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How a fixer-upper practice might be just what the veterinarian ordered

If you start thinking like an investor and look for a poorly performing clinic, you could build it into your dream practice

It’s tough out there for buyers of veterinary practices and it seems to be getting worse. Every year, a few new investors and/or corporate consolidators call me looking to spend way too much money on two-plus doctor practices.

So how can you, the young, ambitious associate, compete for one of these? You can’t, unless you get lucky enough to find a seller morally opposed to corporate veterinary medicine, or who likes you well enough to give up $500,000 to $1,000,000-plus on the asking price.

Thankfully, there’s another way. If you’re willing to live in a smaller town, you could find a true gem of a clinic with little competition from other buyers. Alternatively, if you start thinking like an investor and look for a poorly performing clinic, you could build it into your dream practice. The marketplace is flooded with underperforming clinics, their owners anxious to find a buyer like you, particularly if they are retiring and want to solidify a succession plan. In this article, I’ll focus on what you need to know when buying a fixer-upper with real upside potential. I’ll also offer tools on how to spot and fix the most common issues that can drain a practice’s profits.

Why a fixer-upper might be a good thing

A practice with low gross/profitability can hold a wealth of opportunity if you know what to look for, are willing to put in the work, and will follow through to correct its course. The goal is to get a great clinic for very little money and realize a bigger return more quickly than if you bought a slightly bigger practice.

Procedures: The root opportunity

Most growth opportunities stem from poorly laid out procedures. When touring a clinic, look for an employee manual and a written protocol for all aspects of the business. If there aren’t any, this may be an indication the practice could hold untold opportunities. All it may need is a little organization.

Also look for the following:

  • a clear mission statement;
  • a schedule indicating regular, focused team meetings;
  • a detailed process for each job description;
  • an openness to feedback from the staff on how to do their job better/more efficiently; and
  • appropriate investment in continuing education.

Whether or not there is a procedures manual, interview the owner about how he or she operates the practice and trains staff. If a manual exists, try to get information on how well the owner follows through to ensure employees live up to its requirements. Examining procedures is the best way to assess the likelihood a target practice suffers from common profit-killing mistakes.

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Cost of goods sold

Cost of goods sold (COGS) often holds the biggest growth opportunities in a practice. COGS refers to the direct cost of producing income from goods, rather than services. Sometimes you’ll find wages and other expenses in this category, but it should only represent the direct costs of the goods you sell (i.e. drugs, medical supplies, pharmacy products, and food). Not every business entity includes the COGS category on its tax returns, and many include expense categories that don’t actually belong in there, so you’ll have to parse out what really matters.

Once you have a clear picture of what the practice actually spends on COGS, you can start hunting for growth opportunities, particularly if that expense is greater than 25 percent of gross revenue. The biggest COGS issues include poor ordering procedures regarding supplies and price negotiation, a lack of procedures for implementing consistent price increases, and weak or no safeguards against embezzlement, theft, and walk/discounting/gifting (more about this later).

Ordering supplies

Suppliers offer deals to convince veterinarians to stockpile items, but buying this way often leads to poorly tracked inventory, resulting in expirations and a higher chance of theft, embezzlement, and walk. A well-run practice should strive to have only what it needs on hand at any given time.

When you visit a practice, look carefully at the drug, supplies, and food inventory. If there is extra storage just for food, they’re probably over-ordering. You can also ask the owner about his or her ordering policy. If the owner delegates the responsibility to a staff member, speak with that person. If not, consult the practice’s procedures on ordering (if they have any) and gauge the owner’s level of oversight. Owners will often gladly tell you about how much money their office manager “saves” by stockpiling a year’s worth of something. However, if a practice is struggling, it could boil down to the fact expenses aren’t being tracked closely enough for inventory turnover calculations to be useful.

Vendor price negotiation

The other easily fixed COGS mistake is not negotiating with and/or price shopping among vendors. Remember, most things in business are negotiable, including the price of drugs and supplies used in a practice. Competing companies are always looking for an advantage and will offer varying price structures to get your business. This is another missed opportunity you can pinpoint in conversation with the owner, and an easy one to fix if and when you take over the practice.

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Price increases

Implementing price increases is the last of the somewhat easy-to-diagnose-and-fix COGS considerations. This isn’t as straightforward as the opportunities discussed earlier, given the ongoing struggle of veterinarians to compete with online pharmacies and, in turn, limit their ability to increase prices. When evaluating a practice, ask the owner about their procedures regarding raising drug and supply prices. If they don’t have any in place prompting them to reflect vendor price increases, you’ve found another great opportunity for the practice to grow.

Embezzlement

Embezzlement is difficult to identify; however, it is possible to determine if the practice is at higher risk for it by examining its procedures and interviewing the owner. Affecting cost of goods sold, embezzlement refers to misappropriation of funds (e.g. a bookkeeper removes entries from inventory sales reports and pockets that income). The embezzler can never take too much at once or their theft becomes too obvious. Over time, this significantly impacts a practice’s profits.

To see if the practice is at risk for embezzlement, look for procedures that decentralize balancing the books, close out invoices at the end of the day, and require employees taking cash to the bank. Many practices have only one person responsible for this entire procedure, maybe two. Without a dedicated system of checks and balances among multiple people, the practice is at an elevated risk for embezzlement.

Theft

If theft is an issue in the practice, it’s likely you won’t be able to deterimine it easily. That said, you can ascertain whether or not the practice is a high risk for drug and supply theft. No owner thinks theft is a problem, but you would be amazed how often tightening up procedures around theft seems to magically improve the COGS expense.

To assess the practice’s susceptibility to theft, look for procedures regarding supply storage. Are drugs and food kept in places that are highly visible? If not, can the storage space be locked and only accessed by a few trusted people? Does the practice have cameras? Does the practice conduct random audits of items (e.g. flea and tick preventives and food) to ensure inventory and sales data match?

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Walk/discounting/gifting

“Walk” is essentially a euphemism for theft, but it can also blend into discounts and gifting. The only major difference is the thief doesn’t really think of it as theft. Walk refers to inventory “walking” out the door. It could arise from the mindset an employee believes there is no harm in taking just one heartworm dose or a small bag of food here or there.

Discounting refers to an employee or even an owner allowing a client or another staff member to purchase an item for less than the practice generally charges. Receptionists might give some clients a break on their bill, or toss in extra free supplies. Again, these small dents in profit add up quickly.

Incidents of walk/discounting/gifting (WDG) are similar to theft and embezzlement in that they’re difficult to pinpoint exactly. That said, they’re easier to fix. With WDG, the party doesn’t think they’re doing anything wrong. Educating staff and implementing procedural follow through can correct this behavior.

To track down potential growth opportunity in WDG, seek out procedures. If you’re lucky, the owner may even mention they give staff and good clients a break. Barring that, if there aren’t specific policies and dedicated education around informing staff how these actions harm a practice, it’s very likely this is happening and driving up COGS.

Bringing it all together

A poorly run practice results from poorly thought-out and implemented procedures. If you’re willing to buy a fixer-upper, you could easily walk into a business with the potential for great cash flow. COGS often offers the best opportunity to improve an underperforming practice. It’s a great space to start to quickly build that lackluster practice you’re looking at and turn it into the beautiful practice you’ve been dreaming about.

Joe Stephenson is a mergers and acquisitions (M&A) advisor dedicated to helping veterinarians buy and sell practices in New York and New England, and make the most out of their veterinary business investment. He speaks regularly at conferences and veterinary schools, and provides management continuing education for veterinarians on business valuation, exit strategy planning, buying and selling practices, and negotiating consolidator sales.

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