VALUATIONS / PRACTICE APPRAISAL

Purchase/Sale of a Veterinary Practice: Speech by Louis M. Gatto, CPA

Given at AAHA Conference in San Diego, California
March 9, 1997

The purchase/sale of a veterinary hospital is critical to the seller's and buyer's future financial security. This manuscript will look at the detailed items which make the transaction a deal for both seller and buyer. Overall, the seller is looking for a monthly payment to cover their living expenses, while the buyer is looking for a cash flow which will pay the operating expenses of the practice, make the seller's payment, and pay their living expenses. The first question regarding the seller which must be answered is: Are they a seller? What is the motivation for selling? Age, change of life, burn out, clients, illness or other. The seller at this stage is very security oriented. It is very tough for them to let go of the practice they have put so much time and energy into, which means they usually vacillate. They are extremely influenced by their circle of friends. They are not sure of the financial consequences of this transaction.

The questions surrounding the buyer revolve around experience, confidence, ambition, energy level, planning, available capital, lines of credit and other support. The buyer usually exhibits blind ambition which, as we all know, is a blessing and a curse. They also show signs of impatience and are subject to frustration. They are usually bad negotiators due to their youth, their need to be liked, their inability to say no, their impatience, and their desire to not be confrontational.

What does the seller want? The seller wants an all cash transaction, a down payment to cover the purchase of the practice, security in hard assets, a stock sale, giving of no warranties, an all capital gain transaction, and a defined monthly payment. The buyer wants a 90% plus financed transaction, excellent physical structure and equipment, trained clients, trained staff, an asset purchase transaction (not stock), and the purchase price to be allocated to depreciable assets.

The purchase/sale of a veterinary hospital usually proceeds in the following order. Motivation to sell or buy the practice, the spirit of the negotiations, determining value, getting into the detailed negotiations, document signing, and a future relationship between buyer and seller.

The following are the three types of sales which usually occur:
Straight Sale. The straight sale involves a sale of 100% of the stock or sale of all the assets. The stock sale transaction usually occurs with a purchase of 100% of the stock. The purchase of the stock is no different than the purchase of stock in IBM Corporation, where the goal is to have the value of the stock increase between the time you purchase the stock and the time you sell it. The purchase of the assets usually requires an allocation of value to drugs and supplies, furniture and fixtures, medical equipment, office equipment, computer equipment, covenant not to compete, patient records, and goodwill.

Step Sale. The step sale can be done for either a corporation, partnership, or proprietor. The step sale for corporate stock could be accomplished by a shareholder-to-shareholder transfer, a redemption and issuing of shares, the re-issuance of treasury shares, or the issuing of new shares. Certain transactions are between individual buyers and corporate sellers. These are usually asset purchases, as no buyer is readily willing to buy corporate shares. There are circumstances related to cash flow down payments and special terms where the buyer in essence is required to purchase the stock of the seller. The other transaction could be a corporate buyer purchasing from an individual seller. Again, these transactions are very rare as under the current tax laws there is no large advantage to have a corporate buyer.

A partnership may sell an interest to a new partner, it may sell assets to a new partner, or the partnership may distribute assets to the seller who sells to the buyer, and they create a new partnership. The most common partnership transaction is usually having the buyer purchase assets from the existing partner so they can get a step up in the basis of the assets they purchase.

The last method for a step sale is where the seller sells a percentage of the assets to the buyer and they either form a new partnership, or form a joint venture. This type of sale transaction again is very rare.

Partial sale. The reason for the partial sale is the seller is not ready to make a commitment to sell the entire practice at this time. The seller, however, may have a candidate who is an excellent potential buyer and wants to lock in this potential candidate to buying the practice.The seller usually will value a portion of the practice for a period of time and sell that portion to the buyer. The seller usually will commit to a minimum percentage to sell to the buyer and on occasion commit to selling over a specific time period the entire practice. The seller usually values a small portion, 25-35% of the practice, then usually requires another appraisal to be done at some specific time, for example, 3-4 years in the future for the practice to be appraised again. Partial sales are becoming more of a common way for a seller to transfer ownership to a buyer. The reason is the limited availability of capital, the need for the buyer to secure his or her interest in the practice, and for the seller to lock in a potential buyer much earlier in the selling phase of the practice.

The deal breakers and deal points must be discussed as soon as possible after the start of negotiations. The major deal points and deal breakers consist of a stock sale versus an asset purchase, the purchase price versus the price per share, the down payment, and other sensitive issues such as the interest rate, term of note, warranties, covenant not to compete, and asset allocation.

The following are some of the consistent problems which usually arise in the purchase/sale of a veterinary hospital. The value of the hospital is always a problem due to the fact that there are usually three values. The first value is that of the appraiser or expert. The second value is the value that the seller has had in their mind usually for a number of years, and the third value is based on a feeling of what the buyer would like to pay for the practice. The key is to find a common ground for all three of these numbers, because usually none of the three is exactly where the deal will end up happening. The second major problem is an inadequate down payment. The down payment is always an issue due to the problem of accumulating capital especially for any young aspiring veterinarian. The education and living costs that the veterinarian deals with their first 4-5 years out of veterinary school is almost prohibitive in accumulating any major amount of capital. The down payment is usually a function of family money as well as savings that the buyer may have accumulated. Security in a practice purchase becomes a problem because the security that is asked for is on an intangible asset. The intangible asset is the goodwill of the practice which usually accounts for approximately 80% of the value of the practice. Buyers are unwilling to offer hard assets to secure an intangible asset and this makes the seller who is very security oriented uncomfortable. Another problem that arises is that of double taxation for the seller usually in a corporate sale environment. This cannot be avoided usually, but there is some tax planning which can be done in advance to lower the tax exposure. Another problem is assets which are on hand at the time the buyer reviews the hospital and later finds out that some of those assets will not be sold. Such items include accounts receivable, other assets such as investments in emergency clinics, copyrighted material such as tapes and books, and potentially cash and automobiles. Other problems consist of post-closing adjustments to inventory, accounts payable, accounts receivable, and other liabilities. The four remaining consistent problems appear in all transactions and require a lot of time to resolve. Those problems relate to asset allocation which usually is worked out between the accountants, landlord negotiations which are worked out between the lessor and the lessee, management control and benefits usually worked out between prior owner and partial buyer, and the last one is insurance that the seller may want the buyer to purchase in case anything happens to the buyer from a disability or death possibility.

The allocation of assets in the purchase and sale of a veterinary hospital requires some special attention. The allocations are usually based on the negotiating skills of the buyers and the sellers, with an overview of the tax ramifications. The allocation of assets is usually done to the following items: drugs and supplies, furniture and fixtures, office equipment, computer equipment, medical equipment, covenant not to compete, client records, and goodwill. The accountants are usually the people who negotiate the allocation due to the potential tax problems created for the seller and the buyer. The tax consequences, however, should not rule the allocation, but, more so, the concerns of the seller and the concerns of the buyer should rule the allocation. Asset allocations as it refers to land and building are usually on an appraised basis, and the appraisal is the document which dictates the allocation between the values of land and building.

Once the transaction has reached the state where the economics are agreed upon, the details of the transaction are turned over to the attorneys to document. The document review will involve not only the purchaser and seller and their attorneys but again an economic review by the accountants. The attorneys may bring up warranty issues and security issues that may not have been discussed during the negotiating period of the transaction, but need to be resolved at this level. As soon as the review is done it is a game of signing documents and exchanging notes and down payments. The future relationship between the buyer and seller at this point becomes one of a legal and friendship environment. As long as the payments are on time, the relationship stays very calm. However, if the cash flow dictates problems for the buyer, the seller unfortunately will be pulled back into the transaction.

The spirit of the transaction is usually controlled by the seller. The seller has the opportunity to make everyone comfortable very quickly, first of all by knowing exactly what they want out of the transaction, and conveying those expectations to the buyer as soon as possible. The last thing either the buyer or the seller wants is to come away from the transaction with a future relationship which is very, very strained; both should come away from the transaction feeling comfortable.

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Copyright © 1999-2003 Gatto McFerson