Dave: Welcome to unsuitable on Rea Radio, the award-winning financial services and business advisory podcast challenging your old school business practices in the traditional business suit culture.
We’ll hear from industry professionals and experts. Our guests will challenge you to think beyond the suit and tie while offering you meaningful, modern, and sometimes controversial solutions to help you enhance your company’s growth. I’m your host, Dave Cain.
Many of our listeners own and manage their own business, which is the primary asset on their balance sheet. Many times that’s the main investment. We have to work really hard to increase the value of that business over time.
A lot of times when a business owner goes to retire, or sell the business, maybe the valuation isn’t where it should be. Today we’re going to explore that concept. Today’s guest is Mary Beth Koester. She’s a famous person on our Rea business valuation team.
Mary Beth is going to talk us about the many reasons why business owners find themselves in need of a business valuation and why it’s important to be proactive rather than reactive. Mary Beth, welcome to unsuitable.
Mary Beth: Thank you, Dave.
Dave: Before we start talking about business valuation, we want to talk a little bit about your professional qualifications. Obviously, you’re a certified business appraiser, valuation. You’re certainly famous in the field of business valuations, not only in Rea & Associates, but within the community. I also understand you’re a marathon runner.
Mary Beth: I am.
Dave: You have a degree in accounting …
Mary Beth: I do.
Dave: … international business with a minor in French.
Mary Beth: Oui.
Dave: Can you say something a little bit more in depth than just oui?
Mary Beth: J’aime beaucoup parler avec you.
Dave: Could you translate that for our audience?
Mary Beth: I really enjoy speaking with you.
Dave: Thank you, I do too.
Mary Beth: You’re welcome.
Dave: I also learned recently that you’re a karaoke singer.
Mary Beth: Once in a blue moon.
Dave: What would your favorite maybe 1 or 2 tunes that you would jump up and sing?
Mary Beth: Oh gosh. You’re putting me on the spot here, Dave. Anything country really is my jam. Anything Luke Bryan, Blake Shelton gets me going.
Dave: All right. Let’s dig into the business valuation. Your specialty is valuation of professional practices. As I read the intro and your bio, I found that rather odd. I think the long standing industry standard has been 1 times revenue. Let’s start there. What are professional practices and am I way off base on the 1%, or percentage of sales as a selling point?
Mary Beth: Yes. The professional practices that we’re valuing, or that we’re focusing on growing in our business valuation group are veterinary practices, dental practices. Those are the main 2 and then other professional practices. My experience prior to joining Rea was working exclusively with veterinarians.
In my time working with veterinarians, a lot of them have this misconceived notion that they look at their most recent year’s gross revenue. Exactly as you said, 1 times gross, that’s what my practice is worth. It’s just not true today.
Part of our goal is to dispel that myth and help them realize that there is a lot of other things that factor into the value of their practice, or the value of any business for that matter.
Dave: In your vast experience in valuations, obviously you’ve done all different levels. Professional practices just seem to be on the rise, the valuation of these type of practices. You see that as a trend, an increasing trend?
Mary Beth: I do for several reasons. One, a lot of veterinarians, in particular, they work really, really hard in their practice, but they fail to work hard on their practice. A practice valuation isn’t meant just for when they’re ready to sell, or when they’re ready for retirement. It’s also a really great business planning tool.
I think more veterinarians are starting to realize that they need that tool in order to better manage their practice. Another factor that’s contributing to the growth of professional practice valuations is the age of the baby boomers. A lot of those folks are the ones that own these practices and now they’re hitting retirement age. They’re planning for their retirement. They’re ready to have an associate buy in.
Dave: Do you run into …. I’ll just use an example. Let’s say we’re having discussions about engaging you to perform a valuation of my professional practice. I think that practice is worth $1 million. You come back with a number that’s far less. Does that happen? Is that a frequent …?
Mary Beth: Of course that does. That happens, because for a lot of business owners, whether they’re a veterinarian, or any other type of business owner. Their business is their baby. They’ve put their blood and their sweat into it. Everyone thinks their baby is the cutest baby, or the most precious baby. Everyone thinks their business is the most valuable business.
I’ve been in situations where we’ve finished the valuation and given it to the client and had that discussion. They’re not only shocked that the value is what it is, but they don’t understand. They think exactly what you said, “My practice is worth a million dollars.”
One thing I’ll say to them is, “Your practice is actually worth whatever a willing buyer’s going to pay for it.” Our valuation might have come in at $500,000. If you can find somebody that wants to pay a million dollars for your practice, then you’re right. That’s what it’s worth. That typically doesn’t happen.
Dave: You just delivered the valuation. Now what the heck am I going to do with it? Am I going to use that to try to sell my practice, or will you help me increase the value that you just gave to me in the valuation?
Mary Beth: We’ll always help educate the client owner, but it depends on the reason why you’re having the valuation done in the first place. There’s lots of different reasons for getting your practice valued. Sometimes you’re going to have it valued because you’re using it as a business planning tool.
In that situation, the valuation is our health assessment, if you will, of how well the practice is doing. Then we use it to have the discussion with the owner of, “Here are the things that you need to be doing right now, working on these specific opportunities in your practice to grow the value.” That way, 3 years, 5 years, 10 years down the road when they are ready to sell, the value is where they need it to be.
Sometimes we do a valuation for buy/sell agreements. They have a partner. It’s 2, 3 doctor practice and they need to either update the buy/sell agreement, or they don’t have a buy/sell agreement. You need a valuation for that. In that situation, we can certainly walk them through an outline of items to consider for a buy/sell agreement.
Other times, they’re ready to retire. They’re either selling their practice outright to someone else, or they’re having an associate buy in. Then we walk them through other items that they need to consider as they’re going through that transition process.
I’ll give you 1 example. Often times an associate that’s buying into a practice, they’re coming out of school with a lot debt. A lot of them don’t have a whole bunch of capital for a down payment. They’re anxious. They don’t know a lot about the business side of running a practice. They’re worried about how they’re going to make their loan payments.
One job as a valuator is to help explain to the buyer how they’re going to pay the loan over the life of the loan, over the term, how they’re going to make those loan payments. Also, teach them how their equity’s going to grow in the practice over the life of the loan and then beyond.
Dave: Maybe an example, a question. Let’s say the cash flow in my business has had its challenges the last 2 years. It’s negatively impacted. Would that negatively impact the business valuation?
Mary Beth: Cash flow is not what we rely on for the business valuation. We’re looking at lots of different factors, 1 of which is the earnings. That’s the normal operating earnings of the practice after you take out non-recurring unusual expenses, after you take out taxes and depreciation. We’re looking at the earning stream that the practice generates for the owner as an investor of the practice.
It has nothing to do with cash flow. However, I will say that cash flow, understanding what it is and what the cash flow of the practice is extremely important. Cash is king. You need the cash flow in your practice to continue operations normally.
Dave: I pay my country club dues through the practice. I drive a really decked out black Mercedes, paid for by my practice. Is that negatively impacting the EBITDA and the valuation of the business. Should I tell you about those during the interview process?
Mary Beth: Again, I wouldn’t say that it negatively impacts a valuation. We look at expenses such as those. What we do is we normalize the earnings, or we adjust them out. We realize and you realize that those are not normal expenses that another business owner might incur in order to run the operations, run the practice, run the business.
Yes, for valuation purposes, we take things like your country club dues, your family vacations, your cell phone bill that might be for the whole family, your own car that’s not used for actually doing house calls to a patient, or to a client. We would adjust those out and normalize the earnings.
Dave: I’m the buyer. I’m going to sell. I’m looking at a buyer. Obviously, the buyer has to borrow money to buy the practice, or redeem the stock, or however that transaction is developed. Will you help the business owner with that process; helping the prospective buyer with cash flow to pay for the business?
Mary Beth: Short of me actually giving a loan out to the buyer, yes. We will help them. Part of what we do, again, is just educating, educating the client, the seller, educating the buyer what are their options. Helping them to explore what options they have for different loans if that’s the route they’re going to take.
Often times they don’t know where to turn. Us, as valuators, we’re also business advisors. It’s our job to help them. Whether that’s referring them to someone outside of our firm that can assist them with the loan process and getting the financing that they need. Also, explaining to the seller the options for having this transaction go through.
We’ve worked with veterinarians who actually go on the note themselves. They make the loan, if you will, to the associate in the practice. Basically, the associate maybe they’re buying in 25%. In a few years, they’re going to be buying another 25%.
We’ve seen it where the owner will actually be the bank for the buyer and structure, basically, a note that way to make it more affordable for the buyer to buy in.
Dave: We think and I use that word lightly, we think the financial recession is over and most businesses have recovered. Does that lingering recession, is that still having a negative impact on the valuation of my business?
Mary Beth: Again, that really depends, Dave. It depends on what kind of business you are, if you were hit by the recession. It depends on where your business is located. There’s a lot of factors at play there.
Some of the practices that I valued in the last couple of years never really recovered from the recession because of the area that their practice was located in. Others, it was like the recession didn’t even happen. They just kept drumming along, doing just fine. Again, I think it just depends on what kind of business and your demographics.
Dave: I have a financial statement prepared every year, a tax return prepared every year. I meet with my business advisor, my investment advisor every year. Should I have a business valuation each and every year?
Mary Beth: You certainly could. I personally don’t think a business valuation is necessary for every year unless there is a transaction that is happening. You do valuations if you’re gifting, for estate planning, for buy ins and buy outs, as we discussed before.
My recommendation is if you’re using it as a business planning tool, every 3 years have a valuation done. How can you plan for the future? How can you make decisions as an owner, about how you are going to run your company, or your practice going forward if you don’t know where you stand today?
Dave: Tell us, as you go through that, that brings to mind another question. Tell us a little bit about the attributes a business should have, or make available to you to make the business ready to sell. What are the attributes? What are the things, the must haves that you have to see to do a valuation?
Mary Beth: What are the reasons that a business would have …
Dave: What are the attributes?
Mary Beth: … for having a valuation done. One piece of advice that we always tell business owners, if they’re thinking that they’re going to be getting a valuation done, clean up your books. It makes it so much easier for the valuator when we’re looking through the financials and trying to get to that normalized earning stream.
A buyer wants to see clean books, clean financials. If they’re currently running a lot of other personal expenses, other additional business expenses through the books of the practice, clean it up. Remove them. You want at least a steady 3 to 5 years of really clean financials.
Dave: You’re going to ask me to stop paying my country club dues through the practice.
Mary Beth: Yes, I am.
Dave: You are.
Mary Beth: I am.
Dave: Maybe I’m going to hire someone else that’ll allow that.
Mary Beth: I’m sorry to hear that.
Dave: No, no. I understand that.
Mary Beth: They might tell you the same thing, though.
Dave: I understand that completely. That’s an interesting concept. I think a lot of business owners do have the perks running through the business that, to your point, may not be used by the next buyer of that.
Tell us a little bit about the special service offering you had. You talked about a little bit earlier where we do a valuation. You do a valuation, then you go in and you try to help the business owner increase the value. I believe the offering that you refer to is the know and grow concept. Can you share that with me about what that all entails?
Mary Beth: Yes. The know and grow business concept valuation is we start the process with the valuation. Again, that gives us the baseline, the starting point of, “Here’s where your practice, or your company is today.” Through the valuation process, again, I like to use this term. It’s almost like doing a health assessment of the business.
When we look at the financials, we’re looking at the health of your business. We’re looking at all different kinds of financial ratios and trends to see not only what has happened historically, but what the trends are going forward for the business.
Once we have the valuation, then what we can do is we can go into the business, speak with the owner. We identify specific areas of opportunities that we see for growing the value of their practice, or their business.
What we’ll do is we have a discussion with the owner. We give them very specific suggestions, or ways to increase the value whether that’s tightening up their expenses in certain areas, whether there is a particular service offering, or product line that they could increase, or grow to, again, enhance the total profits that they’re seeing. In that way, they’re able to grow the value of their business over time.
Dave: When you were doing a valuation, do you listen to music?
Mary Beth: I do not.
Dave: Never?
Mary Beth: Hardly ever.
Dave: Hardly ever. That means occasionally you do.
Mary Beth: I tried to listen to music when I first started doing valuation work. It just didn’t work.
Dave: What were you listening to? You were listening to the wrong stuff.
Mary Beth: I was listening to music that made me want to get up and dance; then I had to get refocused. I tend to not listen to any music when I work unless it’s at home; then music’s on all the time.
Dave: Then you listen to music at home.
Mary Beth: Yes.
Dave: We promised to our audience a teaser that there was a tremendous business planning opportunity on the horizon. I think we just have a few minutes left. Let’s talk about that. What’s going on in the marketplace on the political front, the tax law changes that I think is going to be a tremendous opportunity for our listeners?
Mary Beth: Yes, right now, currently, the IRS has some proposed regulations that are in their commenting period. They’re in a 90 day commenting period. After that, if they go into effect, it would be another 30 day transition period. What we’re looking at is the possibility of new regulations going into effect by the end of December 2016. It would have a huge impact on estate planning and gifting.
What they are proposing to do is eliminating the discounts that we use for valuation purposes for estate and gifting. Essentially, that discount that would be removed would eliminate the lifetime threshold amount that people could gift to their children and avoid taxes, the estate and gifting tax.
Dave: That’s a huge change in the upcoming perceived law. It has to go through the comment period. That’s an opportunity to beat the threshold if that’s going to happen. We caution our listeners to look at that tremendous opportunity going forward if we can do that.
Mary Beth: Yes, I think if you’re in the midst of your estate planning and you are considering gifting, get it done now. Don’t wait until the potential laws go into effect. Again, it’s going to have a huge, huge impact on the taxes.
Dave: Sounds like you’re going to work a lot of hours in the next couple months.
Mary Beth: We’ve already started.
Dave: You’ve already going.
Mary Beth: Yes, they’re already coming in.
Dave: Put some music on and work and relax and get after it.
Mary Beth: I might have to. I don’t know.
Dave: Before we wrap up, we’d like to ask a fun question to get to know a little bit more about what’s inside your mind. Are you ready for your question?
Mary Beth: As ready as I can be.
Dave: You’ll get this one. We worked awfully hard on your question. We want you to know that. Let’s assume you could be president for a day and Congress gave you the authority to make any rule change, any law change, adopt any policy you wanted to do. What would your day consist of? What would you do?
Mary Beth: I’ll tell you what. I typically avoid talking politics with people. I just feel like it gets you in trouble. If I was president for a day and I could anything, I would eliminate the candidates that we currently have running for the presidential election and say, “We got to go back to the drawing board, people. Starting from scratch.”
Dave: That’s an interesting answer. We appreciate that. You’re not the first person who said that and you won’t be the last. Mary Beth, thanks again for joining us on unsuitable on Rea Radio. You’ve been a pleasure. You brought some great information on not only your famous capabilities in the business valuation of professional services. You have a lot of good ideas.
I want to make sure our listeners know that and maybe go to our web site at Rea & Associates. That’s spelled R-E-A. They can find information regarding business valuations and the know and grow concept.
We invite our listeners to subscribe to unsuitable on iTunes and SoundCloud. While you’re there, if you just favor, rate the show, leave a review. Tell us what’s going on. Tell us what you want to hear. We’ll see if we can get that on to one of the next unsuitable episodes. Until next time, I’m Dave Cain encouraging you to loosen up your tie and think outside the box.