Introduction
Buying a business fulfills a lifelong dream for many people, and many who take this leap of faith look back on the decision to work for themselves as one of the best decisions they made in their lives. The buying process, however, can be complicated, intimidating, and full of opportunities for missteps. As an audiologist, you probably did not learn about how to buy a private practice in school, so you are entering foreign territory and need to prepare yourself for the journey ahead.
In this article, I will attempt to shed light on some of the key actions to take and important decisions to make when buying a company. These tips are based on real-world experience and illustrate examples from real deals that have taken place in the audiology industry. Please note that while the article refers to audiology practices, the concepts apply equally to hearing aid dispensing businesses.
Tip #1: Decide on Acquisition or Start-up
Before you get too far into the buying process, you have to choose from two divergent paths: buy an existing business or start one from scratch. When evaluating the pros and cons of each, focus on two key aspects: availability and return on investment. In a small industry like audiology, you will not find a large number of businesses for sale at any one time. If you cannot locate one, this decision is easy; assuming you can, however, the decision comes down to comparing the potential return on your investment for each scenario.
Without turning this into a detailed lesson in corporate finance and investing, consider how much money you can afford to invest, how much you must borrow, and what the payoff will be on both a short-term basis (annual income) and over the long-term (income growth; ability to sell the company for a gain). When you start a business from scratch, you control your investment because you choose the equipment, lease, and operating budget. You may find that starting a business from scratch costs less in terms of real dollars spent, however, generating income from that investment takes time. You have to find patients, and they have to find you. Ask anyone who has started a business - you don't make money overnight, and you'll be lucky to pay yourself anything at all in the first six months.
When you buy a business, you have less control over the investment because the equipment, lease, and operating budget already exist; you also have a seller who has a price in mind and ultimately has to accept your offer. In exchange for your investment, however, you inherit a stream of income that already exists. While you may have ambitious growth plans to take the business to new heights, you don't have to worry as much about where your next paycheck comes from in the meantime.
Both acquiring a practice and starting a new business has its pros and cons, and thus the decision becomes a function of evaluating the option that provides you the biggest reward for the risk you are about to take.
Tip #2: Location, Location, OK, forget Location
I am constantly amazed when a first-time buyer tells me they are not interested in a practice because it is too far from where they live. I'm not referring to an audiologist in Texas looking at a practice for sale in Vermont; instead, I usually hear it from a person living in the same metropolitan area as the practice, just 20 miles away. In a field as small as audiology, the chance of finding a practice for sale within walking distance of your home is remote; in fact, you may not have any in your town (for sale or otherwise).
Location is an important factor in the buying decision, but it has nothing to do with proximity to home - frankly, if your primary objective is to shorten your commute, you need to re-evaluate this decision. Much more important factors should weigh in to your decision. As you compare cities, analyze the demographic trends, competition, and any unique taxes or legal requirements. When analyzing the specific location of a practice, determine whether it offers easy access, parking, and good visibility from the street.
Market research will help you to better understand the future prospects of the business as well as its competitive position. If the population of the city or county is declining, you will have fewer potential customers and thus risk a decline in future sales. If the business is located in a market with average income (relative to the rest of the state), yet primarily sells high-end hearing aids, you may be looking at a business that has positioned itself as the premier hearing care provider in the area.
While it is critical to conduct this type of market research, don't get hung up on it. You can find great buying opportunities in low income or highly competitive markets. If a practice is in a neighborhood with unimpressive demographics and the business primarily treats third-party patients, it's probably not your first choice. But what if the owner has been trying to sell it for years because of these very issues? He or she may reach a point at which they will sell it for any price in order to be able to retire, and you can buy it at a steep discount. You know that over time you will need to either improve your patient mix or relocate the business, but until you decide on an action plan you can take advantage of the existing patient base and therefore existing cash flow.
Tip #3: Seek Expert Advice
In order to successfully complete a transaction, each buyer and seller needs to seek two types of advice: legal advice, and financial or business advice. Unless your university offered a joint Au.D./M.B.A. degree, you probably don't have experience with business valuations. In order to interpret the finances of your target company and determine an appropriate and affordable purchase price, find someone to help you, preferably someone with experience analyzing audiology practices. Many manufacturers and buying groups offer this type of service for free in hopes of receiving future business from you. A few independent consultants and business brokers specialize in this industry, and they can help you through the entire process from suggesting a purchase price to negotiating terms and completing due diligence.
Make sure that whoever you hire to give you financial advice has audiology industry experience. You can find hundreds of CPAs who offer valuation services, but if they do not use the specific valuation methods that are appropriate for this industry, they may provide inaccurate advice. Consider the rare, but in this case true, example of the owner of a practice worth $1,000,000 trying to sell it to one of her employees for only $450,000. Seems like a steal, right? Not to the buyer. She consulted with a CPA who appraised the business using the wrong techniques, and told her that the maximum she should be willing to pay was $200,000. The buyer could easily have received financing for much more than the $450,000 asking price, and the business generated enough cash flow to cover the loan payments and allow the buyer to give herself a raise. Instead, she lost the opportunity due to the miscalculation in the valuation she received.
Upon completion of your financial analysis, you will need to seek legal advice. Hire an attorney to help you draft a Letter of Intent and a Purchase Agreement, to review all of the loan documents, and to help you negotiate the legal terms of the deal. Make sure that the attorney you hire has experience in transactional law and has completed deals of a similar size.
The best attorneys charge upwards of $250 per hour, and it can be tempting to try to limit your attorney's involvement in order to save money. While I am not advocating fiscal irresponsibility, realize that a few extra hours of your attorney's time are worth a lot more than the hourly rate if they help you complete the deal and reduce your exposure to liabilities.
I once participated in a deal where the buyer was pinching pennies on attorney fees. Her attorney wrote the Purchase Agreement, and the seller's attorney responded with changes. Up to this point, it was like every other deal. Next, however, the buyer decided she wanted to avoid any further legal bills and tried to interpret the changes on her own. She ended up making a number of false assumptions and responded inappropriately to the seller's attorney. The deal died, yet if she had allowed her attorney to do his job she would have avoided these mistakes.
Tip #4: Be Patient with the Seller
More likely than not, the seller has as much experience selling businesses as you do buying them. Most people only sell a company once, and it represents the largest financial transaction of their lifetime. Expect the seller to have a certain amount of trepidation at the outset, as he or she will be sharing intimate secrets about the company and his or her personal finances with someone they just met. Imagine showing your personal bank statements and credit report to someone on a first date.
Don't be surprised if the seller is not prepared to answer all of your questions or provide all of the information you request, especially if they have not hired a broker and are attempting to sell the business themselves. They may ask you to explain why you need specific information at various stages in the process, and some people may even refuse to cooperate. Other than a failure to agree on the purchase price, the biggest deal killer can be a dispute over the information a seller is willing to share. As a buyer, you need to understand the financial and operational details of the company, and should not close until you are satisfied; however, you also need to understand that sellers may not wish to disclose certain pieces of information until they have qualified you as a buyer.
Consider the following example. The owner of a multi-location audiology practice provides a potential buyer with tax returns, financial statements, and some key statistics about his business. The buyer responds asking for greater detail, including individual financial statements for each location.
Unfortunately, the seller does not maintain these statements, and would have to pay an accountant to compile them. He tells the buyer, "Make me an offer, and if I like it I will ask my accountant to provide you with everything you want." The buyer does not like this response, and refuses to make an offer without the information. The two arrive at an impasse.
Who is right in this scenario? Clearly, the buyer should not take an unnecessary risk just because the seller does not track his business effectively, but in this case I think the seller is right. The seller did not refuse to provide the information; instead, he wanted to make sure that he was dealing with a qualified buyer before he went through the time and expense to compile it. The buyer could have avoided this conflict by taking the following steps:
- Assume everything that the seller tells you is true. This may sound naïve, but the point is that you should ask yourself this question: if everything the seller tells me is true, do I want to buy this business? If yes, how much am I willing to pay?
- Make an offer that is subject to due diligence. Due diligence is the detailed research and analysis of a company that you will conduct prior to completing the transaction. In structuring your offer this way, you give yourself the ability to walk away from the deal if you are not satisfied with the results.
- Once the offer is accepted, use due diligence to answer any open questions about the business. Due diligence is complete when you have satisfactory answers to about 80% of your questions. A 100% satisfaction rate would result in an absence of risk, and if there was no risk nearly every person in America would own a business.
- Make sure your attorney includes a Representations and Warranties clause in the purchase agreement. This helps protect you against false claims made by the seller and certain unpredictable liabilities.
Financial statements also create an opportunity for a dispute between buyer and seller. Understand that most small businesses are managed to reduce their tax liability by showing very little profit on their tax returns. On the surface, a business with $500,000 in sales and only $13,000 in net income appears distressed. Look beyond these numbers to determine what the profitability will be once you take over. You are likely to find a number of expenses that do not relate directly to the operations of the business and that can therefore be reduced or eliminated once you take over.
Examples include the owner's compensation; owner's treatment of a personal car and cell phone as a business expense; and, rent that exceeds fair market value because the seller also owns the building.
By conducting this exercise, you may find that once you own the business you can pay yourself a healthy salary, make your monthly loan payments, and show a stronger profit at the end of the year. Then, it's up to you and your accountant to determine your tax strategy.
Tip #5: Watch Out for Warning Signs
Almost every business owner can tell you a cautionary tale that begins, "If I only knew then what I know now..." Understanding what to look for when evaluating a practice will make this lesson less painful. The following are five potential warning signs:
- Inconsistent financial statements.
A seller should be able to provide you with tax returns, income statements, and balance sheets for the 3-year period leading up to the sale. Compare these statements and make sure they align. If you see small differences between them, it's probably due to IRS regulations or specific recommendations made by their accountant; for example, a health insurance expense may appear on the Income Statement, but the owner may choose to treat it as a deduction on their personal tax return (which you won't see) rather than the corporate return. A good financial analyst or broker can help you decipher which discrepancies are normal, and which should be questioned.
- Abnormal or inexplicable fluctuations in sales.
Sales may fluctuate from year to year based on changes in the economy, third-party payers (either due to changing reimbursements or the timing of eligibility renewals), or one-time personal events that distracted the owner or an employee from giving the business their full attention (i.e. a divorce, or the death of a spouse). If you see random fluctuations in sales, find out why. If they prove to be unpredictable, be conservative in your approach. It may still be ok to buy the business, but bring your expectations in line with the lower years in order to avoid setting yourself up for failure.
- Hyper-growth in the most recent year.
Declining sales are an obvious red flag, but what if I told you a rapid spike in sales can be just as worrisome? A number of things can contribute to growth, and most of them are as good for you as the buyer. The few that are not include heavy discounting, that creates a short-term spike in sales without a corresponding increase in profitability; and acquisitions, which can signal that future growth may not come organically.
- Reliance on third parties.
This is a key issue in all areas of healthcare, albeit one to which the hearing aid industry is much less exposed. Many practices are fortunate enough to have a patient base largely composed of private pay patients. People pay cash, Accounts Receivable balances are low, and owners are happy.
Be wary of businesses that have a high concentration of third-party patients. Make sure you understand the reimbursement structure, and the risk of reduction or discontinuation. Understand the market and the local role of the specific third party. If you are buying a business in the Detroit area, for example, you are compelled to become an authorized provider for the United Auto Workers (UAW). The auto industry has such strong ties to the area, even today, that an owner would be unwise to ignore it. There is a big difference, however, between a business with a payer mix of 30% UAW and 70% private pay, and one that is 80%/20%. The dominance of the UAW in the latter practice creates three problems: 1) risk associated with the potential for reduced reimbursements in the future; 2) the extra overhead created by your need to hire a biller; and, 3) the delay between provision of care and payment, which can exceed 90 days in some cases.
- Poor key performance indicators (KPIs).
Look for key indicators of performance, including hearing aid return rate, binaural rate, average selling price, and Cost of Goods Sold as a percentage of sales. In general terms, a practice performing at a high level will have the following:- Return rate,
- Binaural rate,> 80%
- Average selling price,> $1,800 per hearing aid
- Cost of Goods Sold = 30% of sales
There are two ways to look at a practice that does not meet these standards: it's either a cause for concern, or it presents a tremendous opportunity for a new owner to grow the business by improving these areas. Consider the example of average selling price (ASP). A practice with an ASP of less than $1,800 may sell a high concentration of lower-end technology, or it may price its products lower than the market average. If due to the former, this in turn can be due to a high concentration of third-party payers that define which products can be sold, or to poor sales skills by the audiologist. Salesmanship and pricing strategy will be yours to control once you take over, and in this case, the low ASP may be an attractive growth opportunity.
In reality, very few businesses meet every single one of these criteria. Most of the time the owner simply doesn't measure these KPIs and is thus unaware of the need for improvement, or there may be an issue that is out of his or her control. For example, an owner can't do anything about the caps set by third parties, other than to diversify the patient mix and reduce reliance upon any particular third party. If you come across such a practice, evaluate the average selling price of all hearing aids sold to private pay patients; if the ASP is where it should be, the problem is the patient mix, and you can establish diversification of the patient mix as one of your first goals.
Conclusion
If buying a business were easy, everyone would do it. Expect it to challenge you, create doubt, and test your resolve. Use these tips to approach an acquisition with the knowledge and patience required to make it a success.
