Interest Rates Affect on Practice Values – Why now is a good time to sell
By Rod Johnston, MBA, CMA
Some of you may remember that in October of 1981, interest rates on home loans were 18.91%. Over the years, interest rates have gone up and they have gone down. In the early 2020’s, we saw some home mortgage rates go as low as 2.81%. If you were wise, you borrowed as much as you could at that time and bought a house, even though you may already have one. Coincidentally, home prices typically don’t follow interest rates. In fact, there have been periods of time over the past fifty years where interest rates have gone up and the average house price also went up. The same isn’t true for the value of practices.
When I first got into helping doctors sell their practices in the early 2000’s, interest rates for practice loans were about 7.5%. Most of the terms on those loans were 7-year terms. Meaning you had 7 years to pay off or amortize the loan. What does that mean for practice values? Banks determine how much they will lend based on cash flow after debt service. Debt service is the amount of your monthly loan payments.
To calculate cash flow, you start with the net income on last years’ tax return. Banks typically use 2-years tax returns, brokers when valuing a practice use 3 years of tax returns. I’m using one year’s tax return to keep it simple. You take the last year’s net income and then add back the non-operational expenses in the business. Those expenses are those that may not be necessary to run the business. Expenses could include gifts to employees, a continuing education class you took in Hawaii to get a vacation along with the CE, or meals you expensed for business. You can stop those expenses and still run your practice.
This gives you an adjusted net income. You then subtract your annual debt service to get the cash flow number. The banks then divide the cash flow after debt service by the annual debt service to get a debt service ratio number which should be above 1.2 times the debt service. So, if your cash flow is $120,000 and your debt service is $100,000, your debt service ratio is $120,000/$100,000 = 1.2 times your cash flow. Anything lower than that and the loan would be rejected, or you would need to figure out how to make the numbers work to get the debt service ratio up.
What does this have to do with practice values? Well, if interest rates go up, that’s going to cause a buyers debt service payments to go up. An increase in debt service will result in a decrease in cash flow after debt service. This will result in the debt service ratio going down and possibly dropping below the threshold of 1.2 times cash flow after debt service. The same goes for the term of the loan. Some banks now have 15- or 20-year terms on their practice loans. This reduces the debt service payments as the loan is spread out over more years. The result is a decrease in annual debt service payments which improves cash flow. A bank with a 7-year term may not get the loan approved, but a bank with a 15-year term may be able to do it.
Brokers know all this stuff. When good brokers do their valuations, they’ll do a check to make sure the bank will be able to finance the practice at a certain value. So, they’ll do a debt service ratio calculation and if it falls below 1.2 times debt service, then they should lower the value to price it correctly.
The good news is that there was a recent drop in practice loan interest rates. Interest rates on practice loans are between 5% and 5.5% at the moment. As a seller, this means values can be pushed a bit as the cash flow after debt service is improved with lower interest rates. A practice valued at $950,000, may now be worth over $1 million or even more. Because the lower interest rate resulted in lower debt service payments which helped increase the debt service ratio.
It’s good news for the buyers as well. Lower interest rates can lower their monthly payments as well. This may help them get into a practice that they may not have been able to purchase in the past as the ratio now works. This can be especially good in a startup scenario or in larger practices.
In summary, just remember that when interest rates are low, which they are at the moment, it’s a good time to have your practice valued and put on the market. It’s also a good time to be a buyer as your payments could be reduced.
If you would like a free consultation on the value of your practice, or to discuss a possible transition in the future, please reach out to one of the Omni brokers. We are always glad to help. Phone calls are always free and if you do a valuation with us today, we will update them for free in the future.
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The Benefits of Practice Ownership
By: Kim Ford
In today’s market, we encounter fewer veterinarians coming out of veterinary school with the ambition to own and operate their own practice. Several new graduates are lured into a false narrative believing practice ownership is not a career option that would benefit them financially or in their goals to achieve work-life balance in their chosen profession. In truth, there are multiple reasons why a veterinarian may choose to own and operate their own clinic.
One is versatility and flexibility, practice ownership allows a veterinarian to make their own schedule, creating a greater work-life balance. You also have the flexibility to choose your staff and adjust the work schedule in the practice to maximize your time.
Secondly, independence in owning the practice allows the veterinarian to practice medicine the way they want to practice without outside influence. The veterinarian chooses their staff, creates the schedule, and controls pricing and services offered. These are only a few of the items but having freedom of ownership can be extremely rewarding.
Building on the rewards of flexibility and independence, most veterinarians find owning their practice fulfilling and take pride in ownership. They take pride in the client relationships they can build within their community. It is very satisfying to be able to practice medicine the way you choose and structure your practice according to your vision.
Last, but not least is the financial aspect of owning your own veterinary hospital. There is a greater increase in income potential that comes with practice ownership. A veterinarian’s annual income as a practice owner is much higher than working as a salaried employee. Additionally, practice ownership creates a sellable asset when a veterinarian feels it is time to move to another project, career choice, or retirement.
These are some of the positive aspects to practice ownership. Ownership has its challenges. These challenges begin with financing the purchase or start-up of the hospital or clinic. Despite this hurdle, there are several financing options available to qualified veterinarians. There is the task of managing staff and resources, marketing, and other entrepreneurial duties outside of practicing veterinary medicine. These challenges require work, but they are not as daunting as they initially appear. The rewards that come from ownership are worth the work that goes into the initial investment and organization.
Read MoreMaximizing Practice Price
Maximizing Practice Price
By: Bruce Johnson, DDS
If you are considering selling your practice, always try to plan at least three to five years prior to the date that you hope to sell. We would all love to obtain the maximum price for the sale of our practices and I have listed some major points to help you achieve that goal.
- Do not take your foot off the pedal. It is very common for those getting ready to sell to start slowing down by taking more time off and decreasing the working hours. Anything that decreases your overall production will result in a decreased value for your practice.
- Try to keep your existing staff happy and motivated! You may want to consider pay raises or bonuses. I feel bonuses based on production level would be best rather than just hourly pay raises that the new buyer would need to maintain. If it is out of the standard range that may not be viewed favorably by a new buyer. Also, I do not recommend sharing your plans to sell with the staff. People are often afraid of change and sharing your plans too soon could cause some staff to start looking elsewhere. Staff turnover prior to a sale is not something a new buyer wants to see. Your plans to sell should only be discussed with your broker, your immediate family, accountant, and attorney.
- Clean up your accounts receivables and eliminate all credits. Stay on top of collecting from both patients and insurance companies. Call those patients with outstanding balances and do everything you can to collect monies owed. Run your credit balance reports and reach out to patients to whom you owe money. You want to keep clean credit balance reports and stay current on your state’s process and procedures for unclaimed property.
- Make your practice look attractive. Fresh paint, nice carpets, and new or recent countertops. Clean out storage areas and move your personal belongings to your home or to a storage facility. The outdoor landscape needs to be attractive. So, consider a landscape company to help. Make sure your outdoor signage is visible and clean.
- Do not buy expensive dental equipment like a CEREC or a Cone Beam CT because you will likely not recover that investment. But do make sure you have the basic equipment that buyers want. Most everyone expects digital x-rays so consider updating to digital technology. An existing dark room with dip tanks will be viewed less favorably. Evaluate your office computer system and software. Your broker will be happy to provide guidance and best suggestions if some of your systems and office equipment are dated. Make sure handpieces are all in good working condition. If dental chairs are over ten years old, considering having them reconditioned. Buyers will often decrease their offer to allow for major updates.
- If you are leasing your place of business, make sure your lease is current and has at least seven to ten years left with options. Banks will not loan with a weak lease structure. For example, if your lease expires five years from now, be sure there is at least one or more five-year options. The lender will need to assure the buyer can remain in that space for the life of the loan.
- Review your fees and make sure they are in the normal fee range. If they are too low, you should work on increasing them to the normal fee range for your area.
- Review your overall office overhead costs and try to get all categories into the standard range. Avoid running personal expenses/vacations through your practice. Your practice should reflect the true expenses of running the practice. Accountants have ranges in each dental category that are standard in general dentistry.