Associate Equity: A Clear Win-Win Scenario
Most independently owned veterinary practices have a very simple ownership structure with the lead clinician as the sole owner of the business. However, it is possible and, as we discuss below, advisable for practice owners to consider including their key associates in equity holdings in the business.
Excessive student loan debt among younger veterinarians is both a barrier to and an argument for ownership:
As we discussed in a previous blog, veterinary medical schools are failing new graduates in a variety of ways. One of the most significant ways they are failing is by allowing the cost of a veterinary medical degree to continue to skyrocket to unsustainable debt-to-income levels for associate veterinarians entering the workforce. While many lenders are still enthusiastic about lending to veterinarians for ownership even despite large student loan burdens if the practice’s cashflow justifies the business debt, the idea of taking on additional debt when they’re already struggling to keep up with their student loan debt is unpalatable to most younger veterinarians.
However, ownership is currently the best financial path for veterinarians to effectively pay down student loan debt. According to a CVMA survey, owners of 3+ DVM practices on average make 2x more than their associates and 4x more when resale value is included. While that survey looks at the 100% ownership scenario, even partial ownership in a clinic is an opportunity to significantly increase total take-home compensation by virtue of gaining access to a portion of the practice’s profit distribution. The ability for a veterinarian to not just service the interest on their student loans but also make progress in paying down their principal is directly related to their debt-to-income ratio, so boosting income is the easiest way to improve the math and very preferable from a lifestyle standpoint compared to cutting personal expenses in order to pay down debt.
Seller financing opens the door for debt-burdened young vets:
Veterinarians burdened by student loan debt understandably don’t typically have cash on hand to buy directly into ownership of a practice. Seller financing bridges the gap well. Assuming the purchase EBITDA multiple is appropriately matched to the duration of the financing term, the principal and interest of the seller financed equity can be paid down mostly or entirely from the proceeds from that equity share. The equity serves as direct collateral for the note, making this a low-risk proposition for the seller while putting their associate on track for ownership.
Associate ownership aligns incentives:
The relationship that an owner of a business has with their work is fundamentally different than an employee. Having true ownership in the results of your efforts, both in short- and long-term value, is a powerful motivator. Veterinarians are the primary revenue drivers for veterinary practices, so aligning the incentives of your associates with the interests of the overall business is a great way to drive growth and success.
Associate ownership is a retention tool:
Simply put: Owners of a business are a lot less likely to quit their job than employees. There are both tangible (financial consequences such as being forced to sell back equity, potentially at a reduced value) and intangible (pride of ownership and an emotional connection to the success of the business) drivers for why an equity holder is less likely to exit without significant cause. Turnover is expensive for veterinary practices, especially at key positions like associate veterinarians, so there is significant inherent value that a practice owner can attach to building a long-term relationship with an associate that creates financial incentive for them to continue to drive the practice’s success.
Associate ownership is a hiring tool:
You should never give unvested equity to a new hire immediately, as it is critical to make sure someone is going to be a good partner to you and the business before committing to including them in ownership, but communicating a potential path to equity can be a great way to make your job post stand out in a sea of options available to job seeking associates.
Associate ownership can be part or all of your transition plan:
Every business owner should have an exit strategy, regardless of whether they’re planning on retiring in 3 years or 30 years. Arriving at retirement without a transition plan already in place leaves owners in a position of poor leverage in the sale of their practice, and can result in delayed retirement as most practice buyers are looking for at least some degree of post-sale work commitment from selling practice owners in order to facilitate a smooth transition. Getting an associate into a position of equity and setting them on a path to be the new clinical lead of the practice is an important step in solidifying the practice’s future beyond your retirement, regardless of whether that individual ends up being the future sole owner of the practice or a partner to a prospective buyer.
Including other parties in ownership is a good excuse to look at the quality of your practice’s cash flow:
Most practice owners have a good grasp of what their practice’s cash flow is, as it is simple accounting to figure out how much money is leaving the business and ending up in their personal accounts. However, many practice owners don’t routinely break down that cash flow into the 2-3 tranches that it is composed of in in order to assess true profitability:
1) Clinician salary: Any clinical revenue produced in the practice needs to have an appropriate, fair market salary attached to it, even if you are the one who produced that revenue as a clinician-owner. The first step in turning your cash flow figure into a profit figure is to add back or more likely subtract (depending on if and how much salary you pay yourself) the appropriate amount of clinician salary from your cash flow to arrive at a normalized clinical salary for your own work.
2) Rent: If you own your facility, your cash flow should also be reduced by the amount of a fair market rent for the facility in order to arrive at a true profit figure. Some owners apply above-market rent paid from their business to their real estate entity for tax efficiency purposes, so it is important to note that practice does need to stop in a scenario involving more than one owner for the sake of fairness to the non-landlord owner(s) and rent will need to be adjusted to a fair market rate.
3) Any remaining cash flow after these two adjustments can be treated as profit. Profits should be distributed to owners according to equity stake.
Overall, it is important that the accounting for the business is professionally managed in a scenario with more than one owner to make sure that profit is fairly distributed to owners. Taking the time to look more closely at how much of your clinic’s cash flow is true profit is the perfect opportunity to assess the financial health of your practice. Practice owners are often surprised by how little of their cash flow is profit and how narrow their margins are, especially when they are a highly productive clinician and therefore have a high implied clinician salary that drives a large amount of cash flow that might hide low profitability from their view.
The right outside partner can round out the plan and ease associate concerns about ownership:
Concerns about increased responsibility beyond their clinical work is one of the biggest hurdles to pursuing ownership among younger veterinarians, especially as work-life balance has become a growing priority among veterinarians. Partnership with a group like AVP can provide the best of both worlds: A financially maximized exit strategy for the current practice owner, the financial upside of a minority equity stake for the associate(s), and the work-life balance upside for the associate of working at a professionally managed hospital. AVP specializes in flexible partnership structures that have the option for associates to have significant minority ownership stake since the upside for AVP of having associates as partners is clear: alignment of incentives, better continuity of clinician staffing, and happy associates who are sharing in the financial upside of the typical revenue growth and margin expansion that occurs as practices transition to professional management.
Sharing ownership with the right partner in an excellent, optimized business is better than owning 100% of an unoptimized one:
Letting go of the need to own 100% opens the door for your practice to continue to grow and evolve into the best possible version of itself. Whether it is a small change in ownership by including one or more associates in a minority equity stake, or a larger change of bringing in a full business partner like AVP who will carry the weight of responsibility for business operations and let you shift your primary focus back to your clinical work, sharing ownership with the right partner who adds meaningful value is a net positive for you as a business owner.
I am happy to discuss some of the best ways to structure minority equity for associates, including ways to best align incentives, setting vesting schedules, and determining valuation. You can reach me via e-mail at email@example.com or through the contact form on our website.