Demystifying practice valuation
How are veterinary practices valued?
There are many ways to value businesses, but in the veterinary medical industry the prevailing method is based on practice profitability as measured by the metric “Adjusted EBITDA” (Earnings Before Interest, Taxes, Depreciation, and Amortization, which is further adjusted to best reflect anticipated ongoing profitability). The formula for valuation is very simple, although the calculation of the two main components of it is anything but:
Valuation = (adjusted EBITDA) × (valuation multiple)
Using a profitability-based valuation is important because it applies a consistent valuation to veterinary practices regardless of whether the practice owner(s) is/are also working at the practice as a clinician or not. It also assesses the ability of the practice to produce profits that can be used to pay debts associated with acquisition and/or provide return on investment.
My practice’s calculated EBITDA is much lower than my total annual “take home”, why is this?
As an owner of a veterinary practice you wear a LOT of hats, but there are two in particular that a buyer must treat as separate roles when valuing a veterinary practice. Most practice owners serve as both the practice owner and a practicing clinician at their practices and pay themselves one pool of money for doing those two jobs. However, when you’re considering selling your practice these two jobs need to be separated out because practice owners get paid profits and clinicians get paid a salary. In order to assess the true profitability of a practice a buyer needs to first subtract out a fair market salary for the clinical work of the practice owner. For small practices, the overwhelming majority of the practice owner’s “take home” is represented by an implied salary compensation for their clinical work, with only the remainder being attributable to profit (EBITDA). Currently your take home looks like this, even though you are probably not used to thinking about it being broken down in this way:
Take home = (clinician salary) + (EBITDA)
You never had to make this distinction before if you own 100% of your practice, but outside buyers do have to make this distinction since their assessment of the profitability of the practice needs to include paying a fair market doctor salary for all the clinical work that happens at the practice.
What is a valuation multiple and how is it calculated? The valuation multiple is the other half of the equation to turn EBITDA into a practice valuation. Valuation multiples are determined by weighing a variety of factors including:
Comparison to practice multiples for similar practices that have recently been sold
Number of veterinarians
Whether the practice is urban, suburban, or rural
Assessed growth potential
Keyman risk: Does the performance of the business hinge on just one or two key individuals, and is there assurance that they remain after a sale?
Whether the practice is individually owned or part of a larger group of practices
What if my practice’s EBITDA is low?
This is very common with small practices, as both EBITDA margins and total EBITDA typically scale up with practice size. A buyer will not be able to offer you a valuation on your practice that isn’t based on the reality of your practice’s current financial state, but that doesn’t mean that you’re out of options. There are still some options available to you:
1) Find a buyer who is willing to value your practice on an asset basis (the value of your equipment, and ideally some value for client goodwill). This is not a desirable option since it will still leave you with a very small valuation on your practice. This is typically a “desperation move” for a seller who has not developed an exit strategy in advance.
2) Try to increase your practice’s bottom line yourself before engaging with a seller. This may mean spending more clinical and non-clinical hours working at your practice, re-evaluating your revenue and expense strategies, and generally refocusing your efforts on operating a profitable business. This might also mean hiring an additional associate and giving them time to reach full production capacity.
3) Consider an equity partnership with someone like AVP who has a clear vision for how they can develop stronger profitability at your practice and dramatically increase the value of your retained equity. Selling a majority stake of your practice at a low valuation today might seem like a step in the wrong direction, but because practices are valued by profitability the right business partner can make all the difference. For example, owning 100% of a practice with $600,000 of gross revenue at 3% EBITDA margin ($18,000 EBITDA) has HALF as much value compared to owning 40% of a practice with $750,000 of gross revenue at 12% EBITDA margin ($90,000 EBITDA, $36,000 attributable to you). A dedicated business partner with the skills, resources, and time to improve profitability at your practice can develop a significantly larger total value for your exit strategy than your practice is worth today. Partnerships represent a great opportunity for practice owners struggling to achieve the profitability that they need in order to secure a large valuation for their practice, but don't want to miss out on the financial upside of what their practice could be worth with expert help from the right business partner.