Every veterinary practice seller wants to maximize the equity they can extract from their practice. Sellers sometimes research the Internet regarding what practices are selling for prior to putting theirs on the market. From time to time, the seller will run across a practice that sold for 100% of collections and mistakenly believe that this is the norm and that they should receive no less than that for their practice. Although this would be nice, most buyers need loans to buy practices and the lending institution will not loan more than the practice is truly worth.
While some who appraise veterinary practices will say that there is no rule of thumb for pricing veterinary practices and that those who use rules of thumb are less expert than themselves, there are ranges of fair market value based on comparable sales for the ordinary veterinary practice that can be utilized under some circumstances.
Let’s take the upper limit. If a practice is located in Washington, DC, and there are five buyers for every practice available for sale, the law of supply and demand dictates that the purchase price for a veterinary practice will go up. Up often means all the way up to 100% of the gross collections of the practice.
Let’s say, for example, that a veterinary practice in Washington, DC collects $1 million per year. Further, let’s assume that one of the five buyers has offered to purchase the practice for $1 million. Should the seller rejoice at their good fortune for having located their practice in the Washington DC area and start planning how to use the money? No, unless the prospective buyer has $1million in their bank account. The buyer, in all likelihood, is going to have to approach a financial institution, such as a bank, and borrow the money to acquire the practice.
The bank is going to want to know three things. First, can the buyer produce as much as the current owner of the practice? In other words, is the buyer going to be able to duplicate the work habits and collection patterns of the current owner of the practice? If the owner is a $1 million per year producer and the most that the buyer has ever produced is $400,000, the bank will study that situation closely before funding the loan.
The second thing the bank is going to want to know whether the buyer will earn enough from the practice to be able to pay their current debts that he/she had before borrowing to buy the practice. In other words, that the buyer will have enough money to pay for the loan to buy the practice, and enough money left over on which to live. As counter intuitive as this may sound, the bank is much more likely to provide financing to a buyer for a large amount than they are to loan a small amount. The practice collecting $500,000 per year is less of a risk for the bank but may not generate the necessary profit to satisfy the buyers current debts, his/her newly added bank debt, and living expenses. The practice collecting $1 million, on the other hand, is twice the risk for the bank but may generate plenty of revenue to satisfy the buyer’s current debts, the newly added bank debt, and living expenses. Therefore, there is relationship in the banks decision based on not only the practice but on the prospective borrower seeking the funds and their individual financial status.
Finally, the bank will want to make sure that the price of the practice falls within the normal range of sale prices of other veterinary practices. If practices ordinarily sell for 70% of collections in a particular area, a buyer will have a difficult time obtaining a loan on a practice priced at 100% of collections. An example of this would be the acquisition of a piece of residential real estate. While the buyer of a piece of residential real estate may agree to pay the seller $400,000 for that property, the bank is going to require an appraisal by an appraiser of their choosing. Regardless of what the buyer and the seller have agreed is the value of the property, if the appraisal for the property is $300,000 as opposed to the $400,000, the bank will refuse to make the loan. Just such a scenario has foiled thousands of real estate purchases.
Once the prospective buyer of the veterinary practice has been rejected his/her attempt to receive bank funding, the relationship between the buyer and the seller is often damaged irreparably in the process. Because the bank tells the prospective purchaser that the practice is not worth what he/she has agreed to pay for it, the buyer often comes to the conclusion that he/she has been misled by the seller regarding the true value of the practice and terminates any further efforts to obtain the practice.
Therefore, even if you find a purchaser naïve enough to offer to overpay you, based on comparable sales, for your veterinary practice, it is unlikely you’ll ever see that money. Not only is it unlikely you will ever see that money, it is unlikely you’ll ever see that prospective purchaser candidate again.
When a seller says I want to get the most I can for my practice, it is the responsibility of the broker to educate the seller that while pricing at the upper end of a fair range may be smart business, seeking a price to the high side that is outside that range can often have permanent negative effects. That’s the old saying, “pigs get fat and hogs get slaughtered.” The pig prices within a fair range which often results in the sale. The hog, tries to get all it can get, and ends up with nothing.