Practice Acquisition and Start-Up Guidelines

It is very important to create a sound business plan prior to making an investment in a practice. Lenders generally require a business plan for a practice acquisition or start-up loan.

Vision One Credit Union has been reviewing business plans for optometrists for over 50 years, and has put together some guidelines based on the best plans we have seen. We have also included some helpful hints in each of the key areas of the business plan.

Anytime a business changes from its' historical patterns, some form of business analysis should be performed to determine the current and future financial and business implications. In a start-up practice, the analysis process is from the ground up.

A business plan has many elements. Some of the key elements used when applying for a practice acquisition or start-up loan are discussed below.

What do you hope to accomplish with the practice? Will any of the owners work outside the practice to supplement income? If so, where, how much, and for how long? With most start-up practices, the optometrist plans to work in other practices part of the time to make ends meet.

For each proposed practice owner include education and ophthalmic specialties, employment history, and other areas of expertise (i.e., business minor in college), previous experience in managing a business and professional affiliations. When attempting to get a practice acquisition loan it is best to have actual experience working in a private practice. Generally two to three years is adequate. This will give you an idea if you would like to own a practice, give you hands on experience and hopefully an opportunity to learn some of the business aspects of managing a practice.

Specify the preferred business structure: sole proprietorship, partnership, corporation, shared overhead.

When purchasing a practice, specify the level of participation of the seller after the sale. The selling doctor, at minimum, usually informs the patients about the new optometrist, reassuring them they are still going to receive the same high level of service. Many sellers continue to work in the practice as a contractor for a specified period of time. If the selling OD does not stay on to aid the transition in the practice purchase, in many cases, gross revenue may be diminished by 20% or more. This can result in as much as 50% decline in net cash flow.

Understanding the demographics of the trade area surrounding the practice is critical to the success of the practice.

What is the geographic profile in the area of the practice (by household income, households with children, age, education, ethnicity, employment type)? What is the past and future growth potential?

How many potential patients are covered by insurance--what kind? How many other providers are in the trade area of the practice? What is their specialty? Where are the closest competitors located? You don’t want to locate your practice in an area that has too many eye care providers. You should determine your service area, the number of providers and the population in that area (people who live or commute to the area). Then divide the population by the number of providers, including you. Vision One Credit Union’s experience suggests a minimum ratio of ODs to population of 1 : 7,000.

This analysis will help you determine if you are targeting the population that works or lives in the area. Once determined, your hours of operation must accommodate when potential patients can see you.

Determining your target market by demographics and capacity for purchasing eye care is important in establishing exam rates, product lines, specialties, and marketing strategies. This is your source of income--focus on it.

See Resources below for a list of internet based resources Vision One Credit Union uses to help determine demographics.

Different strategies for attracting and retaining patients are used depending on the type of setting you choose--shopping mall, medical building, business district, or residential area. What is the merchant composition in the immediate vicinity? What are the future development plans in the vicinity? The county planning office will generally know of major developments planned in the area well in advance of any groundbreaking.

What is the visibility and accessibility (freeways, commuter traffic, etc.)? Visibility during commuter traffic does not ensure potential patients will stop on their way to or from work unless you give them a good reason! Your advertising must reach those people! Are there any barriers that restrict patients from reaching the practice? For instance, a parking lot entrance that is difficult to maneuver could prevent patients from getting to you.

Negotiating a lease is required whether you buy or start-up a practice.
When entering a lease arrangement, check comparable rates per square foot in the area. If you have done your demographics homework, you should feel comfortable signing a five-year lease knowing the area will support your practice in the years to come. Make sure you have options to extend the lease so you are not forced to relocate or renegotiate a lease on disadvantageous terms. The lease term plus options should be at least as long as the term of the loan you might need to acquire or start up the practice. Specify the terms of any option or renewal periods. Make sure you have your loan commitment before you sign your lease. Negotiate the lease but signing is subject to obtaining a financing commitment.
When entering into a lease on a new location (start-up practice) there is a need to build out the space for optometric use. You can generally negotiate some or all of the build out, also known as leasehold improvements, to be paid by the lessor, depending on the strength of the real estate market. Try to negotiate a few months of free rent to allow you to complete your tenant improvements and help cover costs during the move in and ramp up of business. Get estimates or actual bids on the improvements you want before signing the lease. You will want to know the actual cost of improving the leased space to your specifications. This aids the lease negotiations and planning for capital investment for the practice. A lender will require this as part of the loan application.

Watch for hidden costs that could substantially change your occupancy expense:

A copy of the property's actual expenses for the prior year and the budget for the current year will help you calculate your exposure in these areas. These charges can be capped from increases from year to year, generally based on increases in the consumer price index (CPI).

Parking and signage costs must be considered; needs depend on your setting. Your practice purchase support team attorney should be able to quickly review the lease to make sure there are not any unusual provisions.

The marketing strategy should be focused on the best means to reach your target market.

Practice Acquisition: For the acquisition of an existing practice, determine what marketing strategies have historically worked best. Then look to see how you can improve the impact.

Start-up Practice: For a start-up practice you need to define your target market. Understand the competition you face and explain how you will differentiate yourself from them. Then determine how you will let your potential patients know about your practice and specialties.

Determine which vision and health care plans you will join. There is great value in letting the insurance plan do your marketing. You will need to analyze each plan you are considering to ensure you will get referrals without selling yourself short in compensation from the plan. Understand the plan and each party’s responsibilities before joining. Know how your practice will be referred by the plan. When buying existing practices, make sure you join the insurance panels used by the patients. Expansion to new panels should be reviewed based on the insurance utilized by the practice patient base or proposed base within the trade area.

What kind of advertising will you do—website, telephone book, newspaper, direct mail, patient referrals, telemarketing, newsletters, community groups, TV, radio, patient recalls, trunk shows, etc.? Get estimates of the costs of any type of advertising you choose. If you are going to offer discounted services for new patients, make sure you take this into account in your financial projections.

There are two types of cash flow to look at when purchasing or starting up a practice. First is cash flow from operations which comes from collected patient revenue less all of the ongoing expenses to run the practice (cost of goods sold,wages, occupancy, utilities, etc.). Capital costs are the other type of cash flow. Capital costs are up front costs to purchase or start-up a practice. These costs include acquisition price and working capital. Additional capital costs for start-ups include equipment, leasehold improvements, fixtures (frame displays) and initial inventory. Capital costs can be financed through practice “acquisition” or “start-up” loans

For practice acquisition loans your due diligence must determine if the ongoing cash flow from operations is enough to pay acquisition loan debt service and provide you with enough income for your living expenses. Your support team accountant can help you with the calculations. When applying for a loan through Vision One Credit Union, we will also review the cash flow to help determine if the acquisition loan can be repaid. We can send you an electronic spreadsheet form you can use to help determine the expected cash flow requirements and capital budget. It is not a substitute for your due diligence but is one additional tool that can help.

Key considerations in your analysis include making sure all income sources are sustainable upon your acquisition, such as being able to join the insurance panels used by patients, offering similar and additional specialty services, succeeding in interest to any existing direct contracts for patient sources such as those with a colleges or large area employers, etc. Make sure there will be no material increases in the expenses of the practice when you takeover, such as ongoing property lease rates, employees that have to be replaced (maybe the selling doctor’s spouse worked in the practice without compensation and will need to be replaced with a new salaried employee).

When performing your due diligence, you will want to review the last three years financial statements and tax returns of practice. Make sure the statements you receive are for the practice you are buying and do not include any other business interests. Sometimes a seller is selling one of many practice locations. Make sure the financial statements reflect just the location you want to purchase. In addition, sometimes the seller has other income sources such as lecturing, out-side contracts, etc. that will not convey to you as the buyer. Be sure to identify non-transferable income sources.

Look for trends in gross income, operating expenses (by category), and net income. Negative trends will need to be explained to determine if they are short or long term in nature (i.e., income went down because a significant employer left the market, which represented 40% of the patient base). A part of your due diligence is to determine what if any cash out flow (capital costs) will be required. Capital costs include:

Once you have completed your review and determined your capital budget, you will want to project future operating cash flow by creating a Cash Flow Proforma. Vision One Credit Union has templates available to help you with this process.

In your Proforma, you will project your expected Revenues, Cost of Goods Sold (COGS) and on-going operating expenses based on the historic findings. From your due diligence, you can determine and adjust for changes that will affect the practice cash flow and will include these changes in your projections:

Be sure to include the debt service of the new loan as well as your required owner draw.

Start-up practice operating cash flow is strictly based on projections; both expected revenue and anticipated expenses. Therefore, it is imperative that a thorough business plan and demographic study be completed. Be sure to explore in your study:

Operating expenses will still occur, whether or not there is revenue, therefore start-up practices generate negative operating cash flow until break even is achieved. Start-up practice operating cash shortfalls should be quantified through a Proforma (budget) which you will need to prepare. Vision One Credit Union also has templates you can use to help in the analysis. It is not uncommon to start out with $125,000 or more in working capital for a standard start-up. It might take many years to reach a breakeven point, which means you will need adequate working capital to cover the shortfall.

The following is the partial budget of operating expenses:

The capital costs for a start-up practice is a little more extensive than in an acquisition. Capital Budget items include:

To summarize, for the acquisition of existing practices, project your cash flow realistically for each of the first twelve months to ensure you have allotted enough working capital. For start-ups it is important to budget through a breakeven point including owner draw and debt service. This can take anywhere from one to three years or more depending on specific local circumstances. Make sure you budget conservatively so you don’t run out of cash (working capital) prior to the practice achieving positive cash flow.

Both the capital requirements and the operating projections are generally best prepared by you with support of your accountant. The projections should be prepared in a spreadsheet program so you can make any changes to your projections quickly, easily and consistently. Vision One Credit Union has spreadsheet programs you can use that are formatted specifically for practice acquisitions and start-ups.

To help establish a reasonable price for the practice, many buyers hire a
professional practice appraiser. The appraiser will determine the value of the practice as a going concern. This means the appraisal will be heavily reliant upon the net cash flow of the practice to determine value. You might want to also have the equipment appraised.

An investment in an appraisal at the onset is small when compared to the cost of the practice and is helpful for both buyers and sellers to understand the value of the practice. It can be used as a negotiation aid. A lender might require an appraisal.

There are no quick formulas for determining the value of a practice and each situation has unique circumstances that affect value. There are a few things you should be aware of regarding practice values.