ORLANDO — Before you sell your O&P practice, you must address several questions that will help you determine how much your business is worth to a potential buyer, according to a speaker at the O&P World Congress, here.
Barry Smith, Esq, owner, Lloyds Capital Inc., noted the detrimental effects of recovery audit contractor (RAC) audits on a practice’s value. Some businesses are no longer sellable because of compliance problems, while others have gone out of business.
“If you haven’t faced the issue yet, spend a few thousand dollars getting an expert to come in to make sure you are compliant,” Smith said.
Value of your business
Smith said the typical practice is worth somewhere between three and six times its annual net cash flow.
Figuring your worth is part science, part art, Smith said. “The key is figuring out what your net cash flow is. That is what will drive the value of your business.”
It is a myth that a bigger business is worth more; profitability trumps business size, Smith said. “If you are not profitable, your business may not be sellable. If it is profitable, the amount of profit you have will dictate the price.”
Other factors come into play in determining valuation, including the business size, number of locations, reputation, up or down sales trends, number of contracts and with whom, personnel, compliance, and if you are willing to stay on once the business is sold.
Buyers were more plentiful a few years ago, Smith said. Now, RAC problems have made it more difficult to court potential buyers.
To bigger buyers, your location is important too. “If you’re in a place where everybody else has sold, the buyers have enough dots on the map. Geography is not necessarily interesting to buyers now. The low-hanging fruit has already been sold.”
A local competitor may present itself to be a potential buyer but Smith warned that a local company may not actually have the money to buy, and may simply court you to find out more about your business.
“There are a few venture capital and regional firms that are buying, such as Level 4 [Orthotics & Prosthetics, N.C.], but they are buying selectively. The major players are Hanger, venture capital firms and the local competitors.”
Selling your business to current employees may be tempting, but “those deals are tough to do,” Smith said, primarily because often the money is not there.
“Banks and the SBA [Small Business Administration] don’t like to finance because of the problems, reimbursements are bad, etc. If you have to do a deal with an employee — and that might be your only choice — they can be done, but you have to think carefully about how you structure the deal.”
Sell the entity, stock or assets
Most transactions involve stock, Smith said. Most sellers want to sell stock, but most buyers would rather buy assets because of the benefit at tax time.
“Think about this. [The buyer will] inherit all the problems that owning that stock brings with it. If that company has problems, RAC problems — you just bought my problems. Payroll tax problems? You bought my problems. So buyers are reluctant to buy stock, but in the final analysis, stock transactions are quite common and the way you want to go from a tax standpoint.”
Every transaction is different, but the seller usually doesn’t sell cash; if you have money in the bank, you keep it. A buyer typically gets the receivables and payables. And if there is any debt, such as bank loans or SBA loans, that debt is your responsibility as a seller to pay off at closing.
“Buyers don’t want to buy your business and then have to pay off the bank that loaned you money in the first place,” Smith said.
How to get paid
Transactions are rarely done in cash; most depend on a promissory note or earnout, Smith said. Cash or a note are guaranteed. An earnout is a payment made to the seller during the first year or two, based on the practice achieving an agreed-upon collection target. Earnouts are not guaranteed.
“I don’t know anyone who likes earnouts,” Smith said. “Buyers don’t like them because they are a pain in the neck. Sellers certainly don’t like them. So if you have been doing a million dollars in sales for the last 3 years …maybe 10% or 20% of the purchase price is left on the table and is paid to you in a year or two predicated on your business continuing to do a million dollars a year. If you hit the target, you get the money. That is the buyer’s way to protect themselves and a way to keep the seller focused and not become an empty suit. Sellers hate that because they want to get all their money upfront. Buyers aren’t in love with earnouts because if a deal goes bad, it is usually because of earnouts.”
Smith said a safety net may be built into the earnout so if the practice falls slightly short of the goal the seller would still get paid a percentage of the earnout.
“But if you’re not even close to the target you may lose the earnout payment. You have to have a fair [selling] price. The buyer won’t want to pay you those last few dollars because they’ll feel like they’re paying too much.”
A promissory note is a way for the seller to help the buyer finance the transaction. The seller may carry the note for a few years and expect to get monthly or quarterly payments. Smith said notes give buyers leverage; if they’re looking to buy more than one business, they don’t have to invest all their money into just one.
“Also, if you sell and there is a problem with the business — RAC audits, IRS problems, lawsuits — as a buyer, I can offset that damage by accessing whatever money is in the note. So you have to stand behind the fact that if you sell your business, you are responsible for the problems that happened up to the point of the sale. And that note effectively becomes a hammer to make sure that you have told the buyer everything and that there are no issues.”
Time to sell?
Smith said the time can vary from 3 months to several years to sell your business. Currently, many businesses are looking to sell and buyers are being very selective.
“Many people who want to sell are selling for the wrong reasons; they are scared, they have cash flow problems or RAC problems, they just want to get out, and the pipeline is getting clogged,”Smith said. A particularly attractive business can ‘jump the queue,’ he added. If multiple buyers are calling, the process can take longer, but that is not a problem for most sellers.
Well-kept data and good housekeeping can help prevent transaction delays, Smith said.
“Take a long, cold, hard look at the profit and loss statement,” he said. “Make sure your data are clean. Make sure labor costs and cost of goods are in line.” Fix your current problems and agree to talk more in a year. The goal is to make your business as attractive as possible.
“Pull the tax return apart. If I took a normal salary, if I got rid of my kids on the payroll…what would my business look like in the hands of a buyer, from a profit standpoint? Make some changes and some tough decisions before you talk to a buyer.”
The cost to sell a business depends on its size, but typically ranges from $2,000 to $4,000 in fees, with commissions of 3% to 5%, Smith said. Additional costs might include an accountant to help clean up the books and a lawyer, who should only be involved if a deal is struck.
You can expect to indemnify the buyer, meaning that you will hold it harmless for litigation that happens post-sale for events that happened before the sale.
“Whatever went on with that business to the point of sale, it is your problem. Even if it raises its ugly head a year later, it is your problem. A buyer is going to want you to indemnify it for those issues. They will defend against that lawsuit, they’ll deal with the RAC audit, but if the net result of that issue is a $20,000 fine or $100,000 judgment, they’re going to look to you to bail them out because it happened on your watch. That is why they want you to hold a promissory note for 3 or 5 years, so if you say, ‘I’m not going to indemnify you,’ they can offset that money against the note they still owe you. That is the ultimate hammer.”
Best time to sell
It seems counter-intuitive, but Smith said the best time to sell is when your business is booming.
“Most people don’t want to sell then; you think ‘Look how much money we’re making! Just another couple of years to slay this pig and I’ll be fine.’
“But then something happens. The wheels come off, someone dies, an employee leaves and takes half the business with him and starts their own office across the road. And then [a buyer] calls, and you say ‘Can you help me?’ and the answer is, ‘Yes, but now your business is only worth 50% of what it was a year ago.’
“The time to sell is when things are so great you can’t stand it.” — by Carey Cowles
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Disclosure: Smith is owner of Lloyds Capital Inc.