market value is the standard of value in veterinary practice appraisal that is commonly used in tax matters.
Let’s take an example where you own only 25 percent of a practice, which makes you a minority owner. The value per share ranges accordingly, depending on what percentage of the clinic you own. Minority owners often play the role of a silent partner as they do not participate in strategic direction or operational management. According to fair market value, the minority owner will be worth less than the partner who owns 75 percent, which will have to be reflected in the transaction.
Valuation Methods for a Veterinary Practice
Here are some classic simple valuation methods that you, as a practice owner or manager, can apply right now. You should consider three fundamental approaches to value: income, market, and asset.
Income Approach: Determining income is the most popular and preferred method. The value of the practice depends on the profit, and the income approach focuses on the cash flow of the practice. Cash flow helps to determine the level of risk of the practice and its growth prospects. The income approach requires the seller to estimate the company’s risk:
- Geographic risk. Shows the dependency of a practice on the economy of the area in which it is located;
- Size risk. Pertains mostly to small businesses;
- Keyman risk. Determines if the business relies on a single veterinarian (solo practitioner).
Market Approach: This approach assesses a value based on the value of similar veterinary practices in your region.The difficulty with the market approach is associated with the availability and accuracy of data from public companies. As most acquisitions are private, it becomes challenging to evaluate the practice adequately.
Asset approach: This approach focuses on determining the value of the practice’s net asset value (NAV), which is how much the current tangible assets are worth. It also includes goodwill. Goodwill represents the fair value of the company’s assets minus the market value of its liabilities. Goodwill is an intangible asset that is based on the reputation of the practice, its clientele, value of future patronage, etc.
EBITDA as the Primary Number for Veterinary Practice Appraisal
Despite the reason you have for the practice valuation, it’s important to accurately assess EBITDA.
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. Other than profitability, EBITDA also shows the ability to repay debt. This measure is significant as it shows earnings before accounting and financial deductions.
While EBITDA is not based on any accounting standards, it shows a more realistic number for the buyer as it excludes owner benefits, rent, and other factors that have nothing to do with the actual profit of the practice. Another variable to keep in mind is that practice owners frequently make management decisions based on quality of patient care as opposed to profitability.
Factors that distinguish EBITDA from profitability are shown below:
|What factor in|
|Owner comp / benefits||✓|
|Family working in practice||✓|
|Other discretionary spending||✓|
Veterinary Practice Valuation Formula
Even though assessing actual EBITDA is vital, there are other numbers, such as net income and SDE, that can be considered in the veterinary practice appraisal.
SDE stands for Seller’s Discretionary Earnings and is calculated by adding EBITDA to the owner’s income and benefits. Net income defines earnings after the deduction of all the expenses; subtract total costs from total revenues. One of the veterinary practice valuation formulas uses valuation multiples, as shown in the example below:
|Multiple||$||Multiple value||Practice value|
|Average Practice Value||$245,200|
The idea is to determine annual net sales, net income, EBITDA and SDE.
Once you have these numbers, you set an appropriate multiple depending on the market. Finally, you calculate the average practice value.
Other Factors Affecting the Sale
Determining the price is not the only factor affecting the sale. While price is one of the most objective negotiation points, there are numerous subjective factors. You and the buyer may not agree on the value, your role in the clinic or other circumstances. The following tips can help you to successfully negotiate with the buyer
- Clean-up your bookkeeping. If your bookkeeping is haphazard and not transparent, invest in having a CPA come in and organize your recordkeeping. There are good off-the-shelf software options that are easy to implement and use. It will make it much easier to compile reports. Decide how you want the buyer to pay you out. For instance, you may choose to roll some of the expenses back to the business
- Decide what you want the partnership to look like. First of all, determine if you wish to stay in the practice or leave. In case you decide to stay, consider what role you want to take on (doctor/administrator) and how much your salary should be, including benefits and profit sharing. (if any).
- Think about how to improve performance. It is also a good idea to consider factors that affect the clinic’s performance as it impacts your profitability and value. For instance, finding ways to manage your staff efficiently and dealing with inventory helps to improve the profit.
What Can You Expect to Make as a Practice Owner?
The average veterinary practice owner earns a little over $280,000 annually, while the average veterinary associate earns $80,000 annually.
At first glance, everybody should strive to be a practice owner since their salary is more than triple the average associate’s. However, there are significant responsibilities practice owners deal with that an associate will never encounter.
Associates make a set salary, so their financial stability is not directly tied to the practice’s overall performance.
Whereas a vet owner has much more business paperwork, risk, and management decisions to make, which is why they are paid so much more.
However, there is a balance where an associate can add value to the owner in a couple of areas:
- They allow the owner to take a vacation as well as hand over some of the responsibilities to the associate so that they have a better work-life balance
- If the associate has a complementary skill set, the owner may be able to offer more services
There are other reasons to hire an associate, but the pay discrepancy also provides an incentive for the associate to save up and eventually buy their own practice.
The Essential Value Drivers for a Veterinary Practice
Various external and internal factors influence the valuation of your practice.
Everything from where your office is located to what type of clientele you serve impacts the ultimate valuation of your business.
We will look at the top five factors that drive the most value for a veterinary practice.
The most valuable veterinary practices are usually small animal practices.
This may seem counterintuitive because large animals require more expensive care, but much more volume passes through small animal care facilities.
For example, large animal practices need a robust clientele of farmers, equestrian customers, and other animal specialists to have enough work.
Whereas most Americans have at least one small animal as a pet, it is easier for small animal practitioners to develop and maintain a strong client base.
Finally, more small animal vets are available to hire associates who are looking to purchase a practice, which makes the market more comfortable to invest in.
Physical assets play a huge role in the overall valuation of a veterinary practice.
For instance, an investor is looking to purchase a practice and narrowed the choice between two potential alternatives — one with state-of-the-art amenities and modern furniture or the other with more dated equipment that would need to be replaced soon.
Given a choice between these two options, the investor would most likely opt for the practice with up-to-date equipment and amenities.
All of the furniture and medical equipment needs to be replaced eventually. When a practice is being evaluated, newer and more modern equipment lowers the risk that the new owners would need to replace many of the assets sooner rather than later.
Where veterinary practices are located has a strong influence on its valuation.
Urban areas with lots of traffic and popular suburban centers are attractive options for investors and vets because they know there will be consistent foot traffic to their practice.
This is contrasted with veterinary practices located in the country and far away from urban centers where the clientele may not be as reliable.
Your reputation as an operator and how you treat your customers play a significant role in how much your company is worth.
Especially in today’s review-centric market, having a positive reputation is very important in securing a favorable valuation.
Finally, the size of your practice carries much weight in how much your business is worth.
A small office with only one vet will not be worth as much as a larger office, potentially with multiple locations with several veterinarians and associates.
The logic behind this stems from if one key member of the organization decided to leave, the business would continue to function since there are multiple doctors to do the job.
Hopefully, this article has demystified some of the more advanced business terminology and valuation practice methods for veterinary practices.
Successful practice owners should be rewarded for the years of hard work and immense efforts required to build their business.
Even if you are not ready to sell your practice, getting into the habit of valuing your practice will keep you abreast of any industry trends and opportunities, and will protect you from any bad deals that may come across your desk.
If you are ready to begin thinking about selling your practice, check out this article, which dives deeper into the topic, and discusses various scenarios where you could sell your business for a healthy profit.
Whether you are ready to sell your practice tomorrow or just want some peace of mind about how much your practice is worth, understanding valuation tactics and terminology keeps you on the straight and narrow path for a successful veterinary practice operation