IN AND OUT

SAYING GOODBYE

Creating an exit strategy when it’s time to leave your retail optical business

BY COLLEEN HANNEGAN

The day you open for business is the beginning of a story that will some day have an ending. You will, at some point, leave your business. That’s a thought so far away from opening day that the majority of owners never take the time to include it in their business plan.

Whether it’s two years or 40+ that you will own your business, you need an exit strategy. It’s important to face this future fact with a well-planned strategy early on.

When I opened my optical store in 1990, the big question on my mind was whether it would survive that first year, not how to prepare to sell it 22 years later.

Two years before eventually selling (in 2012), I woke up to the fact—and figures—that it was time to get ready. At that point, I employed part-time staff as needed, but handled all the day-to-day operations myself. There was an on-site lab for finish work and an inventory of 1,200 frames.

Business had always been steady with dependable income…until optical insurance issues, a changed economy, competition, location, and the simple fact I was ready to shift gears and let go…led me to seriously considering the sale.

Holding on through two difficult economies, three moves, a divorce, and the worst recession since the Great Depression, I’d never thought I’d ever be ready to sell. I loved everything about owning my own business and had never considered leaving it. Nor had I ever heard the term “exit strategy.”

The next two years were focused on researching, creating a plan, and, fortunately, finding the perfect buyer. My only regret? That I hadn’t planned years earlier, while the business was at its most profitable and before the need was pressing.

In the process of planning during those two years, I learned five important things about creating a great exit strategy.

1. VALUE OF THE BUSINESS

Beyond the tangible assets, the fair value of your business includes intangibles such as goodwill. This is referred to as a going concern value. Essentially the value of the physical assets working together is worth more than if sold separately.

“Understanding your current market value, projections for long-term growth, and building an exit plan are too often overlooked. Every owner should have an exit plan because one way or another they become a seller at some point,” says Scott Daniels of Practice Concepts in Orange County, CA, who became my business broker.

“Your net profit after paying yourself a reasonable wage for the same job type is one of the main factors in valuing a business using an income approach,” explains Daniels. “A buyer will need to earn an income while paying any loans needed to acquire the business. Recording all income, keeping good organized books and records, and categorizing those discretionary owner expenses will help maximize the value of your business. Apart from that, the intangible goodwill or emotional side might include good reviews, a clean interior, or good ‘sidewalk’ appeal.”

Bringing in an expert opened my eyes to the complete picture of what my business was worth. I knew I had a successful business to sell to the right buyer. But I learned from Scott where the hidden treasures were in adding up the complete assets. My buyer would be purchasing more than frames, lab equipment, a lease, and location. A positive reputation, a happy and productive employee, a satisfied-client history of 22 years, and clean credit all added dollars to the deal.

2. EMPLOYEES = TOP ASSET

Take a closer look at your key employees and ask yourself: Do they add value? Are staff changes needed? Will salary, bonuses, other incentives, and encouragement motivate them to stay?

In my case, I asked my daughter, an optician employed out of town, to move back and work full time at the shop. Reducing my own salary in order to afford a full-time salary and medical benefits for a key employee would create better value for my sale.

If she worked with me for the two years before selling the store, we might ease the transition for our faithful clientele. Plus, she would likely stay on as lead optician—a win-win offer.

This worked out well. The new owners bought an existing business that carried forward the good will of a full-time employee with established client relationships.

3. HIGH DOLLAR, LOW LIABILITY

Making sure that your bookkeeping records are current and taxes are filed and paid is paramount in planning your sale. Whether you are a sole proprietor or a multi-office corporation, keeping financial and corporate records organized and in easy reach is a strong foundation for a smooth exit. Working with my business attorney and CPA, all state filings and amended taxes were completed and all business accounting was up-to-date months before putting the business up for sale. Ask your CPA if being a “C” or an “S” corporation is in your best interest when selling.

Besides an accountant, also speak with a tax professional (see sidebar, page 41).

The goal? To create team-coordinated planning that includes an experienced tax planner who can pinpoint any tax problems and research, identify, and facilitate the tax solutions; utilize tax authorities and your CPA to validate structure under tax law; and rely on a brokerage professional to guide the sale.

4. DEFINE POST-SALE PLANS

Papers are in order, the books are tidy, key employees are in place, the business is running smoothly, and potential buyers are knocking at your door. What next?

Time spent honestly evaluating life beyond this business you’ve nurtured and worked very hard to make successful is also a part of the exit strategy.

To make a transition, I needed funds to pay off business debt plus income enough so I could take two years off. After many years working single-handedly six days a week, I was physically ready to ease out of long retail hours. Finding an optometrist as buyer was right for me.

5. ARE YOU (EMOTIONALLY) READY?

If you could keep the business, reduce your work hours, and offer a key employee the day-to-day management duties, would this be an acceptable alternative to selling? Maybe what you really need is a vacation.

Then imagine YOU without your business. Who are you without it? Is selling a well-planned strategy or a knee-jerk reaction to another need in your life?

Selling was the best choice for me. It was time, and selling was a very good and financially sound business decision. But, I just wasn’t prepared for the emotional letdown and loss of community that came with the territory.

The books I read on exit planning didn’t cover preparing yourself emotionally for the experience. For fuller perspective, I’d add a chapter that explained the change is tantamount to saying goodbye to someone you love with all your heart, and the experience, freedom, and lessons learned are treasures to move you forward to your new world.

While I still very much miss the connection with clients and business friends, I was lucky. I was successful in my desire to see the business and clients I loved continue and move prosperously into the future.

A business consultant, Colleen Hannegan is an ABO-licensed optician with 33 years experience in optical management. www.colleenhannegan.com

SAYING HELLO

How to assess the value of an optometric practice you want to purchase

BY BILL NOLAN

Most doctors go through a long process of deciding what to look for when buying a practice. Unfortunately, during their four years of professional education, there isn’t much covered on the business aspects of purchasing a practice or the realities of ownership. The answers to these concerns will ultimately be premised on one thing: the determination of what a practice is worth.

REALISTIC VALUATION

Over the last several years, the value of optometric practices has declined. Twenty-five years ago, a standard rule of thumb for evaluating practices would be some multiple of gross revenue. It was quite common to expect one year’s gross revenue—meaning that if I had a $600,000 practice, I would expect to sell it for nearly $600,000.

Over the last two decades traditional valuation formulas no longer apply, and the real intrinsic value is closer to 50% or 60% of a year’s collected revenue. An optometric practice is like any business—it is worth a combination of only two things: assets and earnings. It might be helpful to have a common understanding of what optometric assets and earnings really represent. In the following few paragraphs, we’ll look at the commonly accepted formulas used to appraise an optometric practice.

DEFINING ASSETS

First, assets are either tangible or intangible. Tangible assets would include items such as ophthalmic equipment, computers, frame inventory, contact lens inventory, furnishings, and supplies. Some examples of intangible assets would be goodwill or a covenant not to compete. In my experience, the ophthalmic equipment—a large part of any optometric practice asset base—is the most difficult for which to determine value.

Hard tangible assets can be valued using one of three methodologies: book value, replacement value, or fair market value. An understanding of what these terms mean will help you get a better grasp of what these assets are worth.

➡ BOOK VALUE is simply the value of an asset carried on the books of the business. This value generally is acquisition costs net of accumulated depreciation. For example, if in 1990 you bought a slit lamp for $18,000 and its current accumulated depreciation is $12,000 on the company books, this asset would have a value of $6,000.

➡ REPLACEMENT VALUE is the cost of replacing that piece of equipment in today’s market. Using the slit lamp example, if the slit lamp (which was purchased in 1990 for $18,000) was destroyed in a fire and needed to be replaced, its replacement value may be closer to $22,000 or $23,000—the cost of replacing it brand new in today’s market.

➡ FAIR MARKET VALUE is the most subjective of the three accounting concepts, especially as it applies to ophthalmic equipment. It is nonetheless the concept that is most often applied to determining the value of hard tangible assets like equipment.

WHAT IS GOODWILL WORTH?

Once all tangible, physical assets—equipment, frames, contact lenses, etc.—are accounted for, some value needs to be put on the goodwill or “blue sky” of the practice.

Though often misunderstood, goodwill is the expectation of future earnings based on the management skill, know-how, and favorable reputation a business has with its customers or patient base. After an optometric practice is purchased, goodwill is generally transferred to the new doctor, and thus has a rightful place as an intangible asset.

There are many ways to look at the overall value of a practice. Typically, they are the net value of assets, capitalization of earnings, and percentage of revenue stream (though the last is useful mainly for checks and balances for the other two methods).

➡ NET VALUE OF ASSETS is a methodology that determines the net fair market value of the assets previously discussed, including goodwill. Net value of assets, of course, deducts any outstanding debt on the practice at the time of sale.

For example, if a $600,000 practice appraised for $275,000 and is still encumbered by $200,000 of debt, the value of the assets would be $75,000.

In many cases, when an associate doctor buys into an existing practice, he or she may do so through a combination of cash and acquired debt. For example, if I agree to a purchase price of $275,000 to buy a 50% interest, and the practice had $100,000 of outstanding debt, the terms of my buy-in would be $225,000 in cash and $50,000 in acquired debt.

➡ CAPITALIZATION OF EARNINGS values the net earnings of a business as an investment. A cap rate is determined, which is an assumed return on investment for the buyer. Using this methodology, no specific value is determined for the assets, but rather the assets’ ability to produce income.

The trick in this methodology is to determine the true net income of the business. Generally, the net income of the business is all dollars paid to or on behalf of the equity owners, including doctor salaries, allocation of income for things like automobiles, country club memberships, certain insurance policies, and funded retirement accounts. From this total earnings pool, an amount is subtracted that represents the optometric compensation. The balance is the true net earnings of the business. This dollar figure is divided by the capitalization rate to arrive at the overall value of the practice as an investment.

➡ PERCENTAGE REVENUE STREAM is used to determine some sense of value. Currently, good practices are appraising for between 50% to 65% of a year’s collected receipts. This means a $500,000 practice will appraise for between $250,000 and $300,000.

This multiple of revenue is helpful because many banks will not lend money for a practice purchase if the appraised value exceeds 70% to 75% of collected revenue. If a buyer pays more than these multiples as the appraised value, the practice will have a hard time with cash flow to provide an adequate salary for the optometrist and the debt service needed to buy out the practice.

OTHER ISSUES

As important as determining the intrinsic value is to this process, it is by no means the only issue to consider. When buying a dream practice, remember that an optometric practice is unlike anything else you will do in your financial life. There is a small market for potential buyers and sellers wishing to transfer ownership of a practice. Most are other optometrists, which by definition limits the liquidity of the marketplace. Occasionally, some other entity may buy a practice, but these are few and far between.

Location, demographics, and economic vitality of a community are important issues to address when buying your first practice. One additional factor often overlooked is where optometry has a strong presence and is supported by the state’s legislative practice act. There is no doubt that in certain regions of the country our profession has thrived and been a key player in the healthcare debate due to hard-fought battles and victories in state legislatures.

Another key component is the saturation levels of optometrists to populations. The American Optometric Association (AOA) reports a desirable level should be one O.D. for every 7,500 residents in a community. That means that if your target market has a level of saturation of one optometrist to a population of 4,000, you will be in a very competitive and difficult market for short-term growth. Due to the competition in this market, you should be sure to look for a strong and vibrant practice to purchase.

Intrinsic value, as well as location, optometrist/population ratios, demographics, etc., should all be analyzed and weighed. Applying the best of these important factors will increase the odds of successful practice ownership.

Bill Nolan, an executive vice president at Williams Group, has been in practice management consulting since 1989.