Dave Cain: Welcome to unsuitable on Rea Radio, the award-winning financial services and business advisory podcast that challenges your old-school business practices and the traditional business-suit culture. Our guests are industry professionals and experts who will challenge you to think beyond the suit and tie while offering you meaningful, modern solutions to help you enhance your company’s growth. I’m your host, Dave Cain.
Every business is different, and those differences are a big deal when it comes time to determining the value of a business. For that reason, the one-size-fits-all approach to business valuation will never ever work. A few weeks ago, we talked to Tim McDaniel, and we talked about methods designed to help business owners grow the value of your business. Today we’re going to talk about how evaluation can be used to maximize your ownership experience from day one, especially if you own a veterinary or a dental practice.
Today’s guest it Mary Beth Koester, a manager on Rea’s business valuations team. Mary Beth has worked with a large number of vet and dental practice owners over the course of her career. She’s going to share her professional insight with us today on unsuitable. Welcome back to unsuitable, Mary Beth.
Mary Beth Koester: Thank you, Dave. I’m glad to be back.
Dave: Good. Last time you were with us, it was pre-election, and now we’re into 100 days of post-election. Anything fallen out of, in your industry, of the impact of the election on the valuation of business?
Mary Beth: So far, no. When I was on unsuitable last time, there was the issue of the 2704 regs, and we weren’t really sure what was going to happen with that. Since Trump has come in to his presidential election, that has fallen to the wayside. I don’t think anything’s happening right now in terms of those regulations being passed and any impact on valuations at this point.
Dave: What you’re hearing is the attitude of business owners about the value of their business still remains pretty strong?
Mary Beth: Correct.
Dave: Good, good. Today we’re going to talk about a very … You have a very, very specific specialty about valuations of professional practices, specifically veterinary and dental practices. How did you ever arrive at those two specialties? Very, very unique in the marketplace. You might be one of the very few in all of Ohio and this area, the Midwest, that does that.
Mary Beth: That’s true. I think there’s very small handful of consultants and advisors that specialize in that niche. I started in it over five years ago. It was just something that came about. I started being trained in valuations, and it was specific to the veterinary profession, so I began there. I fell in love with it. I love working with veterinary owners. They’re a very unique particular breed of people, but they’re wonderful. It’s just been a lot of fun for me to do that work, so I’ve continued down that path of professional practice valuation and consulting.
Dave: Great. Fantastic. What I want to do today is talk about some of the benefits to owning or operating your own practice. The first thing we want to start with is maybe greater earning power, and that’s a note that you gave me in the production notes. Let’s talk about what that means in your eyes as you look at a practice, greater earning power.
Mary Beth: Sure. Well, I’d like to start off first, too, and just make a note that everyone’s different, and each individual will have different benefits that they’ll see in terms of practice ownership versus non-ownership. For some of those individuals, those might be quantitative advantages. For others, it might be qualitative advantages. A key one that a lot of people come back to is your earning power.
As an associate in a veterinary practice or a dental practice, my earning power is somewhat limited. What I mean by that, Dave, is I basically have one stream of earnings and that’s my doctor production, or my doctor salary. What do I produce as a veterinarian, as a dentist? When I look at becoming an owner, that expands the earning power that I have over the course of my career, so now it’s not only my salary that I earn as a veterinarian and doctor-producing person, but there’s several other buckets.
One of those is going to be your management fee. That’s the compensation that an owner earns for all of the responsibilities that he or she takes on managing the practice as a business. There’s a lot of decisions that have to be made at an owner level and, for that time and effort, they deserve compensation for that. Typically, we see somewhere around 3% of gross, so that’s one bucket of earnings.
The second bucket is, again, going to be your doctor production. Now for some doctors, that might be a fixed salary. For others, it might be production-based, let’s say, for example, 20% of the total revenue generated. Then for others, it might be a combination of the two, so you’ll have that earning power.
Then the third one is your return on investment. As an owner, as an investor, I get a percentage of those earnings that are left over or generated by the business once all the other expenses are paid.
Then the fourth one that is available to some owners is the rental income. Now if the real estate is owned by the practice in a separate business, in a separate entity typically set up as an LLC, and that associate who’s buying in as an owner has the opportunity to also buy into the real estate, then he or she will be able to earn a percentage of that rental income that the practice pays to the LLC, to the building.
Dave: There’s a lot of education for the associate who is looking to buy, and you start with the earning power. I suspect that the marketplace isn’t aware of all those benefits of the earning power of being an owner.
Mary Beth: I think a lot of associates maybe aren’t aware of it. They’re coming out of school. They’re just getting started. They’re still learning the ropes of being an associate and working in the practice. Once you start to explain to them or have that conversation of, “Look, here are the possibilities. Here’s the opportunity to really grow your earnings and do more with that …” Maybe that’s creating a nest egg and preparing for retirement early, early on. Maybe that’s paying down a heavy burden of student loans that they came out of school with. For some of them, that might be the opportunity to purchase their first home well before they were expecting to be able to do that. I mean, the list goes on and on.
Dave: Another benefit in our notes is the authority to mold your practice using your values, desires, areas of medical expertise, your core values. Can you talk us through that?
Mary Beth: There’s a lot of similarities between veterinary practices and dental practices, but then there’s a lot of unique factors of each practice. I think it really comes from the tone that’s set by the owner. When you become a practice owner, you have a voice, and you have the authority to kind of direct where that practice goes. That might be in terms of what kind of medical protocol and standards of care that you really emphasize and set in your practice, making sure that all of the other doctors in your practice adhere to that high level of medicine and that that’s being practiced across the entire practice. That might mean focusing on specific areas of services or procedures that you want to offer in your practice that maybe other practices aren’t doing, setting up and determining the kind of continuing education that not only you, but the other doctors and staff get in your practice. Again, using your authority to kind of drive or steer the car, if you will, and say, “Here’s where we are right now, and here’s where I’d like to head. Here’s the direction I want to go in.”
Dave: It may be you want to expand to another market. That would be up to you.
Mary Beth: Maybe you want to expand. Maybe you’re currently just a small animal practice and you want to become a mixed animal practice. You might live in an area where it is rural and there’s an opportunity to tap into that large-animal side. On the dental side, maybe you want to expand into [Pedo 00:08:24] and start offering that service and not just be a general dental practice, so yeah, having the power and the authority to explore those areas for expansion.
Dave: You briefly touched on the technology side of it. Also, as technology continues to grow on both of those practices, it also gives you the opportunity to reach out and invest in some really cool medical stuff, new technology.
Mary Beth: It sure does, and so that’s always a conversation I urge an associate to have with the current practice owner before the buy-in process starts. You want to understand what each person’s mentality is on investment, on reinvestment in the practice. Some people are very debt-averse and would be perfectly happy chugging along for 10, 15, 20 years using the same old equipment that they’ve had because it’s not broke, and they don’t want to reinvest. Then other people, every time they go to a conference or a trade show and they see the new latest-and-greatest piece of technology or equipment, they want to go out and buy it. Having that conversation and getting on the same page in terms of how we deal with the spending and how we want to reinvest is important.
Dave: Yeah. As we talk about an associate buying a practice, what’s the market out there for financing? What do you hear? What do you see?
Mary Beth: There are several options for financing. I’ve seen it done many different ways, Dave. Again, it depends on the situation. Is an associate coming in and buying out the owner 100%? Is it a 100% sale? Is it a minority buy in? Are we just talking about 10, 15, 20%? Sometimes with a minority buy-in, what we’ll see is the seller will finance the note. Maybe the buyer, the associate, is struggling to obtain financing. It might be easier to have the owner, the current owner, finance the note for them, so sometimes that’s done. There’s lots of lenders out there. I could rattle off five or six, but there’s lots of lenders out there who offer really great financing opportunities for buyers.
Dave: The market’s right?
Mary Beth: Yes.
Dave: The market’s right.
Mary Beth: Yes.
Dave: The other part I want to dive into is the flexibility to … As a business owner, you get the flexibility to balance your personal and professional life while building a retirement nest egg as an owner. As an associate, you don’t get to do that as much but, as an owner, that’s one of the side benefits I don’t think we talked that much about.
Mary Beth: Well, I think those are some great benefits. With lots of risk comes lots of reward, so I’m not going to paint this really glossy, beautiful picture and say, “Hey, practice ownership is just wonderful and, you know, all sunshine.” No. There’s going to be some difficulties. There’s going to be a lot of responsibility, probably a lot of time invested getting the practice to where you need it to be that you don’t have to burden that as an associate necessarily. Then with all that risk comes a lot of reward. Let’s say down the road you want to start scaling back. Priorities change, right? Life happens day in and day out and our priorities evolve and things change. Maybe you get to a point in your life where you still want to own the practice but you’d like to scale back hours and maybe bring on another associate to start taking over some of that case load. You can do that.
Dave: Play golf every Thursday afternoon?
Mary Beth: Play golf every Thursday, go down to Florida in January and February. I don’t know.
Dave: Are you a golfer?
Mary Beth: Didn’t you see me at Top Golf last week?
Dave: I did. I did.
Mary Beth: I was swinging for the sticks. I mean, I was just launching-
Dave: Swinging for the fence.
Mary Beth: Yeah, swinging for the fence.
Dave: Go for it. Like you said, you can set your own schedule as a business owner.
Mary Beth: Right. Right.
Dave: Sometimes that’s a double-edged sword as associates look at that and say, “Why isn’t that individual here?” But now you’re the owner, you can do that.
Mary Beth: Sure. Being an owner, hopefully, the idea is you’re … As an owner, you’re more invested, right? You have more skin in the game. You’re doing everything you can to continue to grow this practice, build it up, and as that practice is growing, so is your equity. Just like a home, the longer you own it, it’s appreciating in value, you hope. The longer you own this business, it’s appreciating in value. You’ve built up all this equity that, hopefully, you have really smart advisors working with you and guiding you on how to best invest that money. You’ve got time on your side depending on how long you’re an owner, and so that whole time that you’re working, now you’re creating this really nice nest egg that eventually you’ll have when you’re ready to retire.
Dave: You can begin to develop, I would assume, a transition plan, “Hey, I want to practice til I’m 55, 58, 62.” That’s now in your hands.
Mary Beth: Absolutely. I always tell business owners, “You can never be too young to start your transition plan, your succession plan. Actually, the day you start talking about practice ownership should be the same day you start talking about your transition plan. You should already have an idea in mind of how you’re going to get out before you get in.” Of course, that might change over time, but at least having that picture in mind.
Dave: How do you get my mind working in that direction? I’m pumped up. I just bought a practice. I’m ready to go. They increased my earning power, and flexible schedule. You also want me to think about retirement, and I’m age 30?
Mary Beth: Yes, yes. If you’re an associate at a practice, I would encourage you to talk to the practice owner about a mentorship plan. That typically begins anywhere from two to three years before practice ownership. There’s so many topics to cover, so many things that you need to consider before you jump into practice ownership. I’m not trying to scare anyone away from it. I think it’s a very exciting opportunity if you have it, but it’s an emotional roller coaster thinking about all the exciting opportunities, and changes, and what’s going to happen once you become an owner. There’s lots of things that go into running a practice or a business that you need to consider first.
Dave: Sure. You mentioned risk. I mean, obviously, there’s a very positive spin on ownership, but there are some risks, and you mentioned that. Can you share maybe a risk that you’ve run into that is kind of a bummer?
Mary Beth: Sure. Well, one risk that comes to the top of mind, Dave, is having a buy-sell agreement or a lack thereof, not having a buy-sell agreement. In the beginning, when someone enters into partnership or ownership with another partner, usually everything is wonderful and rosy and we’re getting along. What I’ve seen a lot of times is, at some point, there comes a fork in a road and the two partners butt heads and they start to collide with each other. One of them wants out and we don’t have a good buy-sell agreement in place, or we do, but it was written years and years and years ago. We never went back and updated it, and now we’re in this terrible situation. What do we do? It’s really critical and important that not only do you have an advisor on your side that’s preparing a practice valuation and guiding you through this whole process, but that you have a good attorney to draft the buy-sell agreement and make sure it’s covering all your bases.
Dave: Good, good. Good point. We’ve talked about the benefits of owning-operating your own vet or dental practice and obviously some greater earning power, the authority to mold the practice to your abilities, and the flexibility to … work-life balance flexibility. Those are fantastic goals, but let’s talk about buying, the valuation. This is a professional practice. I’m going to the old standby read in a book, one times fee, that’s what I’m going to pay. Am I still on point or … ?
Mary Beth: The one times gross, look at my most recent year’s gross revenue and multiply that times one and that’s what my practice is worth, that’s what a lot of people think. Often times, very rarely is that true. Some other things that I’ve heard is, “Well, we’ve heard that … Here’s a common multiple. Here’s a common cap rate multiple,” and whatever that might be, a four, four-and-a-half, a five, “and I’m just gonna take my net income, or my earnings, or my EBITA, and I’m gonna multiply it times that multiple, and that’s gonna get me to what my practice value is worth.” But that’s not the case because not everybody has a professional valuator doing the valuation. There’s lots of things that we might have to adjust for to really get to the free cash flow of the practice.
For example, I mentioned rent. Often times, a practice owner might own the real estate themselves. Now some may or may not have it set up in a separate entity or a separate business, so they may or may not be charging the practice fair market rent. Now if I’m an associate buying in, or better yet, if I’m an associate and I’m buying a practice outright from the current owner and that owner’s going to walk away and retain ownership of the real estate, they’re going to expect me to pay them rent, right? That’s one of their income streams into retirement is that rental income. Well, if that rent wasn’t previously being paid, then the earning stream that I’m looking at, or the cash flow, isn’t actually reflective of what it will be when I’m the owner. There’s things like that you have to consider. Doctor compensation’s another common adjustment we have to make.
Dave: The percentage of gross fee, that’s a fallacy?
Mary Beth: It is. If it wasn’t a fallacy, a lot of us would be out of a job if it was that easy just to take one little ratio and multiply it times our gross revenue.
Dave: We ought to look for practices that are percentage of gross and invest in those because it’s probably a good buy.
Mary Beth: Let’s do it.
Dave: Let’s go. Let me give you an example and maybe respond to that. Let’s say then I own a vet practice, age 60, looking to get out of the practice, retire around 65, 67. Should I have a valuation of the practice right now and begin to get my arms around what that value is?
Mary Beth: Absolutely. You cannot wait until the day you’re ready to sell or walk out the door to get your practice valued, and you cannot wait a year before then to get it valued. Often, people do, and the mistake in that, Dave, is that leave me no time. If I’m the business owner or the practice owner, that leaves me hardly any time to prepare, make adjustments, step back, restructure my retirement plan, because if that practice isn’t worth what I was planning on it being worth or it’s not where I thought it would be at and I need … For most practice owners, the practice is their largest investment, their largest asset that’s going to fund the retirement, and so if it’s not worth what I think it’s worth, that’s a huge issue. If I’m waiting until the day I’m ready to sell or just a year before, I’m kind of out of luck.
Now if I start the process seven years before, and I get the practice value today, one of two things happens. One, I find out, “Oh, my gosh. It’s worth half of what I thought. What’s going on here? What am I doing wrong in the practice? Where are my leaks?” And my practice valuator will hopefully be able to point those out to me, explain where my areas of opportunities are, and help identify a plan to get me to that point that I need it to be, and I’ll have the time to do that, to make those implementations and make that happen. The other thing that might happen is I find out my practice is worth twice what I was expecting it to be, and then I’m going to retire tomorrow. You could push up retirement.
Dave: There you go. There you go. From the other side, the risk side of it, let’s say an illness sets in, whether with the business owner or a family member, and I have to change my transition plan. Now I’m under the gun about getting evaluation, so I guess start early and look at it … How often would you update that valuation?
Mary Beth: Right. In situations like that, the unexpected, what we call life, that brings about a whole load of stress on its own. Do you really want the added stress, then, in a situation like that of, “Now I have no idea what my practice is worth and I have to get it valued, and whatever it’s worth, I mean, that’s what I need to sell it at.” Again, it’s all about preparation.
Dave: It could even be if there’s two or multiple owners, a dispute among the owners. That valuation, if you start early, it’s a great document.
Mary Beth: It’s a great document, and it’s just a really great internal management planning tool. Again, how do we create a path or a way of getting to point B if we don’t know where we’re starting at point A. I always say that evaluation is our starting point. That’s point A. Once we have that baseline, now we’ve got something substantial to work from and create a plan to continue to grow the value of the practice.
Dave: Right, right. Well, thanks again for joining us on unsuitable, Mary Beth. Our guest today has been Mary Beth Koester from Rea & Associates’ valuation team with a specialty in professional practices, vet clinics and doctor offices specifically. We’ve got some really great articles and insight on our web page about this topic. Check them out at https://www.reacpa.com/podcast. We’ve also added episodes of unsuitable on YouTube. Check out the Rea & Associates page to view episodes, and don’t forget to subscribe. You can also subscribe to unsuitable on iTunes. Until next time, I’m Dave Cain, encouraging you to loosen up your tie and think outside the box.