To own or not to own…that is the question at hand. Let’s examine why a veterinarian should even consider veterinary practice ownership.
First, getting to be the boss has its advantages. You get to control your own destiny! Success lies in your own abilities and faculties, which can be equally invigorating and terrifying in the same moment. You have control over the medicine, the finances, the culture, team members, schedules and the list goes on and on. The point is, you get to be in the driver’s seat—which comes with great responsibility but also freedom.
Next on the list is the ability to make more money. On an annual basis as an owner, you get access to another slice of the income pie that generally is not available to an associate. If you are in the driver’s seat, you get the say in how and where the money gets spent. Depending on how the practice is operated, generally the income for the new owner comes from a few different streams. Most of the time the new owner veterinarian is still seeing clients and entitled to the income they are generating for their work as a veterinarian. Then, as the owner, he or she would be entitled to a management fee as well as a return on investment for the business. Rent is also another source of income for the owner if real estate is involved. All of this increases the potential pool of dollars that are available to the practice owner rather than only having access to an associate salary income. Many veterinary owners tend to fail to recognize and manage these different roles separately, and instead lump all of their income into one stream, thus making it hard to decipher how each role should be managed for maximal profitability of the business.
One part of the story that tends to not get as much attention in the “own or not to own” discussion is wealth creation. One of Webster’s definition of wealth is “all property that has a money value or an exchangeable value.” We typically think of millionaires as those who have a million dollars in cash in their bank accounts. Though millionaires are actually typically measured by having $1,000,000 net worth (meaning their assets minus their liabilities is over a million dollars), not necessarily that amount in cash. Assets are possessions of value that you own, and liabilities are debts or obligations that you owe. Therefore, owning a practice affects your net worth by coming into play as an asset that you own. And while, yes, a large liability often comes with that, the beauty lies in how the income generated by the business is paying down the liability each month and is helping build your net worth. Investing in veterinary practice ownership allows for significant opportunity (over being an associate) to bolster your personal balance sheet.
Classic investing advice is to invest in the thing you know best. When you invest in the stock market you are owning a small piece of a business in an industry you may or may not know much about. So why not also invest in the thing you know best, veterinary medicine? Typically, the response is “money of course, or rather the lack of it.” Entering the veterinary profession is not a cheap endeavor, and a lot of money has already been invested just to become a member of this profession. Then the barrier to entry to invest in the businesses veterinarians know best, a veterinary practice, is a much higher dollar amount than buying a small piece of a profitable company in the stock market. With recent graduates having high student debt and often little money to put down, investing in a practice may seem inaccessible. The amount of money needed to buy a practice often dwarfs even the large student loan debts balances that veterinarians have accrued. Often with a lower total cost to get going, starting a practice can seem a more accessible route, but the long ramp-up period before breaking-even can make start-ups unfeasible for recent grads as well.
With the challenges and burdens that student loan debt has caused in the profession, it is easy to see why veterinarians may have a hard time imagining how more debt to buy a practice may actually be a part of the solution. However, obtaining a loan to purchase a business has some fundamental differences from many of the loans veterinarians may have previously dealt with. For most consumer loans, the income to make the payments on the loan is coming from a separate source. Yet, for a veterinarian purchasing a practice, the loan is approved based on there being historical or projected income from the business to pay for the debt being taken on. Therefore, the loan proceeds are purchasing an asset that is generating income that can pay back the loan. This is a fundamental difference from a personal home mortgage, where the debt being taken on is being supported by the person’s income from their job (or other income streams unrelated to the house itself). In the case of a practice acquisition, the practice must have historical performance that demonstrates its ability to generate enough earnings each year to make the monthly loan payments, cover a reasonable salary for the new owner and some cushion for savings. Therefore, in addition to the buyer’s financial position, the practice’s financial performance and the purchase price are key components as to whether veterinary practice ownership is possible. For start-ups, the financial projections must demonstrate that within a reasonable time period the new practice will be able to financially support the debt and the new owner in the same way.
So, we have a highly responsible, skilled professional with low liquidity (predominately due to obtaining the education to become this responsible and skilled professional) wanting to purchase a valuable income-generating but intangible asset. When examining this loan on paper using traditional lending lens, it can look like a risky loan. While owner financing has and will likely always be around in this industry, third party lenders have become familiar with the challenges and opportunities that this scenario creates within the veterinary practice succession landscape. A collateral-based lender lends on a percentage of the tangible assets, but a cash flow lender will analyze the cash flow of the practice to determine the amount of debt the business can support. If properly understood, what looks risky on paper can be a sound lending decision with the right structure. Each lender may assess and structure the loan differently based on their credit policy.
The transition of veterinary practice ownership not only allows young vets and longtime associates to become owners, but also allows retiring vets the opportunity to realize the value of their practice. In a healthy practice, most of its value is based on the business’s ability to earn a profit. This makes it an intangible asset as this ability comes from the practice’s reputation, operations, client base and employee relations. Being intangible this is deemed the “goodwill” or “blue sky” of the practice, and represents the dollar value set for how valuable the practice is. The tangible assets of the practice include inventory, furniture, fixtures and equipment. Working with a third party who understands the veterinary space to value the practice can help ensure the price is accurate.
For a good transaction to occur, the seller needs to decide early in the succession planning process what is for sale, just the practice or the practice plus real estate, and the selling price for each. This is important for financing because if the purchase is just for the practice, but not the real estate, the loan term could be stretched up to 10 years. If both the practice and real estate and the real estate cost makes up the majority of the loan proceeds, the loan term could be extended up to 25 years. Spreading the payments over 25 years allows for lower monthly payments, possibly making the loan easier to cash flow. It will be necessary during the loan process to have an appraisal done to value the real estate. Updates and equipment purchases can be included in the loan or purchased later. Ultimately, the purchase price will be based on several sources including asset values, annual revenues, multiples of earnings and other intangible assets. With proper planning, the sale and transition can be smooth and successful.
The lender will look at the full financial landscape, including both the business’s finances and the buyer’s personal finances, to make a credit decision. The process of purchasing a practice can look different depending on individual circumstances. To determine if financing is possible, the lender will need to assess whether this business will be able to support this buyer and the new debt. To make an assessment the lender will need the practice’s prior three years of tax returns and interim profit and loss statement and balance sheet statements from the beginning of the fiscal year. They will also need a personal financial statement, resume and three years of personal tax returns from the potential buyer. The amount of debt needing to be supported is primarily determined by the sell price and the buyer’s down payment. However, working capital and soft costs may or may not be included in the total loan amount as well.
The personal debt obligations of the buyer will determine the annual salary needing to come from the business. During the loan pre-qualification stage, the buyer’s credit report will be pulled as it is an individual’s track history of owing and paying back borrowed money. The lender uses it is an indication of how that individual has performed in paying back debt in the past as well as their current debt obligations. How someone manages their personal credit is typically a good indicator of how they will manage the business’s credit. Part of the analysis will also include looking at the payments owed to other creditors, including a mortgage payment, any car payments, student loan payments, etc. The practice should be able to support the new veterinary owner’s salary with at least a 50% debt to income ratio. Thus, personal obligations influence the size of practice that can be purchased. Interestingly, this means that an individual may qualify to purchase a higher priced practice and be denied for a lower priced practice because the cheaper practice’s financial earnings is not large enough to support their debt and their lifestyle.
It is worth noting how this is where veterinary student loan debt plays in the financing equation. While the obligations on the credit report are used to calculate a minimum salary estimate, generally, the salary that the potential new owner received as an associate was higher than the number calculated for the 50% DTI which included their minimum student loan obligation. Thus, the amount calculated into the cash flow analysis for the loan analysis can be similar to what they were making as an associate or close to the national average for a veterinary associate. This number is a conservative estimate used in the analysis to ensure that the new owner veterinarian will be able to at least continue to maintain their current lifestyle as an owner, with the hopes that they will be able to make more.
Ultimately, the lender wants to know that the veterinary practice ownership will be bringing in enough money to cover the business expenses, business debt, new owner’s salary, and feel comfortable that the historical financial performance will be repeatable with the new owner in the driver’s seat. Once the loan has been approved by the lender, it moves into the closing stages. This is when all of the legal documentation and contracts are being drawn up, acquired and signed. The day of closing is when money changes hands and veterinary practice ownership officially transfers.
Successful transitions happen when good communication and transparency has occurred between both parties around what will take place during the transition. There are important questions that need to be discussed during the process to help ensure the continued success of the practice. Will the seller continue to work at the practice once the purchase is finalized? What will the non-compete agreement for the seller be? How will clients be introduced to the new owner? When will the staff find out about the sale?
The staff is a key part of the practice being able to repeat the financial results that the new owner just paid for, so it is important that the team has a good transition as the buyer takes over. Losing key associates and valuable team members to a competitor can hurt the performance and thus value of the practice. Initially, the staff may be wary of a new owner, and while fresh eyes can lead to improvements in the practice, people tend to resist change. It is usually in the best interest for the new owner not to radically change the experience for staff and longtime clients until he or she has gained their trust. Finding a doctor and practice that operates under a similar style of medicine will aid the success of this transition.
From selecting the right practice or start-up business plan, to securing financing and making a successful transition into ownership, acquiring a vet practice requires planning and patience. While veterinary practice ownership requires hard work, it is one of the best ways to maximize your degree and build net worth.