We define a single corporate Buyer’s Valuation of a specific veterinary practice as follows: Buyer1 Valuation = Buyer1 Normalized EBITDA x Buyer1 Veterinary Practice EBITDA Multiple. Buyer1 Valuation is how Buyer1 values the Practice. By implication, Buyer2 (another potential buyer) may generate a different veterinary practice valuation (Buyer2 Valuation) for the same practice with the same information.
Note that a single Buyer’s Valuation is not the same as the “True” value of a practice. Also, the Buyer Valuation may be much higher than the purchase price offered. Sellers only see the buyer’s offer price, which may differ from the Buyer Valuation. We discuss the reasons for this in several articles on this site.
*Veterinary Practice EBITDA stands for Earnings Before Interest Taxes, Depreciation and Amortization.
Buyer’s Determination of EBITDA
This analysis is relevant to valuation in the context of a practice sale.
A buyer, particularly one with private equity backing, wants to estimate the current, stable, annual cash earnings power of your veterinary clinic in a corporate setting. This estimate is the Normalized EBITDA. Right away you should see that there is subjectivity in deriving this important metric.
It is a two-step process:
1. The easy part: calculate Last Twelve Months EBITDA (an industry proxy for cash earnings or cash flow) of the practice by adding interest, income taxes, depreciation and amortization to operating earnings.
2. The hard part: Normalize the EBITDA so that it is stable, and reflective of a certain corporate environment. This is the input a buyer needs to determine what your practice is worth. Each potential buyer is likely to get a different answer at the end of the “normalization” process.
A Buyer Considers Three Types of Adjustments to EBITDA in Order to “Normalize”
1. Smoothing adjustments to address one-time expenses or benefits that cause variation which is not expected to re-occur. Nearly any expense is a candidate for one-time adjustment depending on the circumstances.
2. Acquisition adjustments to eliminate expenses, or benefits in the EBITDA that won’t carryover to the buyer’s organization. Here the buyer is calculating: “what veterinary clinic level EBITDA could this practice generate if I dropped it into my corporation?”. This is where the buyer strips out personal or practice owner expenses. It is also where a buyer may estimate the impact of corporate buying programs, or process efficiency technology.
3. Pro Forma adjustments are adjustments to reflect the current operating profitability of the business. These adjustments can be diverse depending on the practice so here is an example: If a doctor joins a practice two months before the practice is sold, only a portion of that doctor’s annual production will be included in the last 12 months of EBITDA. Without a normalizing adjustment last twelve months EBITDA will under-state the annual earnings power of the practice. There are many other potential adjustments in this category
What Does a Buyer Need to Calculate Normalized EBITDA?
No potential buyer can determine a Normalized EBITDA, and subsequently the valuation of a veterinary practice without access to your financial statements and other operational statements. Of course, these statements have no context if the buyer does not also have the ability to ask questions of the veterinary practice owner. If you have received an offer letter from a corporate, you should ask: what information did he use to get the valuation implied by the offer?
Unless the buyer has seen your financial statements and had a chance to discuss them with you, the offer is based on very little, and likely worth very little. Any valuation multiple suggested by the offer should be taken as highly preliminary
Unless you go through the process or normalizing your EBITDA, you won’t know what the buyer is concluding with respect to his normalization process. If a buyer identifies a potential adjustment that increases your Normalized EBITDA, he may choose not to include it in his valuation, or “give you credit.”
