Most veterinarians are shocked to learn that the clients they’ve painstakingly worked to attract and maintain amount to very little when it comes to a hospital sale. Yet doctors who are planning a sale constantly ask, “What is my client list worth?” When it comes to practice value, the short answer is nothing.
Dr. Darren Williams, owner of Mayde Creek Animal Health Center in Katy, Texas, agrees. “We have no exclusive contracts with our clients,” he says. “They’re not ours to keep, and they’re free to seek veterinary care from any provider they choose. A list of their names is simply a record of those individuals who’ve used our services in the past, not a guarantee that they’ll continue to use our services.”
Lorraine List, CPA, CVA, owner of Summit Veterinary Advisors in Littleton, Colo., asserts that a client list has no more value than the paper it’s printed on. “The value of the list depends on whether those clients, and the earnings they represent, can actually be transferred to the purchaser,” she says. “It’s important to remember that no one actually ‘owns’ clients—they always have choices on where they can get veterinary care for their animals. That’s why the steps in an ownership transition are so critical.”
A big portion of practice value is tied to the earnings the practice generates for the owner after operating expenses have been paid. While it’s true that without clients there would be no earnings, the only true value of a client is in the earnings. This explanation sounds circular and a little confusing, so let’s explore the long answer to the question.
Two common methods of valuing veterinary practices—single period capitalization and excess earnings—both entail capitalizing an earnings stream that reflects normal practice operations. The chart below shows how you would determine excess earnings if you used this valuation method.
Table: Calculating excess earnings
(percentages of gross revenue)
|LESS: Operating expenses|
|Variable expenses||– $625,000||24%|
|Fixed expenses||– $195,000||8%|
|Staff compensation||– $600,000||23%|
|Facility expenses||– $212,000||8%|
|Total operating expenses||– $1,632,000||59%|
|Amount available for doctor compensation||$968,000||37%|
|Veterinary compensation||– $500,000||19%|
|Management compensation||– $78,000||3%|
|Total compensation||– $578,000||22%|
|LESS: Return on tangible assets||– $17,000|
|Excess expected earnings||$373,000|
Once excess expected earnings have been determined, the valuator applies an appropriate capitalization factor to the earnings figure to arrive at goodwill (intangible asset) value. The capitalization rate reflects the return the investor wants to achieve based on the risk associated with owning the practice.
> expected revenue and earnings growth
> competitive position
> demographics of the area
> condition of the facility
> management systems
> quality and quantity of the staff
> fee structure
> percent of revenue generated from dispensing
> percent of revenue generated from ancillary services and products
> transferability of goodwill
> ability to cover expenses and debt payments
> compliance with federal and state laws
> marketability of the practice
> percent of the practice being sold (majority or minority interest)
Understandably, investors want to know what kind of return to expect. So potential practice buyers ask themselves, “What’s the likelihood I’ll recoup my investment, and how many years will it take?” A capitalization rate of 25 percent means the investor is expecting to recoup the investment within four years (100/25 = 4, where 100 = investment and 25 = rate of return).
Unfortunately, your client list has no place in these calculations. A list doesn’t promise that those clients will remain with the practice—and generate earnings—after a sale. Typically, an investor only wants to pay for what he or she can reasonably be assured to get in return.
Part of the confusion about client lists comes from obsolete U.S. income tax law, List says. The law used to allow a faster write-off of the value of the client list and no write-off of purchased goodwill. So buyers were motivated to put separate values on the client list. “However, that law changed several years ago,” List says. “Current law allows a 15-year write-off of intangible assets, whether that asset is called a ‘client list’ or ‘goodwill.’”
So from a valuation standpoint, a client list has value only in regard to how those clients generate earnings for the practice. And it’s the earnings that truly determine practice value. Still, isn’t there more to consider? Doesn’t a client bring more than just dollars? What about the value of the relationship?In the October 2007 issue of The Harvard Business Review, a trio of researchers asserted that when determining client value, most analysts fail to take one very important factor into account: how many new clients a happy client generates. “A client’s true lifetime value incorporates her own expenditures with the business as well as the expenditures of new clients she refers, or her Customer Referral Value,” the report states.
Dr. Damon O’Gan, co-owner of Austin Equine Associates in Driftwood, Texas, agrees with this way of thinking. “The financial reward of one good client is worth a fraction of the goodwill a happy client provides,” he says. “If we take good care of a client, it often results in five new clients directly gained by the satisfied owner’s referral.”
To illustrate, Dr. O’Gan shares a story about a new client who brought in a miniature donkey that was having difficulty becoming pregnant. “We weren’t terribly excited about dealing with the breeding of miniature donkeys, but we’re always happy to meet a new client,” he says.
Not only did this new client turn into a regular customer and a good friend, but her influence in the industry benefited the practice in far-reaching ways. “She’s our loudest cheerleader and has brought numerous new clients from various disciplines to our practice in a very short time,” he says. “Reputation is critical in equine practice, and it’s the client who perceives and spreads a good reputation that results in more growth than any amount of advertising I can imagine.”
Dr. Williams believes it’s important to focus energy and attention on these cheerleaders—or, as he calls them, “advocates.” “The value derived from an impassioned advocate who makes numerous referrals has the potential to outweigh the value derived from a big spender,” he says. “In my practice, we want to identify—and cater to the needs of—our advocates just as thoroughly as we do our big spenders.”
Dr. Keith Brady, co-owner of Old Dominion Equine Associates in Keswick, Va., says his practice has three types of clients: type A—clients who know him and use his services; type B—potential clients who know him but use a different practice; and type C—potential clients who don’t know him and don’t use his services.
“Our philosophy is to spend 95 percent of our effort on type A clients, 5 percent on type B clients, and forget about type C clients,” says Dr. Brady. “Equine practices often have a few prominent owners or trainers who control large swathes of revenue, so maintaining good relationships with them is paramount to our success.”
“Shouldn’t a client relationship be worth something?” asks Dr. Brent Cook, co-owner of Kingsbrook Animal Hospital in Frederick, Md. “We’ve invested significant dollars to get clients, worked long hours to keep them, and spent years teaching them to be responsible pet owners, so that definitely has value—but it’s the relationships that we value. Remember the last time one of your clients requested his records? Was your first thought, ‘I just lost $2,433 over the course of the next few years?’ Or was it, ‘What didn’t they like about me?’”
When it comes to the value of a client relationship, I agree with all of these doctors. It’s not just about the money—it’s also about the relationships, the referrals, and the fact that you like your best clients and they’re fun to work with (most of them, anyway).
“As a veterinarian, I can’t stand the thought that someone may not like me,” admits Dr. Cook. “Oh sure, I like it when clients pay for our services, but what really makes me smile at the end of the day is when a client says something nice about me or a staff member, sends us a gift, bakes us a cake, or writes a note thanking us for what we’ve done. What I really crave from my clients is a relationship. And you can’t put a price on that.
Denise Tumblin, CPA, is a Veterinary Economics Editorial Advisory Board member and the president and owner of Wutchiett Tumblin and Associates in Columbus, Ohio, which offers management advice as well as valuation and acquisition services to equine and companion-animal practices.