OBSERVATIONS ‘05

 

Q&A OF BLUNDERS, CAUTIONS, AND STRATEGEMS IMPACTING THE PRACTICE SALE THROUGHOUT  2005 (PART I)

by Sam Reader

Compliments of S.G.Reader & Associates Inc.

 

Q:        Can the corporate or personal tax return from the seller guarantee the verification of the clinic’s income?

 

A:        Sure it can.  But not necessarily income being produced from chiropractic treatment of patients.

            Case in point: Doctor A hires the best CPA money can buy to begin due diligence on a small chain of three clinics.

            The CPA gives the go ahead; a cash offer is accepted.  Within the first two or three weeks of ownership, Doctor A becomes sick and anxious over the realization that this is not the clinic he thought he bought.

            Sure enough, 70% of all income was produced from an unrelated enterprise.  The monies from this unrelated enterprise were laundered through the chiropractic offices and reported in full on the tax returns.

In another situation, the owners would soon find that the patients were being paid bonuses or rebates to encourage and promote return visits.  These same owners would also find that 50% of the clinic’s income was paid referrals from personal injury attorneys and bird dogs (ambulance chasers).

These bonuses, rebates and referral fees were reported in full on the tax return as legitimate expenses, under marketing and promotion.

The tax return cannot stand alone in the due diligence of verifying how that clinic is producing income.

Unfortunately, too much trust is placed on the tax return.

Q:        Assuming the income being produced from the clinic is legitimate, doesn’t the tax return verify the current status and income from clinic?

A:        Yes and no.  Yes, if the clinic is still going strong.  No, if numbers for the clinic have dropped during the current year.

            Case in point: Doctor P was excited about adding a new satellite office across town.  The asking price was $650k.  The clinic showed tax returns of $850k in annual collections.  A pretty good buy.  Several days prior to closing, Doctor P instinctively thought to take a closer look at production or services rendered over the last nine months.  To his surprise, production had dropped by 65%.  Due to the natural lag time in accounts receivable, the 65% drop would not have been fully realized until a year later.

            The bank (or funding group) was set to cut the check.  Unfortunately, they would not have caught this potential catastrophe.  Here is why.  The funder requires only three years of tax returns and an interim (profit and loss) report of the current year to verify and satisfy the status and strength of the clinic.  Again, due to the natural lag time of accounts receivable, the interim report will usually show strong.  The most recent production or services rendered is not reflected within the interim report of the current year in question.

            In another situation, the bank went ahead and gladly cut the check in what appeared to be a long-standing and strong cash flow clinic.  Several weeks after the new owner settled in her routine, she found that 40% of her cash flow would be walking out the door.  Unfortunately, 40% of the cash flow was represented by a small group of doctors subletting space.  This group of doctors was not under contract to stay.

            Again, these are the subtle nuances not reflected in the tax return and interim report, nor scouted by the funder.

Q:        Is it possible that I can build a clinic so big it becomes too difficult to sell?

 

A:        It all depends on who buys it.  For a doctor who is depending on a loan, most lenders or funders will cap at $1,000,000.  The seller will have to carry back a note on the balance.  If the buyer is an independently wealthy investor, he/she may then avoid the funder.  It has been my experience, however, that wealthy investors still want the seller to carry back a portion of the note exceeding $1,000,000.

            In practice building and practice sales, we refer to this as critical mass.  In other words, the apex of that clinic’s power (production and collections) will realize the greatest gains for the least amount of effort invested in the building of that clinic.

Q:        What’s in a name?

 

A:        The name of a clinic is a strong percentage of the good will.  Buying or selling a clinic is not a tangible item such as selling or purchasing a car or home.  The funding of a car or home is asset based.  The funding of a clinic is cash flow based.  A guarantee of continual cash flow may be perceived by the potential buyer as the name on the sign or window of the clinic.  In the buyer’s mind, this is good will.  This is what he or she is buying.

            Case in point: Doctor E was practicing in a small community.  The name of his clinic was his last name.  Doctor E was thinking about selling his clinic, but instinctively felt the name of his clinic may diminish the good will or value for the potential doctor, particularly since he (Doctor E) was born and raised in the community.

            So he changed the name of his clinic from his name to the name of the township. He did this one year prior to his desire to sell.  It paid off!

            The new doctor later stated that his desire to purchase the clinic was “in the name”.  This was his comfort zone.  The new doctor felt the old name would have overshadowed and threatened his transition into the community.  He would not have purchased the clinic.

            The name of the clinic can account for as much as 45% of the good will.

            Learn from the mistakes and prudence

            of others.

            Move Forward!  Be Smart!  Enjoy!