Dr. Bob Deckett has been the sole owner of Heritage Veterinary Hospital, an equine and companion animal practice in the Northeast, for 15 years. His business has done well; in fact, he recently expanded his facility to include a treatment and haul-in area for his equine practice.

For two years now, he's been thinking about sharing some of the risks and responsibilities of ownership with one of his associates. "While I don't plan on abdicating all of my owner responsibilities," says Dr. Beckett, "it would be nice to spend more time fly fishing in Montana, knowing that someone is back at the practice maintaining momentum."

Dr. Beckett employs two full-time associates: Dr. Amy Rice, who joined the practice in 2001; and Dr. David Thompson, who joined in 2005. A third associate works only during the breeding season. In September 2005, Dr. Beckett decided to offer Dr. Rice, a hard-working, smart associate who's well-liked by clients and staff, a 20 percent interest in the practice. Everything went smoothly at first.

To start the process, Dr. Beckett needed to know the value of his practice. He was hoping it was worth at least $1 million; if it was, he'd feel comfortable going forward with the buy-in. If the value came in lower, we'd determine what management changes he needed to make to hit his goal. Then, we'd re-calculate the value in a year.

Happily, the practice valuation came in at $1.1 million, with a net asset value of $200,000 and a goodwill value of $900,000. So Dr. Beckett began taking the next steps in the sale process.

Two weeks before signing the agreements, Dr. Beckett got cold feet. He'd been thinking about how his share of the owner profits would decrease once Dr. Rice became a partner. He called in a panic. "Cynthia, it looks like I'm giving Dr. Rice the money to buy my practice," he said. "When Dr. Rice buys 20 percent, she'll start receiving 20 percent of the profits, and she'll use these profits to make payments to me. Why should I sell to her? Wouldn't I be better off keeping the practice and all of the profits until I'm ready to leave the practice for good?"

A few days later Dr. Rice called in a panic. "Cynthia, it looks like I'm paying a lot of money to buy a 20 percent interest. Wouldn't I be better off leaving and starting my own practice?"

Why sell to an associate?

Figure 1. Dr. Beckett sells 20 percent

Drs. Beckett and Rice aren't alone in their concerns. Selling or buying a part interest is a significant decision. Yet despite these concerns, it's a good transition strategy. Consider these reasons why Dr. Beckett initially decided to sell a part-interest to Dr. Rice.

• Continuation of the practice. After starting it from scratch and seeing it grow in size and reputation year after year, Dr. Beckett wants his practice to continue to prosper. He knows that no one will run it exactly the way he does, but he also knows that under Dr. Rice's direction, the practice philosophy will remain focused on what's best for the patient. Growing owners from within is the best way to accomplish this—it allows for a smooth transition over time.

Figure 2. Gain from selling a 20 percent interest

• A planned exit strategy. While Dr. Beckett has no plans to retire soon, the shareholder's agreement also requires Dr. Rice to buy Dr. Beckett's remaining interest at the appraised value when he retires. He knows of colleagues who waited until retirement to sell. Some found it took years to find a buyer. Others witnessed buyers using the leverage of the seller's retirement to negotiate a deeply discounted price. He has also witnessed the winding down of a nearby practice as the seller approached retirement age, which sharply cut the value by the time the owner actually retired and sold.

What's the immediate financial effect?

Figure 3. Dr. Rice buys 20 percent

Dr. Beckett will finance Dr. Rice's 20 percent down payment and will set the interest rate at 1.5 percent over prime. In today's market, that's an attractive return that will increase as the prime rate increases.

The gain on the sale of Dr. Beckett's stock will be taxed at the federal capital gains rate of 15 percent versus his ordinary income rate, which is 33 percent. His after-tax income on the sale proceeds would be greater than his after-tax income on owner profits of the same dollar amount.

A seller's affordability analysis shows Dr. Beckett how much better or worse off he'll be in the next seven and 10 years if he sells versus if he keeps the 20 percent interest for himself. (See Figures 1 and 2.)

"Seeing how my value would differ if I solely owned versus if I sold a part interest to my associate was by far the biggest eye opener for me," says Dr. Beckett. "If owner profits grow by only 3 percent more with Dr. Rice as a co-owner, in 10 years, my added personal net worth from selling is $198,000." In 15 years, it would grow to $792,000.

While Dr. Beckett feels confident that Dr. Rice's increased involvement, commitment, and efforts as an owner will mean greater owner profits, it's wise to look at what needs to change financially to achieve these results. Dr. Rice's average per doctor transaction (ADT) is currently about $12 lower than Dr. Beckett's. Reviewing their appointment schedule shows that their outpatient, inpatient, and surgery caseloads are fairly balanced. If the difference in Dr. Rice's ADT is due to missed charges, her ADT would need to increase by $2 to achieve the 9 percent increase in owner profits. If the difference is due to the level of care, her ADT would need to increase by $3 to $6. The reason Dr. Rice's ADT would need to increase more in the second scenario is because there would be some added cost to providing the added services, so the ADT would need to be higher to cover those additional expenses.

Why should an associate buy?

Dr. Rice enjoys working with Dr. Beckett and feels they share the same philosophy. She knows there are several reasons that buying a part-interest is the right decision:

• A practice philosophy that revolves around what's best for the patient. Dr. Rice supports and values Dr. Beckett's philosophies regarding patient care, client care, and ongoing staff development.

• A reasonable balance in her personal and practice life. She knows that ownership requires a greater personal investment and that the time involved in starting her own practice would be extensive. At Heritage, the infrastructure is in place—a steady stream of patients, an experienced staff, and fully equipped exam rooms, treatment areas, and surgical suites.

Sharing ownership also allows time away from the practice and shared on-call time. This would be more challenging as a sole owner. If she starts her own practice, she'll work solo for several years until the practice grows large enough to support an associate. She knows a colleague who started his own mixed-animal practice last year and his workweeks easily exceed 60 hours.

• A shared interest in the value created by her efforts. She doesn't want to remain an employee forever. She sees the investment value of a practice as being necessary for her future financial security, and she likes the idea that the value of her interest will grow with her efforts.

Can the associate succeed financially?

Figure 4. Added value from buying a 20 percent interest

A buyer's affordability analysis helps Dr. Rice see how her income will increase as a result of receiving her 20 percent share of owners' profits and 20 percent of the practice-management fee, how her income will decrease by the cost of her quarterly principal and interest payments, and how income taxes will affect the bottom line.

If she finances her buy-in with a 20 percent down payment, over seven years at prime plus 1.5 percent, her after-tax cash flow will increase by $19,500 in seven years and more as time goes by. (See Figure 3 and Figure 4.)

Like Dr. Beckett, Dr. Rice has a vested interest in growing owner profits and practice value. Her added value as an owner of Heritage helps make her decision. In seven years, after her payments are finished, her added personal net worth grows to approximately $398,000. If she remains a 20 percent owner for another three years, her added value grows to $575,000.

Can you afford not to sell?

Cynthia R. Wutchiett

Veterinary Economics Financial Editor Cynthia R. Wutchiett, CPA, is president of Wutchiett Tumblin and Associates in Columbus, Ohio. Please send questions or comments to: ve@advanstar.com