- Contact a bank that finances veterinary practice acquisitions and makes sure you can qualify for a good loan. Banks can require decent credit scores, cash in the bank, that you are two years out of school, and show production from your current employer. Every situation is a little bit different. Try to avoid SBA loans if you can, as they can be expensive with early payment penalties. However, if that is the only avenue to ownership, do not pass it up.
- The next step is to understand a little bit about veterinary practice valuations. You don’t want to go into a sale not knowing if the practice is worth the price listed or not. If you are looking at a practice that a corporate entity is also looking at, the rule of thumb is that valuations are out the window. Practices grossing 1 million or less could be worth between 65% and 75% of its’ last 12 months’ production. Remember, that’s a rule of thumb - I’ve seen practices go for as high as 160% of production and as low as 30% of production.
- Think about where you want to practice. You’re probably going to be there a while, so you might as well like the area. Research demographics - there are excellent demographic services that sell great Veterinary demographic information for about $500. It will tell you where the best locations to practice are located. Also, do not ignore the smaller, older, and not-state-of-the-art-equipped practices. These can be the best opportunities allowing a higher return on your investment.
- Put together a good team. Get referrals for a good veterinary broker, attorney, banker, and accountant. They’ll help you analyze the veterinary practice, do the legal work and help you find a practice.
- Get an understanding of the true cash flow of the practice and if expenses are above industry averages. For example, is the staff expense greater than 25% of production? Is the reason because one employee is overpaid and will be retiring at the same time as the seller, or is there an overstaffing issue? Be an informed buyer.
- Be prepared for your due diligence. You need to know what to look for when you do get to the point of buying a veterinary practice. Is it an older veterinarian selling that outsources surgery and does very little dentals? Does the practice have a website? As the practice should be valued on current performance, not future potential, there could be real opportunities for immediate growth. Know how to spot these things.
- Finally, spend some time with a veterinary broker before you go look at the practice. Understand what the practice you are looking at is all about. Does the broker think it’s honestly a good practice? Why? Does the explanation make sense? Once you’re comfortable with the numbers, then go take a look at the practice.
I meet hundreds of veterinarians each year who are looking to buy an existing veterinary practice. Of those, I would estimate that 30% have done any research on what is involved in buying a practice. Of that 30%, none know the beginning to end process of buying a veterinary practice. While all the steps cannot be covered in this article, here is some guidance on where to start and what steps to take before buying a practice.
Owning and growing a veterinary practice can be one of the most challenging things in the veterinary field. Advertising for new clients can be hit and miss and expensive. That’s why one of our favorite strategies is to purchase another practice and merge it into your existing practice.
The reason you would consider doing a merger is because you get all of the revenue and current clients from the new practice, but you don’t get all of the expenses. You don’t bring over the fixed expenses like rent, telephone, electricity, etc. You already have those in your practice and don’t need to incur them again when you bring over the practice you just acquired.
As an example, say you own a practice that collects $600,000 per year. You have overhead of $390,000 with 30% of the overhead in fixed expenses – rent, utilities, insurance, etc., Another practice comes on the market that collecting $500,000 with overhead of $325,000 with fixed expenses again at 30% or $150,000. You purchase the practice for $350,000 giving you a debt service payment of $3,500 per month. You work closely with the broker to ensure 100% of the clients transfer to your practice. Your practice now goes from $600,000 up to $1.1 million in revenue. You incur the variable expenses of the second practice, but you do not incur the 30% fixed expenses of $150,000 because you already have rent, utilities, insurance etc., at your current office. In essence, you just gave yourself a $150,000 raise, less $42,000 in debt service and dropped your overhead to the neighborhood of 55%. It would take you much longer to do this if you just did marketing and advertising. By consolidating practices, you get instant growth and income. If you have a practice for sale near you, you should consider merging it into your practice in order to achieve quick growth.
Buying a veterinary practice can be and is a daunting task. It’s much more involved than purchasing a car or even a house. You have to wear many hats including shopper, negotiator, accountant, finance, lawyer, practice management expert, equipment specialist and even human resources manager. One wrong step and you could set yourself back financially, legally and even personally if something goes wrong. You have to know what to look for every step along the process. But, what is the process? Here is an abbreviated version of what those steps are:
Taxes are a fact of life, and an extremely important consideration when considering a veterinary practice transition or sale. Let’s explore some potential tax mitigation strategies to consider.
Stock Sale. If you are incorporated, sale of the stock in your corporation to the veterinary practice buyer can potentially yield you the greatest tax savings, because the sale of stock is almost exclusively taxed at the lower fixed capital gains rate as compared to the higher, tiered ordinary income rates. However, and this is a BIG however, stock is a non-depreciable asset to the buyer. As such, the veterinary practice buyer is not able to write off the sales price and essentially ends up buying your practice with after-tax dollars. Consequently, a buyer is likely only to agree to buy your stock if you are willing to reduce your purchase price by 30 percent or more. For this reason (and many associated legal and liability complications), almost all veterinary practices are sold as “asset sales.” In other words, the seller retains his/her corporation and all of its stock and instead sells all of the tangible and intangible assets of the corporation (i.e., the veterinary practice). The buyer is then able to depreciate and amortize (write off) the entire purchase price.
Price Allocation. The IRS requires the total price of a veterinary practice for sale to be allocated to the various types of assets being sold and that the allocation be made according to the fair market value of the assets. As a general rule, the tangible assets are taxed as ordinary income above basis, and the intangible assets are taxed as capital gains. (Above basis means the difference between what you are selling the tangible assets for and your book value or depreciated value.) Any consideration for a covenant not to compete will also be taxed as ordinary income. Since fair market value is somewhat subjective, there is some room for negotiating the overall allocation of the purchase price. As a veterinary practice seller, you will save taxes if you can negotiate with a buyer for a lower allocation to tangible assets (equipment, furniture, fixtures, supplies, etc.) and a higher allocation to intangible assets (goodwill and patient records). (Unfortunately, it will benefit the veterinary practice buyer to have just the opposite allocation, so consideration must be given to making the allocation fair to both parties.)
Carry back a note. Sellers frequently ask us, “Won’t I save on taxes if I self-finance part or all of the sales price (i.e., carry back a promissory note from the buyer)?” The answer is, “No, but maybe . . .” As mentioned above, the portion of the price in an asset sale that will be taxed as ordinary income will be due in the year of the sale. That recapture will be taxed regardless of the receipt of any actual cash at closing, which means you owe the ordinary income tax associated with the recapture even if you do not receive a cent at closing. Consequently, if you do not want to have to pay to sell your practice, it would be prudent to ask for enough of a cash down payment to cover the tax liability you will incur from the recapture. Since most of the remainder of the sales price will be taxed as capital gains and since the capital gain tax rate is a fixed rate, the same tax will be applied and the same tax amount owed whether you receive that portion of the price now or paid to you over time; unless . . . there is a change in the capital gains tax rate before the note you are carrying is paid off. If the rates go up, you would be taxed at that higher rate on that income as it comes in. Otherwise, self-financing a portion of the price serves only to defer capital gains tax, but it will not lower the total tax. (Also note that the interest portion of any promissory note payments will be taxed as ordinary income to the holder, while the principal portion subject to capital gains will be taxed at the capital gains rate.)
Sale Timing. As discussed above, the tax associated with recapture over basis on the sale of tangible assets will be determined by your ordinary income tax bracket in the year of the sale. If you are planning to retire after the sale of your practice and, consequently, will have a drop in your ordinary income level, it may behoove you to strategically time the sale of your practice until after the start of the next tax year. Also, if you have owned your veterinary practice for less than one year, you should, if possible, wait at least one full year before selling it since the sale of goodwill within a year of ownership will result in the higher short-term capital gains rate being applied instead of the long-term capital gains rate.
“C” Corporation Consideration. If you are currently incorporated and being taxed as a regular “C” Corporation, the sale of goodwill by your corporation will likely be subject to double taxation, once as capital gains inside your corporation and then again as ordinary income when paid as a distribution to the shareholder(s). There is some case precedence that allows for the shareholder(s) of “C” Corporations in closely held and professional businesses to sell goodwill individually, outside of the corporation, thus avoiding that double taxation. If this applies to you, consult with your CPA and/or tax attorney regarding the details of such a tax strategy and its application to your particular situation.
1031 Exchanges. If you are selling a veterinary practice now and are planning to buy another practice within six months, a 1031 or “Like Kind” Exchange may be a tax deferral strategy to consider. It allows you to defer the taxes associated with recapture over basis you would otherwise incur with the sale of your tangible assets. A 1031 Exchange has very specific and rigid requirements. Consult with your CPA and/or tax attorney regarding the details of such a tax strategy.
Charitable Remainder Trusts. Charitable Remainder Trusts are not subject to capital gains tax. As such, a seller may potentially eliminate capital gains tax on the sale of his goodwill by donating it to a qualified charity. The downside, obviously, is that the seller must donate the goodwill proceeds to that charity. This is another strategy where you would want to receive guidance from your CPA and/or tax attorney.