Last week's Financial Friday blog, "Manage Your Solo Practice So That It Can Be Sold" led to quite a few discussions with veterinarians with remarkably strong opinions and experiences regarding the ability to sell a solo practice for any more than the value of the assets. This is called a Balance Sheet Sale, because you sell the non cash assets that are present on the practice's balance sheet.
A few were adamant because they personally were unable to sell a solo practice. However, most were adamant because someone told them about a friend who couldn't sell a solo practice. It was amazing how unwilling most were to listen to my experience that many solo practices sell with little drama, having value in excess of the assets. That is the result of managing the practice with the objective of creating and sustaining enterprise value.
Last week I laid out three components that must be present in order for a practice to sell.
1. The practice must be profitable enough for the return on equity, owner compensation, net of taxes, to support the debt service on the purchase price.
2. The practice must have a transition plan to assure maximal transfer of clients to the new owner.
3. The practice must have a culture in which the buyer wants to spend a career. (Yes, a solo practitioner practice has a culture!)
I would like to spend a little more time on component #1, the return on equity, net of taxes, must be adequate to service the debt on the practice buy in. Numbers 2 and 3 will be for another day.
As far as the financial performance of a solo practice, an almost universally fatal decision made by owners is to run as many personal expenses through the business as possible to avoid taxes. I don't like paying taxes any more than anyone else but hiding personal expenses in your practice kills the value, sometimes all of the value of a practice.
Assuming your solo practice has a good transition strategy and a good culture, it's value is dependent upon the stream of revenue it has generated for the seller.
Let's look at finance from the point of view of two strategies, the strategy of minimizing taxes versus maximizing enterprise value. Practices often sell for two to four times return on equity (the owners compensation excluding veterinary compensation). Practice buyers often pay 40 to 50% in taxes. For our example, let's say the value is three times return on equity and the tax rate is 45%. If we hide a dollar from the IRS we save 45 cents. However, if we declare the dollar in revenue it costs us 45 cents leaving 55 cents in return on equity which is multiplied by 3 in the valuation. We added $1.65 to the value of the enterprise. I am using this example as a rudimentary calculation to get practice owners to think about which strategy they want to use if they intend to sell their practice. There are many micro-detail questions that can be asked about this scenario which I am happy to address if anyone comments on the blog.
