AAHA Economic Bulletin | September 2009

Many of us know a colleague who considered selling their practices in 2009, but then decided to put it off until the economy "turns around.” Maybe they needed to hang in there a bit longer to recoup lost stock values, or perhaps they merely had an unsettled feeling about leaving their practice in these hard times.

Although there may be some validity to those concerns, there are other real concerns - both personal and professional - that may have escaped consideration.

A capital gains tax is a tax charged on capital gains, the profit realized on the sale of a non-inventory asset that was purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property.

In 2003, the Jobs Growth and Tax Relief Reconciliation Act (JGTRRA) reduced capital gains tax rates from a top rate of 20 percent to 15 percent, and lowered the tax rate on qualified dividends from a taxpayer's marginal income tax rate to 15 percent. These lower rates on capital gains and dividends were originally scheduled to expire in 2008, but were extended to Dec. 31, 2010, by the Tax Increase Prevention and Reconciliation Act of 2005. In 2011 these reduced tax rates will "sunset," or revert to the rates in effect before 2003, which were generally 20 percent. President Obama's budget, announced on Feb. 25, 2009, calls for the Capital Gains Tax to be reverted to the 20 percent rate before the sunset date of 2011.

Under current tax regulations, the great majority of a practice sale gain can be structured and allocated as a capital gain. If capital gains rate do increase to 20 percent and ordinary income is also expected to return to the previous 39.6 percent rate (currently 35 percent), any ground gained by postponing a sale could be easily lost. In the year of a practice sale, the price and gain for most sales will place the seller in the highest bracket.

$1,750,000 – Practice & Real Estate sales price (of which $1,500,000 is gain)
$800,000 – Portion allocated to goodwill (capital gain)
$200,000 – Portion allocated to equipment (ordinary income – assuming all recaptured)
$500,000 – Portion allocated to Real Estate gain (capital gain)

Tax at current rate
$120,000 - 15% x $800K (Goodwill)
$70,000 – 35% x $200K (Equipment)
$75,000 – 15% x $500K (Real Estate gain)
$265,000 – Total tax at today’s rate

Tax at HIGHER RATE
$160,000 – 20% x $800K (Goodwill)
$79,200 – 39.6% x $200K (equipment)
$100,000 – 20% x $500K (RE gain)
$339,200 – Total tax at the Higher Rate

$74,200 - TAX SAVINGS FOR SELLING UNDER CURRENT RATES

The tax saving can be significant especially in practices with higher value. So much so, it may be difficult to “make up the difference” by holding on to your practice longer.

The current, cautious “wait and see” attitude most owners are taking in this economy is creating “pressure behind the dam.” Right now it is creating a situation with few practices on the market. At some point these owners will not be willing to hold off retirement any longer. This sudden release of practices combined with the normal amount of practices that one would expect to show up year to year will create a short term over supply on the market. This would result in a buyer’s market and may cause practice value to decrease. In the worst case, due to the large amount of choices the buyers will have, there may be practices that just flat out will not sell as a result of this uncommon competition.

Therefore, if the only reason you are not considering selling now is the economy then you may want to reconsider and sell because of the economy. It is all about supply versus demand.

Right now interest rates on business acquisition loans are very good. The veterinary lenders did not get caught up in all the recent banking problems. In fact, a veterinary loan is still one of the strongest loans a bank can make. With the readily available cash, often times a buyer can purchase a practice with 100 percent financing. This means cash out to the seller. On larger deals, the lender may require the seller carry a second note for about 10-15 percent but this still means 85-90 percent cash to the seller at closing.

With this availability of funding and the knowledge that practice ownership is the path to increasing net worth, there are still a good number of buyers seeking quality practices. In fact, a quality practice in a desirable location usually does not stay on the market for very long and often sells for the asking price or very near to it. The problem arises not that the economy has slowed buyers’ interest, but now there is less inventory on the market.

One unexpected consequence that is starting to show up as a result of the lack of good practices on the market is the increased number of startups. The desire for practice ownership is still high and the veterinary lending industry is very strong. In fact, interest has never been better when it comes to the desire for practice ownership. Buyers understand the value of practice ownership and do not want to put off the personal net worth build up that one enjoys as a practice owner.

As a result, more and more buyers are seriously considering a practice start up rather than a practice purchase. This may be reversing the trend of less single doctor practices in favor of the more efficient multi doctor and the economy of scale that goes with it. It also creates at least three situations in the future. First, in the immediate future, there will be fewer qualified buyers available to purchase practices resulting in many practices going unsold and some closing their doors. Second, this increase in practices will make every owner’s “piece of the veterinary revenue pie” that much smaller, not only affecting take-home income but practice values as well. Then lastly in the distant future, there may be another glut of single-DVM practices coming on the market as these current buyers want to become sellers.

“Buy low and sell high” is the mantra of any good investing strategy. Of course that is often the exact opposite of what most folks do. When the economy gets shaky people start to get very conservative. “Better to do nothing and hang on to what I have” is what is heard around the water cooler. However, smart investors see opportunity in any market. If the market is at an all-time low then BUY and BUY some more. This may seem oversimplified, and you need to rely on your experienced financial advisors, but the basic concept is sound.

Veterinary practices, as a general rule, weather economic downturns very well, and today’s economy is no different. Most of the practices valued in 2008 and 2009 showed improvement over previous years. There may not have been double-digit growth rates but most practices held their own with several inking out a mild increase in gross revenues.

Therefore if your practice value has maintained and your original desire was to sell, why not sell high (your veterinary practice) and buy low (stocks, real estate). As the markets return, your net worth will surely go up, hopefully more than if the economy had not taken this downturn.

It is human nature to be overly cautious in a shaky economy. However, it may not be in your best interest to “play it safe.” It may be best to look for opportunities and take advantages while others fall behind. So if your personal exit strategy was to sell soon and you have decided to put that off while waiting for better times, you may want to reconsider. The current time may be perfect.

David King, DVM, AVA is the president of Simmons Southcentral. Simmons is the nation’s leader in veterinary practice sales and valuations. www.simmonsinc.com