Finances

Practice Opportunity Costs: Build, Buy or Start-Up?

By Alissa Wald, OD, and Scott Daniels

Optometrists considering practice ownership face an initial question: Buy an existing practice or start one from scratch?The right decision (for you) is based on a thorough financial analysis of both options.

The age-old question for anyone who would like to be a business owner is whether to build or buy an existing business. Either option hasits pluses and minuses. The following are factors to consider in answering that questions and another: Can theenterprise earn an acceptableprofit?.

Starting a Practice “Cold”

When it comes to starting a practice “cold,” costs can range anywhere from $150,000 – $500,000, excluding monthly operating expenses required for the first few years or until the business is profitable. Rent, labor and other fixed costs must be considered. Always calculate an additional 15 percent to compensate for start-up costs related to unexpected construction delays, extra equipment, security deposits, etc. Most start-ups fail because of a lack of sufficient working capital. It could take months or years until the practice is profitable enough to provide a large enough salary for your personal needs.

Compare Starting Cold to Purchasing
If the practice is larger, it can, depending on net cash flow, produce enough income to repay the purchase loan and offer a great salary for the new owner-doctor.For example, if the net income is $200,000, and the annual purchase loan repayment amount is $80,000—the new owner will make up to $120,000 (excluding any potential transition effects). It’s often an easy decision to buy an existing practice when it grosses $500,000 or more per year.

When a practice grosses $100,000 – $300,000, the value is often less clear. A smaller grossing practice may only net $20,000.This is because fixed expenses will be a higher percentage until the gross revenue “catches up.” Many people believe that the value for any size practice is simply a multiple of the adjusted net.Is it reasonable to buy this practice if it nets only $20,000 to $60,000. The answer depends on other factors such as the quantity and amount of inventory, equipment and tenant improvements. Often the value of these smaller practices is based on a combination of the assets and inventory in addition to any consideration for existing revenue.

Veterinary practice consultants call smaller offices “No-Lo” practices. The term was coined because these offices have no value and a low profit. Of course, this can be said in any type of business. In optometry, this concept is false. Smaller practices can offer excellent opportunities for buyers at great prices. Sellers are more eager than ever to sell these offices, making it more of a buyer’s market. The key for these or any business is to properly appraise the business.A formal appraisal includes various methodologies which are recognized by CPAs and appraisal associations. A business might have some value even though there is little or no profit.

Ask about Financing Options
In today’s marketplace, lenders are more reluctant to finance these smaller practices (as well as start-ups). As a result, sellers must offer owner financing to buyers if they wish to sell. This has created a wave of opportunities for buyers. While larger grossing practices (with lots of profit) are holding their values, those buyers seeking value opportunities should look at these smaller practices. Buyer’s can often obtain 100 percent seller financing without the stress in applying to a bank. Often times these same lenders will refinance the buyer’s new practice after one to two years. This allows the seller to cash out over a short time.

Examine Realistic Expenses
For a start-up a practice, examine how much it would cost to buy the inventory, equipment and to pay for tenant improvements? Then consider how long it will take to bring in enough patient revenue to meet monthly expenses such as labor and rent.

Alternately, let’s consider purchasing an older, well-established office grossing $300,000. The practice is in clean condition but needs some updating. The equipment is working condition. On the older side, it is not computerized and not paperless. It includes two exam lanes. The seller wants $150,000. Adjusted net profit is about $95,000.

Calculate Difference Between Buying and Starting Up
Consider the following. To start-up a comparable practice it might cost in excess of $300,000 including the “losses” for the first year alone. Here’s a breakdown of start-up costs for an office:

Equipment (two lanes) $30,000 (includes used items)
Edger, tinter, tools, etc $25,000

Inventory & supplies $40,000
Phones & voice mail$5,000

Build-out $100,000 (includes sinks, stations, walls, carpet, paint, etc.)
Furniture $25,000

Deposit$5,000

Licenses & Insurance $5,000

Signs $5,000

Misc. $10,000

Subtotal $250,000

Add

12 month’s rent & utilities $48,000

Cost of goods estimated $50,000
Advertising $12,000

Wages (one staff person) $40,000

Subtotal $150,000

First year’s investment: $400,000

Second year’s total investment: $550,000

Assumptions:

Start-up:

Cost: $365,000 (Equals: $250,000 plus $115,000 in cash for first year’s losses)

Purchase:

Cost: $200,000 (Equals: $150,000, plus $50,000 in equipment upgrades and working capital)

Here’s an illustration of the example:

Purchase Existing:Start-up
Initial cost (purchase) $150,000 $250,000

Upgrade equipment expense $30,000 —

Additional working capital needed (startup) $20,000 $115,000

Total loans: $200,000 $365,000

Estimated first year’s revenue: $300,000 $88,000

Estimated annual expenses: ($200,000) ($150,000)

Estimated annual loan payments* ($29,000) ($53,000)

Net profit (first year) $71,000 ($115,000)

If the practice sale price were lowered to $100,000, the profit for the first year would increase to almost $80,000. Starting from scratch is often riskier and makes it more difficult to obtain bank financing simply because there is no track record. However, with sufficient capital and time, the start-up could eventually catch up. The following illustration only reflects the first year. A start-up could show additional losses in the second and third years.

Examining further the pros and cons of both start up and existing purchases:

Start-Up

Pros

Cons

Everything is new

Time consuming in managing construction, build-out and permits.

Youpick the location

Strong possibility of delays before opening.

Don’t have any “skeletons” from prior owner

No history of revenue

New staff/do things your way (no old bad habits)

Harder to get a loan

Youdesign the office layout

May have to work outside or have spouse work.

Harder to get landlord to approve lease (no track record).

May not be profitable for years.

Existing practice

Pros

Cons

Has immediate cash flow/ profit

Furniture and equipment is older

Everything is setup

Systems need improving

Has historically proven track record

May not be ideal location

Replacing new equipment or furnishing is easier when there is profit

Used older equipment breaks

More growth opportunities faster in both increasing revenue-per-patient for existing patients and finding new patients

Did the doctor have poor skills or give things away for free?

Related ROB Articles

2011 a Boom Year in Practice Sales?

Buying into an Independent Practice

Taking the Step to Practice Ownership

Alissa Wald, OD,founded Practice Concepts, along with her husband, Scott Daniels. She serves aslead advisory board member for the ophthalmic division of the company. She also is a successful practice owner, purchasing her first office almost 20 years ago.

Scott Daniels, is executive senior broker with Practice Concepts, and heads a team of all the practice specialty divisions. He has completed and worked on hundreds of successful practice sales and transitions. He has more than 20 years of experience in business management, financing, marketing, negotiations and practice brokerage.

To contact Practice Concepts: scott@practiceconcepts.com

Click to comment

You must be logged in to post a comment Login

Leave a Reply

To Top
  
Subscribe Today Free...
And join more than 25,000 optometric colleagues who have made Review of Optometric Business their daily business advisor.
YOUR EMAIL
FIRST NAME
LAST NAME
  
Subscribe Today Free...
And join more than 25,000 optometric colleagues who have made Review of Optometric Business their daily business advisor.
YOUR EMAIL
FIRST NAME
LAST NAME
Subscribe Today for Free...
And join more than 35,000 optometric colleagues who have made Review of Optometric Business their daily business advisor.
Subscribe Today for Free...
And join more than 35,000 optometric colleagues who have made Review of Optometric Business their daily business advisor.