Let’s start by calling it out. Business ownership is HARD. Sadly, there are many who start veterinary practices with little understanding of how to run an efficient and effective business. The owner was an associate veterinarian working countless hours and wanted control. They wanted the control to treat as many patients as they wanted, come and go as they pleased, and the opportunity to earn more income. As time unfolded for the majority, the owner found themselves having less and less control. The goal for most is to work an entire career and then monetize the veterinary practice into cash that can be used for retirement income. By the time that an owner reaches this phase of life, the planning was done in a silo, ad hoc, and the options to make things better limited without more time. Since many have the desire to sell to an employee or multiple employees, there are crucial steps that must be taken way in advance of selling the practice, so that the event is a win-win for both the seller and the employee who ends up purchasing the practice.
Understand what your practice is worth every step of the way.
This is a tricky one for most. With corporate consolidators coming in with investor money, the expectations for practice values when selling to a consolidator can be substantially higher than selling to another employee or interested person. There are many ways to interpret value, and the most common is what is perceived to be the value. Think about how yard sales work. Someone could be selling a coffee mug they purchased for twenty dollars. That was the perceived value when the mug was purchased. Now that the mug is considered used, other people will not see the same value. The mug today might be worth two or three dollars. When dealing with tangible items there can be a huge discrepancy on price.
Now let’s talk about a veterinary practice. In the past, most practices were valued based on the method of one times revenue. A practice that did $2 million in revenues would be worth an estimated $2 million. As time has changed, and the environment gets increasingly competitive, the focus shifted from revenues to profits. There is a term used very loosely within the buying world called EBITDA. This means Earnings Before Interest, Taxes, Depreciation, and Amortization. Yes, it’s a lot to say! What you take as income as an owner in comparison to what the practice is worth are two different things. To get to the true value that most people will reference you must “add back” these particular items.
Corporate buyers and employees will view the valuation of the business similarly, but there will be a huge swing in price. Since corporate buys have investor money, they see the vision of the practice based on numbers on a piece of paper. The buying company is expecting the practice to increase over time to justify the insane high value that is provided to the seller. You might often find values of veterinary practices by corporate buying groups to range between seven to twenty times EBITDA. When selling to an employee, the challenge is the buyer has little cash and they might expect the practice to be purchased through future cash flows (aka profits) from the veterinary practice. Since the buyer is depending on the future cash flows, there are few options available for selling. This can vary from seller’s notes and funds from a bank.
The above is a great rule of thumb to follow. When you are looking to bring on partners or sell to someone it is suggested to get a formal valuation completed. A basic valuation can be provided by many different professionals using software. More elaborate valuations that can be used to challenge any hurdles the IRS might have when selling are down by professionals such as a CVA or CBA.
How much of your retirement income is dependent on the veterinary practice?
The previous generation of veterinarians from the 1960s and onward depended heavily on the sale of their veterinary practice for retirement income. The landscape has shifted dramatically where the amount of guaranteed income sources are limited such as Social Security due to the aging population in the United States. When planning for retirement, the best approach is to find a balance that makes your veterinary practice a sliver of the pie, not the majority.
For us to increase our clarity on what retirement looks like, we should take an inventory of what we have and what we are expected to have over time. When the veterinary practice is sold in the future, there will be some assigned value depending on who buys the practice. After the practice is sold, it is vital to take into consideration that there will be taxes due, likely in the form of capital gains. Based on the current tax environment, this can be upwards of twenty percent.
Now we should consider the other assets. These categories are broken down into taxable, tax free, and tax deferred assets. There are benefits to each one of them now, and when accessing them for retirement income. Many will focus their efforts on building up tax deferred assets such as SIMPLE IRAs and 401(k)s. Assets that are taxable are business ownership, real estate, and investments outside retirement accounts. The last group of assets are tax free which can be Roth contributions to IRAs and 401(k)s, specific government bonds, and permanent life insurance. Each one will play a role in how taxes can be balanced in the future, what amount of income can be expected, and how dependent your plan is going to be on the sale of the business. When building up assets focus on making each bucket one third of your entire plan by creating a systematic plan to pull money from the veterinary practice ongoing each month and each quarter by doing “dead cash” sweeps.
Are you looking to sell part or ALL of the veterinary practice?
Corporate sales will often result in a one hundred percent transfer of ownership with contingencies like working a few years extra and a lumpsum given now with money held back until later. Since employees need money to purchase a practice, this transition can be a bit lengthier than a corporate sale. Most sellers will opt for a 10 year seller’s note since the buyer does not have enough case or financing to purchase the practice in its entirety. Over the 10 years the practice ownership will transfer by using the profits from the practice. This can increase risk to the seller in the event the practice does not do as well during that time period. The other option is to have the buyer get a bank note and finance the rest using a seller’s note. There will be limitations and how quickly the funds can come through.
The biggest hurdle that buying veterinarians will experience when trying to purchase an existing veterinary practice… no cash. There are multiple financing options available such as conventional and SBA but even those require a downpayment to get started. The easiest way that most selling owners get around this dilemma is to have the buying veterinarian purchase the practice with a promissory note of using future profits from the practice. There could be a select amount in financing from a bank to help reduce the gap. Instead of all profits going to the selling veterinarian during the next 10 years, a portion of the profits will be redirected towards repaying a loan from a bank. Since this is a viable option to transfer ownership, this can be enticing for those that desire veterinary ownership versus investors.
There are two possible risks when transferring ownership with a seller’s promissory note. One, the seller is putting full faith in the buying veterinarian that the practice will continue to thrive and be profitable over time. Objectively, the practice would continue to grow and repaying the note to the seller should be simple. Two, the amount of tax drag on cash can make the transfer incredibly inefficient. When selling through a promissory note, there is what we call a “double taxation” that occurs. In the eyes of the IRS, the practice will be sold for a predetermined amount in the beginning. Since ownership is now transferred to the buying veterinarian, they are granted all rights to the future profits of the veterinary practice. The seller must now be paid using these profits. As the practice earns profits the buying veterinarian pays income tax (and state income tax depending on the state) first BEFORE paying the selling veterinarian. The payment for the purchase is then made to the selling veterinarian through the taxed profits. When the selling veterinarian receives payment, they are now obligated to pay capital gains tax which can often be less than income tax. In this scenario, the buyer could be sending every dollar of profit to the seller depending on the agreed upon purchase price in the beginning.
There are ways to get around double taxation by using multiple techniques at once such as the Lowest Defensible Value, direct payments, deferred compensation, and gifting. The ideal time to start the transition of ownership to another veterinarian is 10 years but sometimes can be doable in a harried 5 years.
Pulling things together
We explored three crucial topics that should be addressed with great detail before jumping in feet first to transition ownership to another veterinarian or employee. The transfer of ownership is a big deal for many because this could be the biggest transaction in their life, there are no “do-overs,” and mistakes can happen without strategic and cautious planning in advance.
Tom Seeko, CExP™ is a Certified Exit Planner and cofounder of Florida Veterinary Advisors, a national business and personal financial planning firm that specializes working with owners, veterinarians, and their teams. Tom and his team want to provide a different way of thinking, to make financial decisions easy, so you can spend time doing the things that you love. He is the cohost of a weekly podcast called The Smarter Vet Financial Podcast, national speaker, author, husband, father, and huge animal lover.
This material is intended for general public use. By providing this content, Park Avenue Securities LLC and your financial representative are not undertaking to provide investment advice or make a recommendation for a specific individual or situation, or to otherwise act in a fiduciary capacity. The information should be relied upon only when coordinated with individual professional advice. Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation.
Tom is a Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is a wholly owned subsidiary of Guardian. Florida Veterinary Advisors is not an affiliate or subsidiary of PAS or Guardian. California Insurance License #0K80141. Florida Veterinary Advisors is not registered in any state or with the U.S. Securities and Exchange Commission as a Registered Investment Advisor. The individuals associated with Florida Veterinary Advisors do not maintain specialized licenses or qualifications for the financial services provided to veterinary professionals. 2024-171642 Exp 3/26