Stage 3: Exiting Practice…Successfully
In the previous two articles in this series (click here for the first article and the second article), we described how practice ownership should be viewed as part of a career path with distinct entry points, a wealth building phase and an exit strategy. The career path should meet your goals of professional fulfillment, comfortable lifestyle and retirement, on your terms. In other words, make the practice work for you instead of you working for the practice. This article, the last in the series, focuses on exit strategies.
Many times, a mature practice at peak value finds a buyer, and an optometric career is concluded happily, all according to plan. However, often times ECPs hang on, unwilling to part with their life’s work, while the practice declines in value. Optimally, you should only sell at peak value, which should be timed with your retirement. Unfortunately, many ECPs, due to lack of planning, execution or random events, do not accomplish this. A sudden downturn in one’s health or poor practice performance may interfere with carefully laid plans. We list some of the situations and emotions we see in the marketplace. We also describe some fixes to help meet your goals under various circumstances. Regardless of the situation, it is important to always grow your practice in a way that maintains peak value at all times.
Average Practice Life
This chart shows the net earnings (left vertical axis) over the course of a practice’s lifetime in years (bottom horizontal axis). The key to your exit strategy is to plan your move while the practice is still an attractive prospect for buyers, before hitting the Declining Stage. Modified from AOA Eyes on America data.
Resources for Planning Your Exit
VisionOne has a number of online articles and newsletters to provide resources to help optometrists understand how to determine the value of a practice. Click on the following titles to see the PDF files on these topics. These articles will open in a new window.
- Buyer Requirements: The Effect of Practice Valuations
- Retirement Planning: How to Maximize The Value of Your Practice
- Understanding Your Practice Cash Flow: Diagnosis Tools
In less than optimal situations, ECPs often come to an unsettling series of realizations: They haven’t saved enough for retirement, their practice is not worth enough to support them over several decades of planned retirement, and–most unsettling–they find themselves forced to continue in a declining practice, not able to retire at all.
Three Forces to Satisfy for a Successful Practice Sale
- Buyer: An OD looking to buy the practice is weighing the prospect of spending many years paying down acquisition debt against prospects of value creation. Therefore, buyers like to target healthy growing practices that offer a greater prospect of success as opposed to declining practices with uncertain value.
- Seller: The sale of the practice must fulfill the requirements of the seller’s overall financial and retirement plan. Too often sellers over-price practices to shore up an underfunded retirement plan or on the emotional concept of “my life’s work.”
- Lender: A good optometric lender will assess the acquisition loan based on the adequacy of the practice cash flow to service acquisition debt and provide for the living expenses of the buyer / borrower.
The key to making a sale work: Realize that all of these three perspectives are legitimate and that common ground must be found to allow for a sale.
The following are strategies for exiting one’s practice, along with tips on how to mitigate the negatives and realize a successful outcome to your retirement plan.
PLANS TO EXIT PRACTICE OWNERSHIP
- SELL AND LEAVE: Sell your entire practice and depart.
This traditional plan is based on the notion that if you perform well as a clinician, good things follow. Your patient base increases, net cash flow swells and you sell your practice to young associates at the peak value of the practice. This scenario is available if you have planned and built wealth properly.
Making It Work
- Always maintain a growing net cash flow, the key to practice value. Be able to demonstrate healthy net cash flow for three years.
- Continue to upgrade facilities, equipment and instrumentation. Design renovations have been known to bump revenues up to 20% in some practices.
- Economically add more ECPs to the staff, preferably those who can take you in new directions like medical model or co-management, or who can bring in new patients. This should be part of a well thought out marketing plan.
- Stringently manage costs (lower cost of goods, avoid excess staff) to help bolster net cash flow.
- SELL AND STAY: Sell your practice and stay on as an associate either short-term or long-term.
This is an increasingly common pathway to exit a practice. It allows the seller to reduce their responsibilities while providing continued cash income through compensation. This allows for a later retirement and deferred use of the retirement fund, which helps an underfunded retirement plan go the distance. Regardless of your situation, short term employment should be considered so you can help mentor the new buyer and help with the patient, staff and business transition. Buyers and lenders generally like this type of transition plan.
Making It Work
- The selling OD needs to realize his or her status changes dramatically. Not having to balance the books and make payroll may be a relief; conversely, being cut out of decision-making, policy and finances can be a harsh new reality to grasp. Remember you are there to mentor.
- Make sure you are compatible for longer term arrangements. This is easier said than done. A minimum trial period of six months prior to sale is a good measure of compatibility–or incompatibility.
- Plan for contingencies: If the selling doctor doesn’t like the new arrangement, have an opt-out clause in the employment contract. If the buying OD wants the seller out sooner than planned, agree on terms for that contingency in your contract. The contract should be “at will.” Short-term transition mentoring is usually one day per week for up to one year.
- A knowledgeable lender will want to understand and “buy in” on these arrangements. They are lending based on continued net cash flow and want to be aware of arrangements that might affect it.
- PARTIAL SALE: Sell shares of your practice to another OD, preferably your associate. Remain either in a majority or minority ownership role.
In this increasingly common scenario, the selling OD sets up either a corporation or partnership entity and sells shares of the practice. The seller remains in an ownership position for a defined time period or indefinitely. This provides numerous exit strategies and retirement options. You can cash out and fund your retirement plan, purchase a second home or pay college costs for your kids, etc. The new partial owner will want the right of refusal to purchase the remaining interest in the practice. Your successor is now known and locked in. This can allow you to slow down, continue to take a paycheck while the practice continues to grow, produce more net cash flow and more value. Continued growth and sales to multiple ODs could even lead to you becoming solely a manager / mentor, able to take a paycheck without seeing patients. Many larger practices also enjoy economies of scale and can push down their cost of goods sold in addition to competing more effectively with commercial optometry (open nights and weekends, etc.).
Another approach is to sell shares which are bought over time. A common deal is a 5- to 7-year buy-in with a balloon payment at the end. This can result in phantom income with tax consequences for buyers and has to be structured properly to work. See your tax advisor or consultant.
Making It Work
- Conduct a trial period before sale for longer term arrangements. Take six to 12 months to establish compatibility.
- The selling doctor should work enough hours to maintain or increase gross revenues. Never let the gross or net cash flow go down!
- Regardless of the ownership percentages, make sure to share major decisions such as borrowing money, pledging assets as collateral, allowing additional owners and capital expenditures over a defined threshold.
- Make sure there is an agreement defining all owners’ compensation. One simple and effective approach is to compensate each owner per diem with a quarterly profit split based on ownership percentage. A seller has to understand, if they are getting paid for the sale of a portion of the practice, they have to give the buyer a reasonably similar amount of the practice net cash flow.
- Agree on a practice valuation schedule. The practice can be valued at the time of the partial sale—or buyer and seller can agree to conduct a revised valuation later at the time of complete practice sale. The latter arrangement may pay off for the selling OD, provided he or she continues to work hard to add value to the practice following the partial sale. From the buyer’s perspective, the value of the practice should be set on day one so that the buyer is not working to increase the price which must be paid for the practice. Valuing the shares at a future date seems to work best, especially if the future sale date is a few years out or more. It assures that both buyer and seller are incented to grow practice value. This increases the value of the buyer’s existing ownership. It beats building a practice from an associate’s position without equity.
Key Points to Obtaining a Practice Acquisition Loan
- Net Cash Flow: Lenders make loans based on the net cash flow, not gross revenues. Net cash flow allows their loans to be repaid, and the buyer to make a living, including personal debt payments (such as student debt).
- A Solid Transition Plan: Patient transition and continuity of business are critical to the preservation of practice cash flow. Associates know the patients and staff. How will a seller stay and help a new outside buyer transition?
- Management: Does the buyer have the skills to run the practice? What outside sources will the buyer enlist? Sellers and consultants are good sources.
- Equipment: This need not be the latest or most high tech. It does need to be able to function for at least at least three to five years and provide for a competitive, competent exam.
- Practice Improvements: You should have a reasonably up-to-date look in relationship to competition, which should be appropriate for the patient demographic. An attractive practice can be a positive sign to lenders, patients and potential buyers; dingy or run-down offices usually signal trouble or neglect.
- Inadequate cash flow to support debt service. Comes from:
- Seller over-valued practice. This pushes up the debt and debt service requirements, often times leaving the buyer without enough to live on.
- Buyer has too much personal debt. This is generally not the case with student debt and a few other reasonable debts.
- The practice requires significant upgrades in equipment or design which has not been reflected in the sale price.
- Onerous provisions in employment agreements such as:
- Seller wants double or triple the market rate to work as an associate, and the cash flow won’t support it. Lenders see this as disguised additional sales price.
- The seller’s contract keeps them in a position to control business decisions when they no longer own the practice.
- The wrong practice:
- Decreasing trends in revenues and net cash flow. Most buyers don’t have the skills to “turnaround” a practice.
- Purchase of a practice that is too small and does not provide adequate income to the buyer.
The adage, “plan your work, and work your plan,” may sound a bit Pollyannaish in a world that changes at warp speed. But in optometry today, working without a career plan (albeit one you need to adjust along the way) is pretty much a plan for never arriving at the professional success that is well within your grasp. Following the priciples laid out in this three part series gives you the tools to move successfully through your practice career.
Vision One Credit Union was founded in 1951 by optometrists as a credit union for optometrists. As a California-based institution, service was expanded nationwide in 2004. VSP and Essilor funded $30 million into “Vision Loans” a venture with Vision One Credit Union. The funds are loaned in creative ways to first time practice buyers to further the survival of independent optometry.
The Vision One Credit Union Practice Acquisition and Start-Up Guide
This guide is available at www.visionone.org/home/education