Article Date: 9/1/2005

Buyer Beware
Ready to make an offer on a practice? Look for these signs of trouble before you take the plunge.

By Gary Gerber, O.D., Franklin Lakes, N.J.

IF YOU were going to buy a car, you'd probably spend a lot of time researching your options. You'd likely ask owners of the car you're interested in about their experiences, and you'd definitely take a test drive. Despite the rich leather seats and the awesome sound system, if you learned you'd only get three miles per gallon or that maintenance costs were way above the norm, you'd probably have second thoughts about buying the car.

The same holds true when shopping for an optometry practice. The following warning signs should prompt you to step back and analyze your decision to move forward toward — or back away from — the purchase.

1. Reluctant Disclosure

Buying a practice is a decision based mostly on numbers. Without accurate numbers, you can't make an educated decision. However, as a consultant who helps O.D.s buy and sell practices, I've found the most common warning sign is when a seller resists timely and complete disclosure of information you need to make a careful and informed decision.

Usually, this reluctance is based on emotion, not malice or deception. In most instances, the seller has nurtured the business since birth and has never shared its inner workings with anyone — let alone a stranger! So compassion and understanding on your part can go a long way toward the goal of collecting the requisite data.

That said, I recommend caution when a seller won't disclose the following four items:

   Three to 5 years of tax returns, banking records, profit and loss statements and accounts receivable/payable history

   Legal documents, such as current lease agreements — for the office and equipment — and any employment contracts with associate doctors or staff members

   Office documents like appointment books — or their electronic equivalent — training and procedure manuals and office policy manuals

   Explanations for any unusual items your research produces, such as liens against the practice, pending lawsuits or other rare but serious roadblocks to a sale.

If the seller provides his own appraisal, make sure to have it reviewed by a qualified appraiser of your choice who has experience with optometry practices. If you're uncomfortable with the appraisal, have another one done. If the seller refuses, walk away from the deal.

All information supplied should be current, complete and accurate. If you're not sure it is, don't wing it or make an educated guess. Again, retain someone who can give you a non-emotional, qualified assessment.

2. Erratic Spending Patterns

I'm not a proponent of putting too much stock in benchmarking and trying to run your practice to conform to industry norms. However, the practice you're contemplating buying should at least have its key business indicators in the right "time zone." For example, in most practices the cost of goods sold (COGS) comprises about 30% of overall sales. A slightly higher or lower number isn't a deal breaker if it's explainable and logical. But, COGS of 15% — or conversely 50% — should stop you in your tracks and prompt you to seek a detailed and credible explanation.

Another key metric is the cost of labor. This index should be about 18% to 20% of total gross sales. However, in some parts of the country, this might be way too high — or woefully low. Finding quality employees in the New York metropolitan area who will work for $10 an hour is unlikely. In other parts of the country, that rate would be overpaying. If this number is close to where it should be, you'll be able to determine if raising or lowering it can help the future net revenues of the practice.

3. Practice Is Trending Down

In examining a practice's financial data, look for trends. Don't make the mistake of looking only at gross sales. Net income to the practice principals is a crucial indicator and if it's declining, make sure you find out why.

Some downward financial trends are more easily reversed than others. For example, if the practice is declining because the practitioner has been cutting back office hours, the buyer has to be extremely careful in forecasting future growth based on expanding office hours. Increasing your hours is no guarantee patients will come flocking back, as they've probably already found another practice.

However, if the practice's numbers are declining because of a continued influx of low paying (and low netting) third party patients, carefully paring down the number of these plans you accept may reverse this trend.

4. Bookkeeping Discrepancies

After the practice pays all its bills, the practitioner keeps what's left. And that's what you're really buying, right? Not exactly.

The practice's bills often include items that should be counted as net. For example, payroll taxes and health insurance paid by the practice should count as net.

A simple rule you can use to find these "hidden" net items is to ask: "If I were an employee instead of an owner, would I be paying these myself?" If the answer is "yes," these hidden costs are probably net income. Conversely, some items that an owner may consider net may not be. Personal automobile expenses are often in this category.

5. Selling Potential, Not Reality

Beware of sellers who try to sell you on the potential of future earnings. I often see this in the sale of part-time practices. For example, one of my clients was looking at a practice that was open 3 days a week for patient care. The seller insisted that if the "young energetic doctor" would be willing to expand the hours, the business would grow.

We examined appointment books from a few years back and cross-referenced with net income. Sure enough, we found that what was a full-time practice with a higher net 5 years ago, was now a part-time, lower netting practice.

6. Cookie-Cutter Practice

The single biggest warning sign is often the hardest one to spot. Bringing in experts to help in your evaluation can pay dividends, especially when they uncover this red flag.

This warning sign is mediocrity. Is the practice similar to others in the area? Does it look the same, offer similar services and products at similar fees, have similar office hours and so on? If it does, then you have to ask yourself, how much work will be involved, and what is the potential in changing the core business culture, values and systems of operations?

For example, assuming you want a very high-netting practice, how much energy and revenue would it take to turn a middle-of-the-bell-curve $400,000 gross, 28% net practice into a $3 million gross, 31% net one? Is the current location large enough? Will the current equipment support the added volume?

If you decide to upgrade what we call the "technology gestalt" by bringing in a lot of new and updated equipment to the practice, consider how staff and patients will perceive this change. A careful look at the pros and cons of this financial undertaking often shifts a buyer's mindset from "buy this practice" to "start my own."

If you successfully navigate these potential roadblocks and do find a practice that fits, I have one more piece of advice. You don't have to reinvent the wheel.

 

What's Behind That Appraisal?
 

A well-done appraisal will fully and accurately disclose all the formulae used to arrive at the fair market value for the practice. Be alert for appraisals that don't disclose exactly how the appraiser arrived at his conclusions.

Don't Change For Change's Sake

Changing an established business from one model of operation to another can work, but it takes time. When the front door keys are ultimately passed to you, don't assume that all the great practice-building ideas you've kept bottled up through the years will work in your new practice. Making wholesale, sweeping changes is usually frustrating and nonproductive. You can't change the Holiday Inn Express to the Ritz Carlton overnight. The guests will leave and the staff will quit.

Similarly, if you have aspirations of converting a primarily retail practice to a more medically-based practice, go slowly. Realize that the current patient base was attracted to the retail flavor of the practice, not the medical one you hope to implement.

Whatever changes you make — and in whatever time frame you make them — the good news is they are your changes at your practice, and this is an enviable position to be in. You have successfully navigated a myriad of roadblocks and have a practice that bears your imprint. Congratulations and best wishes for continued success!

Dr. Gerber is the president of Power Practice, a company specializing in making optometrists more profitable. Learn more at powerpractice.com or contact Dr. Gerber at DrGerber@PowerPractice.com or 800-867-9303.



Optometric Management, Issue: September 2005