Economy altering dynamics of practice sales

NATIONAL REPORT — The business of buying and selling veterinary practices continued into early 2009 at a steady pace, with some brokers even reporting sales increases — but it's clear that market dynamics are changing, and not always in positive ways.

That's the word from lenders, brokers, consultants and others with a hand on the market's pulse.

The slumping economy appears to be motivating some practitioners to postpone selling. Other factors influencing the overall dynamic include age demographics, basic supply and demand and selective purchases by national chains, the experts tell DVM Newsmagazine.

"What I notice — and what others I talk to in the industry are seeing — is that there are many potential buyers, people who want to own a (veterinary) practice and are qualified. What we don't see is enough inventory," says Gavin Shea, director of the sales group for Matsco Companies Inc., a Wells Fargo-owned firm based in Emeryville, Calif., that finances veterinary, dental and optometric practices. "In other words, there's demand, but not (enough) supply."

With the Baby Boom generation of veterinarians at or near retirement age, it might seem like there should be plenty of inventory. Why not?

"My sense is that those who might want to retire are reasoning that, if they cash out now in this economy, where would they put their money? So they're working longer, hesitating to sell," Shea says. "I'm not saying that's the right philosophy, but it's likely how some doctors reason."

Matsco's veterinary-practice sales were mostly flat from the fourth quarter of 2008 until now, and 2008 sales were down from 2007, Shea says. The company's online Marketplace resource, www.matsco.com/marketplace, which offers a tutorial for listing practices and financing purchases, currently shows about 300 practices for sale.

Rather than encourage buyers to compromise on what they're looking for, Shea says his firm urges them to wait until the right property comes along. "We help them identify the right practice, and if that's not available right now we try to keep them focused on looking and not settling for something else."

"Finding quality practices (to sell) has always been a challenge," agrees Dick Goebel, DVM, who directs the Great Lakes Division of the Simmons & Associates practice brokerage firm, based in Monticello, Ind. "It's not difficult to get listings, but it is challenging to find high-quality listings."

Still, Goebel says Simmons handled 73 practice-sale transactions during 2008, up nearly 20 percent from the 61 it handled the year before. In his own Great Lakes region, which includes some economically depressed areas like Detroit, Goebel says his business since Christmas has been better than the entire final quarter of last year.

As more Baby Boomer practitioners do finally decide to retire, "we'll begin to see a greater volume of quality practices for sale," Goebel believes. "In the current conditions some (practitioners) are deciding to stand pat, perhaps work a few more years. We saw a similar situation in previous recessions and right after 9/11."

That agrees with what practice consultant Christopher J. Allen, DVM, JD, observes in his area, near Binghampton, N.Y. "Truthfully, we haven't seen one (practice) sell in some time — at least one we were involved with. I do know a couple of people who are trying to sell. My sense is that everyone is kind of hunkering down, working the practice they own and trying to keep up the gross so they can sell when the economy improves," Allen says.

Another factor that may help explain the dearth of quality listings is that many members of the Boomer generation prefer to extend their working years to stay active, Goebel believes. "Some will reduce the hours they put into the practice. But in my opinion they shouldn't work part-time in their own hospital. They should sell while the practice is at the top of its game and then go work for someone else."

Expansion by national veterinary-practice groups also affects market dynamics in a big way, Goebel says. "The national combiners are strong (business) competitors. Some of them are even paying a premium, buying quality practices for more than their appraised value, especially if that practice has a lab deal and they can pick up that (lab) business. Lab profits for them are sometimes three times what they may get from the hospital acquisition itself," Goebel says.

"I've had some buyers tell me that as soon as they find a quality practice, say in a metro area, before they can act one of the big chains is already there and already has sealed the deal."

A veterinarian who sold his Traverse City, Mich., practice last year to the VCA group, which owns and operates nearly 500 practices in 39 states, illustrates Goebel's point.

Daniel S. Aja, DVM, wasn't thinking about sellng or leasing his practice that was grossing $2 million annually until he received a job offer last August from Hill's Pet Nutrition Inc. He became director of professional affairs for Hill's on Jan. 1 and relocated in Topeka, Kan.

"None of my associates was in a position to buy, nor did I want to carry any paper for someone. We were going to move 1,000 miles away, and my goal was to be completely out of this practice. I didn't want to run it from a distance. My accountant suggested checking out the large corporate practices. I wanted to be finished with the deal in three months. I was upfront and told them I couldn't stay on after the sale, even though they usually want doctors to do that during the transition. We actually had two offers and decided to go with VCA. We sold two buildings, and the practice has four doctors and 30 total staff. My wife, who handled the office and financials, will be staying on until April 1 to help with the transition," Aja says.

Some DVMs who might want to sell and relocate to a distant city are cautious in the current economy, Goebel finds. "They reason that, like everyone else, their home has lost value, they'll have to sell it for much less and then take their chances elsewhere. What they either forget or fail to consider is that what you lose on one end you can gain back on the other; most likely they could have their choice of equal or better properties in the new city at very reasonable prices." That housing principle can apply to practice sales and purchases, too, Goebel adds.

Just what is happening to practice valuations in the down economy?

"The average U.S. practice is devolving in value right now, toward about 30 percent of a year's revenues. The best-managed ones may see 60 percent of revenues," says practice consultant Gerald M. Snyder, VMD, in Secaucus, N.J. "Practices usually are valued using a formula based on the past three years' profits. Who today would take the position that the next three years will provide the same profits as the last three?"

Many banks, Snyder says, are still lending for practice purchases, but have adjusted downward their expectations of revenues as reported in practice business plans by as much as 30 percent. "I expect sales in the near term to be mostly to associates, with the owner holding a note for any deficit in the bank-loan availabilty. Most owners wanting to sell will be disappointed by the practice sale's contribution to their retirement plans," Snyder says.

Much like the scenario Snyder describes, Neal Atkinson, DVM, a practitioner for 31 years who owns the Shandon-Wood Animal Clinic and Columbia Cat Clinic in Columbia, S.C., says he is negotiating a buy-in contract with one of his associates.

"It's a five-year deal, where the associate will gain a half-interest in five years, and have the option to acquire the other half in the following five years." The total business grosses more than $3 million, with six doctors and 30 total staff.

"We've been doing well, even in this economy," Atkinson says. "We haven't seen large increases in transactions, but no major decreases either. January was up about 3 percent from last year."

South Carolina has one of the highest jobless rates among smaller states, but Atkinson says his location in the capital city is buffered somewhat, having a military base (Fort Jackson) and many state and federal government workers.

Determining practice values and asking prices can be a complex process, experts say. Under the methodology Goebel's firm uses, a practice's gross revenue is adjusted to consider its real economic depreciation, one-time expenses incurred, non-business expenses and other factors particular to it.

"On average, practices selling for more than $1 million sell for 4.8 times their earnings," Goebel explains. "The multiplier of earnings (in this case 4.8) ranges from 3.0 to 6.0. This is often referred to as the cap rate (capitalization rate), and is a reflection of relative risk based on quality of staff, quality of location, management systems, demand for services, historic profitability and the ability to transfer good will from a seller to a buyer. There are 13 criteria altogether."

The point, Goebel says, "is that averages should not be used to estimate the value of any particular practice. The chances of being wrong are excellent."

The number of transactions is down in nearly all regions of the country, and that does have an impact on all practice values.

"That is a trend independent of the economic turbulence," says Goebel. "There is a bigger pool of non-users (of veterinary services), and we need to get them back into the pool. In many of the one-on-one conversations I've had recently, many people had poor fourth quarters last year. Major veterinary services were hit, but it's still true that sick animals are getting cared for. Pets still rank high in most families' priorities."

Latest figures from the National Commission on Veterinary Economic Issues (NCVEI) show that practice gross revenues in 2008 were up an average of 5 percent, about half of the previous year's growth.

Looking at practices in his own Midwestern region, Goebel says the worst-performing ones were down about 6 percent in 2008 from 2007, and the best were up as much as 15 percent or 16 percent.

"Some, even in hard-hit areas like Detroit, have learned how to manage better in a declining market. One doctor I know who owns nine practices there was down only 1.9 percent from last year and another was down only 1.1 percent."

While some lenders in the tight credit market no longer offer competitive rates to finance veterinary practices, "the mainstream lenders we've used for years still are competitive and eager to lend, some even accepting credit scores down to 650," Goebel says. "If you've got two years of work experience and clean credit, you can still buy a $1 million practice and get 90 percent financing, with the seller often carrying the remainder."