Tips for Buying and Selling a Practice – Podcast #157 – The White Coat Investor – Investing & Personal Finance for Doctors

Intro:
This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We’ve been helping doctors and other high-income professionals stop doing dumb things with their money since 2011. Here’s your host, Dr. Jim Dahle.

Dr. Jim Dahle:
This is White Coat Investor podcast number 157 – Buying or selling a practice. This podcast is sponsored by ERE Healthcare Real Estate Advisors. Colin Hart, CEO of ERE, has been a guest on my show and specializes in representing leading physician groups and structuring sale and leaseback transactions on their clinical and surgical center real estate. ERE is a real estate brokers, but takes an advisory approach, expertly positioning their clients for real estate sale as part of succession planning surrounding their practice in real estate investment.
Dr. Jim Dahle:
If you’re contemplating a partnership with a hospital health system or private equity, understanding certain real estate principles can help ensure that you maximize the value and security of your real estate. You can learn more about ERE on their website, ereadv.com, or you can reach Collin directly at [email protected], or call him at 702-839-8737.
Dr. Jim Dahle:
Welcome back to the podcast. It’s great to have you here. We appreciate you tuning in each week and hope that as you travel to or from work, that you are safe both in route and when you get there and that you are able to enjoy your lives as much as you can, given the limitations on them both at work and at home these days.
Dr. Jim Dahle:
Our quote of the day today comes from Rick Ferri who says, “The first step is to figure out which asset class you want to invest in and then figure out the best way to get exposure”. And I agree with that. Too many people start at the end of this process trying to pick investments who would in rail that they should be starting with what assets they want to invest in.
Dr. Jim Dahle:
Okay. It is now what? April 21st today. This podcast is going to be running on May 7th so obviously anything I say here, it may seem out of date by then with how fast the world seems to be moving.
Dr. Jim Dahle:
Lately, I’ve been enjoying The Last Dance, which is the most popular TV series going on right now. This is about the Bulls run back in the late 90s or last season together with Michael Jordan and Scottie Pippen and all those folks. It’s really interesting having lived through it to now look back 20 years later at it and what happened. I’m trying to get over how bitter we are about the Utah Jazz being smoked at the end by the Bulls. But we’ve kind of gotten over that and we’re enjoying the story.
Dr. Jim Dahle:
But the reason I bring this up is I think the second episode is pretty illuminating. In the second episode, they talk a lot about Scotty Pippen and how he was dramatically underpaid. In a lot of respects, it could have been said that he was the second-best player in the NBA at the time, obviously playing in the shadow of Michael Jordan.
Dr. Jim Dahle:
But when they started the season without Scotty Pippen playing, he really demonstrated what his value was. Without him they were getting smoked, they were losing. And it was really interesting to hear Scotty talk about his contract despite perhaps being the second-best player in the league. Certainly, in the top five or so. He was the 122nd best paid in the league. He was nowhere near the top. He was dramatically underpaid.
Dr. Jim Dahle:
And the reason why is he felt like he could not take a risk. That he had to take that contract he was offered years before. I think it was an $18 million contract, which is obviously a lot of money. That he had to take care of his family and he had to take care of him and he had to make sure that he was going to at least meet the minimums. And in effect, he probably left 10 times that amount of money on the table.

Dr. Jim Dahle:
And I think doctors do this a lot. We leave a lot of money on the table because we’re so worried about security or we are so unknowledgeable about the contracting process. So, I would caution you against signing super long contracts like Scotty Pippen did when you don’t really know what your value is going to be in a few years. And really take the time when it’s time to negotiate a partnership contract or an employment contract or any sort of high stakes business contract.
Dr. Jim Dahle:
Get advice. We have companies that can review those contracts for you listed on our recommended pages on the website and get some advice and make sure you do it right and don’t be Scottie Pippen in that regard. We have other recommendations pages there you may find useful, especially this time of the year. Two of the more popular ones in the spring, our Disability Insurance and the Doctor Mortgage pages. You can find their recommended service providers for both of those that will help you to get a fair shake on Wall Street.
Dr. Jim Dahle:
We would also like to hear from you a little bit more often. We’d like to hear about guests that you want to have on the show or what you like, what you don’t like. It’s very helpful to get that feedback and much more so than the blog. I view the podcast as a product of its listeners and want to put on there what you guys want to hear about. And a lot of times that is the questions that you guys leave on the Speak Pipe and you can leave those at speakpipe.com/whitecoatinvestor. But a lot of it is also just what you guys want to hear about, what you want episodes dedicated to.
Dr. Jim Dahle:
In the beginning, I dedicated a few shows, kind of two specific topics. I haven’t done that so much in a year or two. If you want to see more episodes like that, we can do more episodes like that. If you prefer kind of the popery of questions approach, we can also do that. So, just let us know what you like. Eventually, I’m sure we’ll get a survey together out and do a little more formal analysis of it. But in the meantime, just email me at [email protected]
Dr. Jim Dahle:
As far as those Speak Pipe questions, we want to make sure that you are leaving us some questions. Any question you have on disability insurance. We’ve got an episode coming up in a few weeks all about disability insurance. Any question you have about disability insurance, we’ll have an agent on here answering those. We can get as far out into the weeds as you want. Just leave those on the Speak Pipe and we will get to them.
Dr. Jim Dahle:
Does your business accept credit cards from patients? Do you think you’re overpaying? You aren’t alone. Merchant Cost Consulting has the ability to reduce your credit card processing fees without switching your payment processor or management software. You keep everything you have in place and have the experts at Merchant Cost Consulting reduce your credit card processing fees to the bottom line. All you have to do is send over statements, receive an audit of the potential savings and let Merchant Cost Consulting reduce your fees. It is that simple. All you have to do is go to the website, whitecoatinvestor.com/merchant and you can engage them in their services. We actually tried this here at the White Coat Investor. We figure, “What do we have to lose?” Because basically what they charge you is half of what they save. They can save you a bunch of money, they keep half, you get the other half, it’s a win-win, right?

Dr. Jim Dahle:
We decided to go ahead and send them our stuff and have them do this audit process. This is something we’ve spent a lot of time on over the years because we know how much it matters. It really does make a big difference in our bottom line. We were eager if they could save us a whole bunch of money to let them do it. Now in our case, probably because we’ve spent so much time and effort on this over the years, we only could save about $30 and they didn’t really want to do that service for $15. But it was at least reassuring to know that we are getting the lowest possible fees we can on credit card transactions. And if you are not sure that you or your practice is doing that, you might want to check them out. That’s whitecoatinvestor.com/merchant.

 

Dr. Jim Dahle:
All right. We got a really interesting interview today that I thought you guys would enjoy and would be able to apply, especially anybody who’s thinking about buying or selling a practice. Especially during these crazy pandemic times. We’ll be addressing that today. In order to do that, I’ve brought on Kyle Rudduck. He is a CFA and a CFP. He works for Constellation Wealth Management, which you can find at constellation-wealth.com where he doesn’t so much work with doctors. He does work with doctors but primarily works with families of entrepreneurs, private business owners and executives.
Dr. Jim Dahle:
But what makes him interesting is his prior experience in the healthcare industry, which I think we’ll get into a little bit of that. Let’s bring them on the show now.
Dr. Jim Dahle:
Kyle, welcome to the White Coat Investor podcast.

Kyle Rudduck:
Thank you. Thank you. I’m a big fan of the show, so it’s a pleasure to be able to join you and record one of these episodes. I appreciate you having me.

Dr. Jim Dahle:
Let’s start with just a little bit about you. Can you tell us a little bit about your background and career and maybe a little bit about why people should listen to the rest of this episode?

Kyle Rudduck:
Sure. So, I spent the early years of my career working with consulting firms out of the Chicago and Los Angeles areas respectively. Our niche focus was working in the healthcare sector with buyers and sellers of medical entities. Our role involved everything from determining a purchase price, which we can talk a little bit more about later, just structuring compensation models for employment post transaction. In that process, we assisted with everything from hospital acquisitions, small physician owned practices to multispecialty groups, ambulatory surgery centers and even some health system acquisitions of entire hospitals.
Kyle Rudduck:
One of the key undertakings and working through the valuation process is proper due diligence of the subject company that’s being acquired. A big part of our job was to really roll up our sleeves and get to know the story behind the numbers of the subject company’s financial statements. And throughout this due diligence process we would work very closely with executive teams and the business owners of organizations that were being acquired.
Kyle Rudduck:
That was by far and away my favorite part of the job. I love working with business owners and hearing the stories of the tragedy and the triumph that they’ve dealt with and kind of turning a vision to reality. In a lot of ways, successful businesses is really pretty incredible because I think it’s taking an idea from infancy and actually molding it into a reality that you kind of have this ability to live and breathe on a daily basis.
Kyle Rudduck:
Long story short, I love the work that I was doing, but I felt like there was an opportunity to really go deeper and serve these clients that I was enjoying working with in a different way. For most people, a business sale is a once in a lifetime thing and it’s a career’s worth of work. It happens in a moment. It’s incredibly important to get that part right. I thought that the price tag of the sale is certainly important and it’s a critical part of the process, but there’s also a lot more that goes into the transaction planning both before and after that ink is dry on the contract. And so, I saw that as there’s really a place where my passion for working with business owners meshed with being able to provide a valuable service to them.

Dr. Jim Dahle:
How does that get started? Nobody in eighth grade takes a career survey and says, “I want to help doctors in the hospitals buy and sell practices”. You got to take me from then until when you started doing this. You’re going to go back a little further, I think.

Kyle Rudduck:
Yeah. I was an economics major in college and I always kind of had a passion for business. I wanted to kind of follow that passion. I would say it was a lot of fate and a little bit of luck that I happen to fall into a role with a great company right out of college in Chicago. And their niche was already set up in that healthcare space. The firm was a full-service healthcare consulting firm and one service line that they had embedded in that was the valuation service line for these health systems. That’s where. A little bit of fate, a little bit of luck and that’s where I was.

Dr. Jim Dahle:
But you eventually left that and went into being a financial advisor essentially.

Kyle Rudduck:
I did.

Dr. Jim Dahle:
What prompted that transition?

Kyle Rudduck:
Yeah. So, kind of full circle to where I am today, it was that passion for working with business owners but wanting to go deeper. I found that opportunity in the wealth management space and that’s where I am today. Our practice serves a lot of physicians and business owners and having that background and that understanding I feel is really helped deepen the level of those conversations we’re able to have. It allows us to better speak their language and more deeply understand the issues most critical to them and their plans and lets us open up that toolbox a little more to demonstrate our value.

Dr. Jim Dahle:
Do you find that most of your clients are owners, they are physician entrepreneurs and physician business owners or are most of the physicians in your practice employees?

Kyle Rudduck:
It’s a combination of both. We have a number of employed physicians, some that are business owners and some that have gone through the process of selling the practice and are now employed with the hospital or health system.

Dr. Jim Dahle:
Let’s talk a little bit about regulation. You have said that the transaction environment for medical practices is a highly regulated space. What do you mean by that and who’s regulating it?

Kyle Rudduck:
Yeah. It absolutely is. The health care field and the financial services field are probably two of, if not the most regulated industries in the United States. And I think when it comes to navigating the logistics of the transaction, the regulation level certainly doesn’t disappoint. There are two major areas that govern that healthcare transaction landscape and namely, you’ll hear them referred to as the Stark Law and the federal anti-kickback statute. So those are the two major sources.
Kyle Rudduck:
There are some general exceptions that go beyond the scope probably of our conversation, but in summary, I would say that these pieces of legislation seek to prevent compensation as a reward for referrals. And then it also prevents healthcare facilities from paying physicians to refer patients to facilities in which those physicians have a financial ownership or interest in. When it comes to that transaction process itself, it becomes important because it requires a certain standard of fair market value to apply when you’re determining the value of a transaction.

Dr. Jim Dahle:
Now, I think we often hear about the Stark Law and I think most of us just assume that Stark was the anti-kickback law. You’re separating them into two laws. What’s the difference between the two?

Kyle Rudduck:
Yeah. The Stark Law is more to the former. It’s preventing compensation as a reward or inducement for referrals. There can’t be an arrangement in simple terms that you send this patient to me and I’ll pay you $5, $500 whatever that level is for the referral. That’s where I think the Stark Law is most applicable.
Kyle Rudduck:
The kickback statute is more in terms of a physician having a business ownership interest in the facility that they’re referring to. Whereas the hospital, they may not own the hospital, but they’re getting the direct financial incentive for referring. Kickback statute applies more to “Okay, I’m only going to refer to a facility that I’m going to reap the rewards of the profitability there”.

Dr. Jim Dahle:
So, the idea behind the two laws is that it essentially forces the physician to have a Hippocratic or fiduciary duty to the patients unlike most business. Honestly, I mean most business, this sort of thing is fine to be paid for referrals and to have a partnership in that way.
Dr. Jim Dahle:
Okay. Let’s just talk about a broad overview of the process. What should a physician or dentist who wishes to sell their practice know about that process?

Kyle Rudduck:
I think it’s important, again, to understand the concept of value and how it applies in the realm of the Stark Law and anti-kickback statute. Because traditionally in an acquisition, a buyer is going to conduct an opinion of value that they’re going to go through an exercise to determine what synergies can we as the buyer bring to this entity and turn around and profit from. Things like if they were allowed in the medical profession, a hospital may have higher contract pricing. They may be able to bring increased volume. They may be able to improve collections. Just to name a few.
Kyle Rudduck:
And when you factor in those synergies, it can make a target much more attractive to one buyer over another and then translate into a sizable premium that would be willing to be paid. In the healthcare space that synergistic value is a giant red flag because it could lead to some violations of those regulations we talked about.
Kyle Rudduck:
What the law requires is that the applicable valuation standard is known as fair market value. Generally speaking, it’s just going to require that an entity more or less be valued on a standalone basis without being able to give consideration to the synergies that any specific buyer could bring.

Dr. Jim Dahle:
That really limits the practice seller’s leverage.

Kyle Rudduck:
It does.
Dr. Jim Dahle:
It weakens their negotiating position significantly.

Kyle Rudduck:
Yeah, I think it absolutely can. Taking a step further, I think to understand in the process, it’s extremely important to understand the impact of compensation in the context of the transaction as well. Because while compensation is subject to the same Stark Law considerations, the sellers can often have some input into the structure that it takes after the acquisition. Where this becomes important is really twofold.
Kyle Rudduck:
Historically as a standalone practice, business owners would typically zero out their profitability at the year-end by way of bonuses just to avoid being taxed twice on that profitability. Historically that’s probably been a good move from a tax perspective for them to make. However, when it comes to the context of a transaction, compensation is very much a real expense. If you’re zeroing out profitability and cashflow because you’re paying it out as compensation, that’s going to negatively impact the purchase price that a buyer would be willing to pay. I think for physician business owners in particular that are looking to drive more or less value upfront looking at the compensation structure is one good way to go about making it happen.

Dr. Jim Dahle:
Yeah, I think that’s a very real issue. In fact, I think we dealt with that recently here at the White Coat Investor. This year we had to get a valuation of the business done for various reasons. And it was interesting that when I set my own compensations as wages separate from the profit of the business, we do so with all kinds of things in mind, particularly taxes. We wanted to maximize the 199A deduction. But by doing that, it actually lowered the value of the business in this valuation. Simply because it was less profitable because more wages were paid out, even though I could have easily monkeyed with that and increase the profitability of the business by paying myself less in wages. So, it’s something you absolutely have to be careful about when doing any sort of valuation of a business.

Kyle Rudduck:
Yeah, that’s a great point.

Dr. Jim Dahle:
So, the overview, how does the process work? Are docs sick of owning the practice? He’s still fine practicing medicine but wants to sell his practice. Can you give an overview of the process?

Kyle Rudduck:
Yeah. In terms of the timeline of the process itself, I think there’s certainly a lot of nuance depending on the buyers and sellers, but oftentimes there are a couple of areas I would expect to remain pretty consistent. As a first step potential buyer and seller have identified each other and they think that there may be a possible transaction. Typically, there will be some legal documents that kickoff this process. Namely, you want to have confidentiality, non-disclosure and other privacy related documents in place. There’s going to be a lot of information, very private information that gets shared back and forth. I think having those documents in place can really allow for that information to be shared and in good faith.

Dr. Jim Dahle:
Private in that you don’t want your competitors to know what you’re making and what your expenses are, that sort of thing.

Kyle Rudduck:
That’s exactly right. That’s exactly right. Yeah.

Dr. Jim Dahle:
For each of the two businesses, the one buying it and the one selling it.

Kyle Rudduck:
Yes. One example, insurance contracts are something that insurance companies don’t want shared and practices may not want shared either. So, the privacy documents would govern that sort of information sharing. Keep that private. Once those documents are in place, there will be the sharing of financial statements, tax returns, asset schedules and other proprietary documents with the potential buyer.
Kyle Rudduck:
So, then the buyer, they have these documents. Now they or their designated representative would use those documents to build an initial model of value and that would kick off then the due diligence process, which would usually entail a site visit or a few to the target’s physical location. It would be an in-depth interview and review of historical financial statements with the business management and ownership.
Kyle Rudduck:
Primarily the buyer wants to fully understand any material variations and historical operations as well as any plan changes that our practice may have going into the future that would impact operations or financials. All of that information gets built into evaluation model and that would initiate or facilitate the negotiations of the transaction between the buyer and the seller.

Dr. Jim Dahle:
Okay, so even before that process, let’s say you don’t have a potential buyer lined up, how do you shop that? You just decide you want to get rid of your practice. What are your options? Do you go to a broker? Who do you go to?

Kyle Rudduck:
It’s largely going to depend on factors like the size of the practice, the specialty of the practice and the ultimate goal – Who you want to align with. In the cases of a smaller physician group, maybe even a multispecialty group that wants to align with the hospital, a lot of times there’s already those synergies in place. You already have a partnership with a local hospital or two and you could approach their management about the potential for an acquisition or some sort of transaction.
Kyle Rudduck:
Private equity is certainly popular right now and I think having an understanding of the representatives in the market, maybe not the PE groups themselves, but the representatives that those groups may use to start to build out some of the network and the transactions. Those could be good people to approach as well.

Dr. Jim Dahle:
Should there be a difference in who you go to, based on whether you want to continue practicing in the practice after you sell it versus just walk away and retire or go somewhere else and work?

Kyle Rudduck:
I don’t think that is necessarily going to drive the decision. I think the business model under the PE group and the hospital affiliation can be much different. The PE groups right now they tend to be buying up single specialty practices, bolding these all together to build these mega specialty groups. But they also tend to turnover more frequently.
Kyle Rudduck:
The traditional private equity model is to flip it at least every three to five years to another private equity firm or a different buyer. Aligning with the PE groups, there may be some more turnover in ownership and management, whereas aligning with a hospital may provide a little more stability over the long term.

Dr. Jim Dahle:
So, let’s talk about what people always want to know about something like this is where are people screwing up? What are the mistakes doctors make? If you had to list out, let’s say the top three mistakes that doctors make in this process, what would you say they are?

Kyle Rudduck:
I think the most common areas that get overlooked is not taking the time to really think about what professional life will look like post-transaction. For many business owners, they’ve built this business so that they could do things their way. Whether it’s lifestyle, flexibility, control over decision making, having the ability to pick and choose coworkers among many other things. When you engage in a transaction, you’re by and large, you’re selling that flexibility to the buyer. For many, they’re becoming an employee for the first time and it can be a bit of an adjustment. I think failing to consider the intangibles. The market conditions can make certain times better than others to sell a business from a financial perspective. But it’s extremely important to consider some of the other factors as well.

Dr. Jim Dahle:
So that’s the first one. The first one is not considering what life is going to be like after the sale. What would you say the other big mistakes are?

Kyle Rudduck:
I think another one is really thinking about putting some thought into the structure of the compensation model post-transaction. For a doc that is nearing the end of their career and maybe looking to wind down a practice, they may not want to lean as heavily on a compensation model that heavily emphasizes productivity measures, RVUs collections, something like that may not be ideal.
Kyle Rudduck:
Conversely, for a doc that’s looking to align with a partner that would enable them to grow, they may want to focus less on high based comp models and more on ones that factor in productivity measures and quality incentives. I think one that’s the compensation model is a big part of the overall valuation as we talked about. But it’s also important for proper alignment post-transaction as well.

Dr. Jim Dahle:
All right, let’s talk a little bit more about the practice valuation process. How does this work? How does somebody sit down and decide how much a practice is worth?
Kyle Rudduck:
Yeah, great question. In terms of the valuation process itself, there are four primary methods that are traditionally used in valuing a business. The first is the discounted cash flow method. That’s the most widely touted both in practice and what you’re going to read about in business school textbooks. Put simply, this method calculates a value by first calculating free cash flows that the business is going to generate into the future and then discounts those back to our present value after you consider things like inflation and the implied risk of actually being able to achieve that projection.
Kyle Rudduck:
There are also separate methods that are comparable company and comparable transaction methods that can be used. Both of these methods will use comparables largely in a way that’s similar to how you would value a house or a piece of real estate. You’re going to assess certain financial metrics and ratios from publicly available data and then apply those metrics to the underlying financials of your subject company.
Kyle Rudduck:
For example, you can look at the price to revenue multiples of either a publicly traded company or a recently closed transaction and then take that ratio and apply it to the revenue of the company that’s being valued. I think it’s important when you’re looking at the comparable company method or comparable transaction method to note that no two transactions or companies are exactly alike. A lack of available market data in some instances can render these approaches a little less useful. But I do think that they may be helpful as a reasonableness test for a discounted cash flow projection.
Kyle Rudduck:
And then lastly, the fourth approach to valuing a business is known as the asset-based approach. And the asset-based approach is typically a floor or a minimum value that a business is worth. The theory is that even though a business it may not be profitable or it may not be generating cash flow, they still have assets and inventory that they could sell off in the event that they needed to so there’s still some value to the practice. But again, if it’s a profitable business or a cash flow positive business, that asset-based approach would typically be the floor and one of the other approaches would provide a higher indication of value.

Dr. Jim Dahle:
Yeah. It’s a super interesting discussion to me now, just because I went through this evaluation process a week ago. We looked at those first three methods of yours for my business, for the White Coat Investor. We looked at comparable public companies. We looked at recent transactions and in private companies. And we looked at cash flow model based on future cash flows. But the really interesting part of it, and then luckily ours all came in using all three methods, it was pretty similar evaluation.
Dr. Jim Dahle:
But what was really interesting about it, it was just how much the process is garbage in, garbage out. We ended up trying to decide which of those three involved less garbage in and weighting that more heavily in the actual evaluation. Because things like future cash flows are never perfectly known and often nobody has any idea what they’re going to be. How do you manage that issue of this whole, it’s a mathematical formula, but it’s heavily dependent on the assumptions that go into it?

Kyle Rudduck:
Yeah, that’s a great point. I think at an extreme example, if you had two houses in the same neighborhood that were built by the same builder and have the same blueprint and sat right next door, when one of them is sold, you’d have a pretty good idea of what the other one is now worth. In reality and especially when you try and translate that model into the business world, the ability to find exact comparables is impossible. It’s next to impossible. There is a lot of part art, part science that goes into the methodology. And I think that’s where the importance of relying on the experts in the field that are not only well versed in evaluation but well versed in health care evaluation because of the nuance is extremely important. I think just having the boots on the ground and seeing more and more transactions, you’re able to really start to build your judgment and incorporate that into some of the models that you would use.

Dr. Jim Dahle:
Yeah, I think we paid an attorney that specializes in this process several thousand dollars to do our evaluation. Is that about what a practice owner should expect?

Kyle Rudduck:
I think so, yeah. Again, it’s going to vary pretty widely depending on the size of the practice and the amount of work that would go into it. But I would say that’s a pretty fair ballpark.

Dr. Jim Dahle:
A lot of this boils down to multiples, particularly multiples of EBITDA – Earnings Before Interest, Taxes, Depreciation and Amortization. What’s the range of multiples on that for a practice?

Kyle Rudduck:
Yes. Good question. I think it’s important to keep in mind that like we just talked about, value is traditionally ascribed by discounting the future value of cash flows. When we start to talk about value multiples like EBITDA for example, they’re more of a derivative calculation as opposed to an approach to determining value itself. Because of this, I think the factors that impact the value calculation that the DCF approach also largely impact multiples that get paid for a practice. All else equal, more in growth-oriented practices will command higher multiples, but also the size, the specialty and the reimbursement landscape can all drive some variance as well.
Kyle Rudduck:
With all of that said, the specialists that we talk to and work with in the field, they’re typically seeing even a multiples that range anywhere from 5 times to 10 times EBITDA, practices with larger physician sizes, higher growth trends and well run administrative teams tend to command the higher end of that multiple. And then conversely the smaller groups, less growth oriented and maybe smaller in-house administrative teams would be towards the bottom of the range.

Dr. Jim Dahle:
This is somewhat comparable to a PE ratio on a publicly traded stock. For Apple, you might be willing to pay 20 or 25 or even 30 times earnings because you’re expecting some growth out of there. Whereas Kmart, you might be only willing to pay 12 or so. But as we get down into these smaller privately owned businesses, those multiples are quite a bit lower. Why do you suppose that is? Do you think they’re just riskier businesses or why do you think the multiples are so much lower?

Kyle Rudduck:
Yeah. Again, the EBITDA multiple calculation is a derivative, right? Ideally what you’re doing is, is you’re determining value based on projected cash flows and the risk that’s associated with achieving those cash flows. That’s an important determination to make. Using your example, a company like Apple that has been around a long time, you have a little bit more faith, they are publicly traded there. There are audits that are happening. You have a little bit more faith in the cashflow projections that are built around that company than you do with either a startup or one that there’s less of a history there and being able to calculate what those cash flows would be.
Kyle Rudduck:
I think growth is important in being able to hit those projections. But also looking at what’s the risk associated with being able to achieve that forecast. The higher the risk, the higher the discount rate that you’re going to apply. And as you backed that down, it results in a lower overall value.

Dr. Jim Dahle:
Okay. So obviously a lot of docs see this coming down the road. They’re thinking, “I want to get out in five years, I want to sell the practice” or whatever. What can be done in the few years prior to the sale to increase the value of a practice?

Kyle Rudduck:
I think when we look at the range of EBITDA multiples that we just kind of talked about and think about what drives multiples toward the higher end of the range, that gives us a good indication of the areas that we can start to focus on in the years ahead. Specifically, I think if emphasizing areas like physician recruitment, younger physician demographics, by and large having a younger physician team, all else equal leads to the higher multiples being paid.

Dr. Jim Dahle:
Is that because turnover is expensive and they’re less likely to have to hire new docs after it’s sold or why is that?

Kyle Rudduck:
True or not, I think the thought is that the younger physician dynamic, yes, to your point, I think they’re going to be stickier. They’re farther away from retirement and not having to recruit and retain. I think there’s also some thought that the younger physician is going to be more growth oriented and looking at becoming part of a team and looking to really ramp up production as opposed to a physician that’s already established or maybe starting to trend down in production.

Dr. Jim Dahle:
Okay, that makes sense.

Kyle Rudduck:
Secondly, having a good enterprise resource planning system, a good ERP system, good clean billing and revenue cycle management. Focusing on getting those areas in order. Quality financial reporting. That’s one area where some valuation opinions, all the practices are able to produce tax returns. They don’t really have a robust reporting capability. I think that can sometimes be indicative of the level of management and the practice. And then a good compensation program that’s going to end in incentivize productivity. And also, just as importantly quality outcome is especially important in today’s environment.
Kyle Rudduck:
And then lastly, I would say a solid practice administration team. Really starting to shore up that administrative side of the business. We’ll often talk about practice transactions in the context of “Is it a platform acquisition?” or “Is it a bolt-on acquisition?” The platform acquisitions are pretty much your turnkey operation business. More or less, they’re solid on the areas above and those are the ones that tend to command the higher multiples.
Kyle Rudduck:
In contrast, a bolt-on is essentially one that gets absorbed into a platform and it adopts those methodologies and processes there. Typically, those are the smaller groups with less robust back office teams.

Dr. Jim Dahle:
What about with a smaller practice? Is there any benefit to playing games with your wages? Gaming the system, a little bit, a couple of years before you sell. Actually, making your wages lower so the profits higher. Is that sort of a thing recommended or is that pretty easy to see through?

Kyle Rudduck:
Well one, I don’t know that you would necessarily want it do that because if you’re reducing then you’re probably dropping some profitability to the bottom line, which instead most corporations in this realm are going to be structured as S corps or some sort of pass through. If you’re leaving money in the books then you’re going to pay taxes twice on that. I don’t know that you would want to do that.
Kyle Rudduck:
Plus, I think when the valuation is completed or when it’s in process, the past financials are only helpful to the extent they can inform what the future projection is going to look like. Even if you cut your comp historically, if you’re expecting to ramp up your comp post-transaction that’s the numbers that that are going to be used in the valuation opinion as opposed to 2019, 2018.

Dr. Jim Dahle:
Yeah, I guess that makes sense. What you gain on the EBITDA, you’re going to lose on future compensation because they’ll say, “Well, you were working for this before. Why do you want so much more than that now?”
Kyle Rudduck:
That’s right.
Dr. Jim Dahle:
But the double taxation would only apply to a C-Corp. I mean on an S-Corp, you’re paying taxes and all of that anyway, whether you take his wages or profit each year. Only if it’s retained in the company as a C-Corp, would you end up getting the double taxation.
Kyle Rudduck:
Correct.
Dr. Jim Dahle:
Now you mentioned something earlier, ERP program, was it?

Kyle Rudduck:
Yeah.

Dr. Jim Dahle:
Well, tell me what that is. I didn’t recognize what that was.

Kyle Rudduck:
An ERP is essentially the integration of all of your administrative systems. Your human resources systems, your billing systems, your collections management. It’s the integration of all of those systems. It really allows certain organizations to scale much more efficiently and achieve higher profitability with less administrative overhead.

Dr. Jim Dahle:
Let’s talk a little bit about taxes now.
Kyle Rudduck:
Okay.
Dr. Jim Dahle:
How do we minimize the taxes when you sell the practice? What can be done?
Kyle Rudduck:
Yeah. Let me lead off here. I do want to say that I’m not an accountant and I’m not qualified to provide tax advice, but I do think this is obviously a very important area. I think it really hits on the value that an individual’s overall balance sheet can have even in the context of transaction planning. One example, Jim you just did an episode a couple of weeks ago on the topic of tax loss harvesting. I think that it’s a great and powerful strategy and can be even more so for business owners when it’s done correctly.
Kyle Rudduck:
For some of those that may be unfamiliar with the concept, tax loss harvesting is basically the ability to sell an investment security and accrue a loss for tax purposes, but then use those sales proceeds to purchase a different security so that you’re not sacrificing time out of the market.

Kyle Rudduck:
There are a significant number of IRS regulations here that surround being able to do this correctly. But when done correctly, I think it can be a very powerful strategy. Primarily the reason that this can be valuable to business owners is because losses can be accrued on your income tax return and carried forward indefinitely.
Kyle Rudduck:
Business owners that may not be considering a transaction today but start accruing those losses, using that investment portfolio to accrue losses today can carry those forward into the future. And then ultimately, one day they decide to sell and potentially now they have that large pile of capital losses that can offset the gains in the sale. I think that’s one great opportunity available.

Dr. Jim Dahle:
Yeah, I think that’s a great tip and that’s part of the reason I still aggressively tax lost harvest. I’m going to have hundreds of thousands of dollars in tax losses. Obviously, I can only take $3,000 a year in that against my ordinary income. And I very rarely take a capital gain on my mutual fund portfolio because I generally just use appreciated shares for my charitable donations.
Dr. Jim Dahle:
But the reason I continue to aggressively tax loss harvest is because I know at some point, I’m probably going to sell the White Coat Investor and I’d like to pay as little tax as possible on it. I think that’s a great strategy and a great reason to be aggressive about that if you have a taxable investing account. What else can be done to reduce the tax at the time of sale?

Kyle Rudduck:
Another strategy, this would apply more in the year of sale and again, it’s not something that I’m qualified to necessarily do for clients, but I would have highly encouraged sellers to retain the services of a high-quality accounting firm in the year of the sale. Because one thing that good firms can do is assist them and the allocation of purchase price proceeds.
Kyle Rudduck:
Essentially when we think back to the methods of valuation, you have your net asset value and then you have these other indications that ideally are yielding a higher result. What the purchase price allocation is doing is essentially taking the difference between those that the intangible value, if you will, and allocating it between personal and corporate goodwill.
Kyle Rudduck:
Personal goodwill ascribes to the owners themselves. Corporate goodwill, which will be ascribed with the brand of the practice. Traditionally being able to allocate more of the purchase price to personal goodwill is going to be more favorable from a tax planning perspective and provide a little bit greater flexibility to the sellers and being able to realize some of the tax loss harvesting, for example, some of those losses. It’s a very complex area that requires a well-versed accountant, but it’s certainly an area that’s pretty important to focus on.

Dr. Jim Dahle:
As a general rule, you end up, I mean assuming you built this practice from scratch, you’re basically paying long-term capital gains taxes on the value of the business when you sell it. Correct?

Kyle Rudduck:
Right.

Dr. Jim Dahle:
Anything you can do to increase your basis I suppose would reduce the amount of that gain that you have to pay taxes on. So, keeping careful records, I suppose any money you put into the practice would help.

Kyle Rudduck:
Absolutely. Yeah. Having those records are going to be crucial.

Dr. Jim Dahle:
Okay. Let’s talk for a minute about some of the other people affected by a sale. For instance, your employees. How does a sale typically affect employees?

Kyle Rudduck:
I think often in our experience it’s one component of the transaction that can be negotiated at least for the first year or two. Traditionally there’s a distinction between, I’ll call them the provider employees – The physicians, the PA’s, the nursing staff and the administrative team, the management, the billing team, et cetera. The production team, the provider team, traditionally it’s not going to be very impacted because their production is pretty crucial to achieving the forecast of the valuation opinion. Overlap when it does occur, it traditionally happens more on the business management side. And this would be the area where typically cost reductions could occur if they’re going too.

Dr. Jim Dahle:
Cost reductions, meaning people get fired.

Kyle Rudduck:
There you go. Yeah.

Dr. Jim Dahle:
Or at least take a big pay cut.
Kyle Rudduck:
Right.
Dr. Jim Dahle:
If you’re not a provider, this may not be very good at all to have your practice that you’re working for bought up or merged with another.
Kyle Rudduck:
Kind of going back to our earlier point, the difference between a platform acquisition and a bolt-on. If you’re a platform group, you’re doing a lot of the right things. You’re one of the more profitable practices, you’re doing something right and so buyers may not want to come in and necessarily disrupt that. I think if you’re doing those things that we talked about earlier in terms of what can you do to gear up for a transaction. If you’re getting those things right, more often than not, in those instances the buyer is going to retain the majority, if not all, all of the staff.
Kyle Rudduck:
I think on the bolt-on side where an acquirer is looking more at simply adding volumes to their platform, if you will. Those are the instances where they may look more heavily at trimming staff on the business side of the practice.

Dr. Jim Dahle:
All right. Let’s talk now about the physician owners, the dentist owners of the practice. How often in your experience do they regret selling their practice? Whether to a hospital or a private equity group or another doc or whoever. How often do they actually regret it afterward do you think?

Kyle Rudduck:
This is one of those things until the transaction is formally closed and the ink on the contract is dry, it’s just next to impossible to know exactly how things will look and operate for you post-transaction. But with that said, I think there are some things that people can do to really try and minimize that potential regret. I think throughout the entire process it’s critical to be asking questions. You’re interviewing your next employer. So is management, and the buying team is onsite. Ask questions of them as well and really try and get an understanding of who they are.

Kyle Rudduck:
I also think it’s important for the seller, the current business owner to have an understanding around two keys wise. So first, why did you make the decision to become a business owner? Why did you choose to take on that risk? Is it lifestyle flexibility, earnings potential, ability to choose your coworkers? Why did you choose to engage in that line of business?
Kyle Rudduck:
And then secondly, why are you doing this transaction? If there’s an inconsistency in why you’re in business and why you’re wanting to sell the business, I think that’s a key indication of a potential red flag that could emerge. You really want to get clear alignment of the reason you’re looking to sell with the solution that the seller is bringing to the table. You don’t want to have a permanent solution to a temporary problem, if you will.

Dr. Jim Dahle:
And do you think docs do that a lot? Do you think it’s a significant percentage that regret selling or do you think it’s a pretty tiny percentage by the time all is set and done? Do you have any sort of sense of that?

Kyle Rudduck:
Yeah, I think there’s certainly a tendency to remember the good things and forget the bad after you’re an employee and you kind of forget some of the challenges of being a business owner and operating in the business as well. So, I don’t know that the regret factor is high, but certainly, the way that your employer is doing things is not as efficient or not as good as the way that we could do them ourselves. I think that’s just natural.
Dr. Jim Dahle:
We’re in the middle of a pandemic, a bear market. What seems like it’s going to be a pretty substantial economic downturn even in healthcare. Volumes are down dramatically in dental and physician practices. Is now a good time to buy a practice? Is it a good time to sell a practice? Is it neither? What’s your sense of this sort of market in a time like now?

Kyle Rudduck:
I think there are other factors that certainly should weigh into that decision. The ability to access capital for a transaction. I don’t think that panic buying or panic selling is ever a prudent decision. You want to really step back and be rational when it comes time to make a major decision like that. Because again, for most the buy or sale of a business or a practice is a once in a lifetime thing. So, you don’t want to get caught up in the moment no matter how long or short lived and make a decision based exclusively on one event.

Dr. Jim Dahle:
All right, we better wrap this up here soon. I wanted to make sure you had a chance if there’s something you felt like we should discuss about this topic but we haven’t hit yet, now you have a chance to talk about that. Is there anything you feel like we haven’t covered?

Kyle Rudduck:
Yeah, so two things I would touch on. I think one metric I’ve found that can be helpful to some business owners in the business valuation world, you refer to it as your weighted average cost of capital or your whack. Essentially what that rate is, it’s the required rate of return to make an investment worthwhile. It’s the rate that you’re in a discount. All of those cash flows back to present value.
Kyle Rudduck:
For business owners we can apply this concept a little differently but also provide some context that can be helpful in the decision-making process. For example, let’s say that hypothetically we could earn an average annual rate of return of 7% on money that is passively invested in the stock market. Compared to owning a business, investing in the stock market is pretty easy and could be done with relatively little work.

Kyle Rudduck:
In order to decide, as you’re deciding whether or not to invest capital back end in the business, I think it’s important to understand what your expected rate of return is on that cash relative to what you can get otherwise outside of the market. If you’re reinvesting a dollar into the business and you expect that you’re going to earn 20% on that money, maybe that’s a better use of capital than putting it in the market.
Kyle Rudduck:
Conversely, if you expect that the market could produce a higher rate of return or even equivalent with far less work, then maybe it’s time to start looking at some opportunities and alternatives to diversify cash flow outside of the business. So again, just one consideration among many, but I think it can be a semi helpful benchmark to provide some context there.

Kyle Rudduck:
The last point I would make is I want to highlight the importance of really appropriately positioning your personal balance sheet throughout the sales transaction process. I think oftentimes it can be very easy to get so preoccupied with the details of the business transaction that you largely lose sight of your personal financial statements during that process and that can sometimes lead to mistakes.
Kyle Rudduck:
I think it’s really important to make sure that your personal financial plan will remain current and relevant throughout the process. You want to make sure that the strategy that you’re using to manage risk on your personal balance sheet is consistent with your lifestyle needs and goals. Some of which may be significantly shifting as a result of the event.
Kyle Rudduck:
For many, the post-transaction life is going to be a big adjustment period. Now on one hand there’s a lump sum of cash that needs to be redeployed and potential tax consequences to deal with. And on the other hand, there may be an adjustment to changes in compensation that needed to be considered. I would just highly encourage spending the time to keep your personal financials plan current and relevant throughout the entire transaction planning process as well.

Dr. Jim Dahle:
Thank you. That’s very helpful. This has been an interview with Kyle Rudduck, CFA, CFP of Constellation Wealth Management. Kyle, we were very grateful you were willing to come on the White Coat Investor podcast and share some of your knowledge on practice acquisition and selling. It’s been a wonderful hour we spent and hopefully it’s really helpful to our listeners.

Kyle Rudduck:
Thank you, Jim. I really appreciate the work you do, both in the medical community and for the medical community. So, I think both services are invaluable and I really appreciate your work.

Dr. Jim Dahle:
Thank you very much.
Dr. Jim Dahle:
Okay. Hopefully, that was a helpful episode for you. If you need help with this process, the sponsor of this podcast, today is probably a great resource. This was sponsored by Collin Hart of ERE Healthcare Real Estate Advisors. ERE is a real estate brokerage but takes an advisory approach, expertly positioning their clients for a real estate sale as part of the succession planning surrounding the practice of real estate investment. You can contact Collin directly at [email protected], or call him at 702-839-8737.

Dr. Jim Dahle:
With the continuing challenges created by Covid-19 and given the lack of liquidity in the stock market, ERE wants to let you know that opportunities still exist in strategically monetizing your practice real estate, providing a more certain exit strategy in an uncertain environment. You can contact Collin directly at [email protected], or call him at 702-839-8737.
Dr. Jim Dahle:
If you need some financial services, we suggest you come by the recommended pages at whitecoatinvestor.com. You can see on the front page there, there’s a tab entitled “Recommended” and you can go down that and find whatever you may need. In the spring that tends to be a lot of people looking for mortgages and disability insurance. But depending on the time of year, you may need a different service, whether it’s legal or financial advisor, whatever it might be. We try to put companies that we’ve vetted that White Coat Investors have been using for years and have those there available for you if you need those services.
Dr. Jim Dahle:
Thank you to those of you who have left us a five-star review and told your friends about the podcast, that really does help get this critical message out to our peers and colleagues. Keep your head up and your shoulders back. You’ve got this, and we can help. Stay safe out there during this pandemic and we’ll see you next time on the White Coat Investor podcast.
Disclaimer:
My dad, your host, Dr. Dahle, is a practicing emergency physician, blogger, author, and podcaster. He’s not a licensed accountant, attorney or financial advisor. So, this podcast is for your entertainment and information only and should not be considered official personalized financial advice.