The succession of a veterinary practice to new ownership rests in much more than the opinion of an appraiser.
Veterinary practice succession planning, a career-long endeavor, is based in the philosophy, policies, procedures and protocols that sustain the practice's economic microcosm.
In the first of this three-part series, we initiated discussion of valuation concepts, appraisal standards and cultural attributes that impact the intangible value of the practice — its goodwill value. This article continues the discussion of asset value and also of associated liabilities that reduce value.
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The component practice assets are a good starting point for understanding how the building blocks of a practice combine synergistically in providing a current income stream and long-term appreciation. We categorize veterinary practice assets into two primary types: tangible and intangible.
Tangible assets are those that can be touched, felt or held — assets that are concretely discernible to the five senses. Intangible assets cannot be felt or easily perceived, but can represent issues of material value. Measurement of value is more challenging than with tangible assets.
Within the intangible asset grouping, goodwill is of primary importance. Sometimes called "blue sky," it represents the earnings capacity of the practice operating entity. In the last article, we listed a variety of leadership and ownership criteria affecting the intangible value of a veterinary practice, measured through its inherent profitability. Additional intangible factors that impact goodwill value include:
The deliverability of goodwill value can be affected by various practice factors. A discount from total valuation might be made due to stock restrictions and/or the lack of control inherent in a minority interest in a closely held practice. Departure of key management personnel or clinicians with specialized skills or reputation could result in a discounted price. Distressed sales resulting from divorce, disability or death can all impact goodwill value and negotiated price.
Goodwill deliverability must be secured by adequate non-compete agreements with present and past employees. Deliverability also hinges on retaining key personnel during transition, if not permanently.
Assets that are not exactly intangible or intangible can be termed "netherworld." [Owen E. McCafferty, CPA, CVPM, (440) 779-1099, from various past writings about veterinary practice valuation. This author also wishes to acknowledge McCafferty's immeasurable and significant contributions to the veterinary profession in regard to practice management, economics and valuation.]
Accounts receivable, computer software licenses and computer data or patient records fall within this meaning.
Tangible assets include personal property and real property. Personal property, or personalty, comprises the following assets in a veterinary operating entity:
Real tangible property, or realty, includes land, land improvements, buildings and building improvements. Most often, realty is held outside the veterinary operating entity and is valued as a separate asset. However, the veterinary operating entity's value hinges closely on real estate value. Goodwill (as an expression of capitalized excess earnings) is impacted by the fair rent required for facility use.
Rent represents the investment return expected on the real estate. A higher rent infers greater real estate value, and results in lower expected excess earnings for a given level of practice gross income.
Investments and cash equivalents held by the veterinary operating entity are additional assets that must be considered. Emergency clinic stock is a common example of an asset held by veterinary practices. Rarely does its historical cost reflect current value. Investments in mutual funds or other stocks should also be valued at present worth when determining overall practice value.
Assets are one issue. Liabilities are another. Each asset should be evaluated to determine whether a correlating liability exists. Identification and measurement can be as clear and simple as identifying the outstanding amounts owed to vendors (trade accounts payable) to as complex and challenging as determining the impact of vaccine protocol changes.
Contingent liabilities depend on the occurrence of some event that has not happened. The fact of a contingent liability's existence may or may not be known. What measure can be given of the liability associated with an environment nurturing potential employee claims of sexual harassment? Or of non-compliance with OSHA requirements or DEA regulations about management of controlled substances? Or the lack of contracts and covenants not to compete with employed associate doctors of veterinary medicine who could effectively siphon away a portion of the client base?
The identification and monetary measurement of liabilities can be as challenging as determining the practice's intangible value, measured through the asset known as goodwill. A well-versed appraiser familiar with veterinary practice operations can help you identify such liabilities, known and unknown, existing or contingent on the occurrence of some event.
The ultimate value of a practice entity then resides in the net effect of total assets less total liabilities. Two rules of preventive practice health abide for protecting value. First, engage competent professional help before you think you need it; don't procrastinate, and don't do your own plumbing.
Second rule: Tax law and legal requirements are not like anatomy. The femur may be attached to the ulna, not the tibia, with next year's election or court case. An ongoing relationship with professional advisors keeps you alert to potentially overlooked opportunities or dangers.
Key attitudes, relationships, business processes, practice systems and leadership vision result in personally rewarding and financially satisfying experiences in veterinary practice buying, ownership and selling. The succession of a veterinary practice to new ownership rests in much more than the opinion of an appraiser. A successful transition is as much about emotions and beliefs as it is about price and cash flow.
In the last of article of the series, we will discuss common sense truisms that combine the implications that emotions and beliefs play on the practice's economic value. In essence, the parties to a practice's succession have as much to do with a successful transition as does a theoretically objective measurement of excess earnings value.