Is your practice low value? Take steps now to protect your retirement nest egg.
When was the last time you checked the profitability of your practice? Even if it seems like retirement is a long way off, experts say that keeping tabs on the value of your business will pay off in the long run.
“It’s important to know what your practice is worth and to pay attention to that on a regular basis,” advises Denise Tumblin, a CPA with WTA Veterinary Consultants. “Even if you’re not ready to sell your practice, do an estimate every three to four years.”
Tumblin and CPA Glenn Hanner of Whitley Penn advise veterinarians on practice valuation and how to avoid a No-Lo practice—one that has no or low profit and therefore a low valuation to prospective buyers. Have your financial house in order before even considering a practice sale, they suggest. Some key points to consider:
1. Use the income approach to valuation. Of the three ways to value a practice—market approach, asset approach and income approach—opt for the income approach. (See graphic.) This formula has two components of value: cash flow/earnings and risk. Says Tumblin: “An investor will look at “How risky is this business? What’s the likelihood that I can duplicate this same cash flow and earnings and continue to do it?”
2. Clean up your books. Sometimes small-business owners make decisions such as writing off a personal vehicle to lower their tax liability, but those shortcuts won’t fly when your practice accounting is being scrutinized. “Bite the bullet and pay the additional tax so you have clean books for three to five years before you sell your practice—so the books really reflect the earnings that are there,” advises Tumblin.
3. Cash flow does matter. The tax strategy of reporting the lowest earnings possible is the opposite of what you want to do for practice valuation, Tumblin explains. The lower the cash flow, the lower the value. “Every dollar of earnings/cash flow equals between $3 and $6 of practice value,” she says. And don’t expect your buyer to pay for potential. “If you want higher value, work now to improve your cash flow,” she advises.
4. Know real estate’s effect on value. Real estate plays a big role in your practice value equation. Consider this example: two practices, each with $1.5 million in gross revenue, have different real estate values ($600,000 vs. $1.5 million). The practice located on the higher-valued real estate may be paying higher rent. That, in turn, lowers the practice value. “In some states rent is taxed,” says Hanner. “Practice value is going to suffer in that equation.”
5. Do the math. Is your practice a No-Lo practice? Download a “No-Lo Practice Threat Advisory Worksheet” from the VetPartners Valuation Council and plug in the numbers. The Excel worksheet will calculate your practice profitability. Estimated profitability of less than eight percent is a “severe threat.” Says Tumblin: “This gives you an idea of what your practice looks like. Are you in danger of being a No-Lo practice, or do you have very strong profitability?”
Elements of Risk
When valuators look at practice value, they look at more than just the books. Among the elements they consider, says CPA Denise Tumblin:
Revenue growth: Investors look for steady upward growth every year in the three to five years being valued. That means there’s less risk.
Volatility of earnings. Volatility up and down adds risk.
Non-compete agreements: Are they in place if your state recognizes non-compete agreements? That’s a way of protecting the practice.
Effective management systems: Are they in place, or is the practice reliant on the presence of the owner?
Boutique practice: Is the practice completely tied to the owner’s personality or services such as avian and exotic work? That would increase risk.