Transitioning Your Practice to a New Generation
September 2019 Issue
Family-owned practices have been an integral part of the O&P profession for decades. Many of these businesses have seen generation after generation pass through their doors. For all of the benefits and rewards of private and family practices, owners know well that there are also plenty of challenges. This is never more apparent than when it comes time to sell. As they head toward retirement, private practitioners face unique challenges in transitioning their businesses.
Whether you're passing your business on to the next familial generation or selling to a larger O&P company or investor, a succession plan is imperative to make the transition as smooth and successful as possible. O&P consultants regularly advise owners on these sales, and their primary message is largely the same: START EARLY AND PLAN AHEAD.
"I always tell folks looking to exit the industry, it's a two-year journey to prepare for the sale because you obviously want to get as much out of it as possible," says Brian L. Gustin, CP, CEO and founder of Forensic Prosthetic & Orthotic Consulting, Suamico, Wisconsin.
To do so, owners must get their books in order and otherwise begin the process of taking a good, hard look at the business to determine what it's worth. Traditionally, when valuating a business, buyers will ask for five years of taxes and five years of year-end profit and loss statements (P&Ls) and balance sheets. From there, a weighted value can be determined.
"Obviously you want your most recent years to be really good because they carry the most weight," Gustin says.
Having real numbers to show a buyer includes doing all you can to strip out the pass-through costs that small business owners have, or those things that can detract from the earnings before interest, taxes, depreciation, and amortization (EBITDA) value of the businesses. "You would need to provide a pro forma balance sheet and P&L with those things stripped out," he adds. "That's why I tell people to spend the two years tightening up the purse strings to get real numbers, which are as good as possible, and then from there you can negotiate some multiple EBITDA."
Valuating Your Practice
Valuating a private family practice can be particularly tricky. Not only is it difficult to objectively set a price for a business you've put your blood, sweat, and tears into, but the overhead of running an O&P practice is typically very high and those costs must be accounted for. From a cost standpoint, many practices have too much space and are overstaffed with expensive labor. Many family-run practices have long-term employees, frequently viewed as family. However, a prospective buyer will not view the employee relationships in the same way, and these staff members' salaries and benefits can be a detriment to your final sale price. So, ask yourself, is every employee essential to the operation of the business or are they simply nice to have around?
By planning for the transition of your practice far ahead of retirement, you can begin to eliminate some of those costs impacting the bottom line. This will make the business more appealing, whether you're selling to a family member or an outside buyer.
In addition to labor costs, Gustin says another major cost contributor he sees in O&P results from practices opening additional offices once their initial location begins doing well.
"Oftentimes when you do this, you've only increased your total costs and have not increased revenues," he says. "So, if you're going to open additional locations, you need to make sure adding locations is accretive to sales, not cost. You have to be sure you're not cannibalizing your main location."
He suggests mothballing multiple locations, which are essentially locations of convenience for patients. Consider whether you are getting new referral sources and new patients in these locations or if you've simply shifted where existing patients are seen. If patients are willing to come to your main location, then there is no logical business reason to open more locations and incur additional overhead costs.
"By tightening up the bottom line over a couple of years, owners will be doing themselves a great service in improving the valuation of their business tremendously," he says.
If you're selling your practice to a family member, he or she can be involved in this process of reducing overhead to achieve the greatest outcome. Particularly if the family member is already working for the practice, he or she can help to steer it down the most profitable path before officially stepping in to take the reins.
A Dose of Reality
Barry Smith, president and owner of Lloyds Capital, also consults for O&P businesses. In his 25 years doing so, he's advised on more than 150 sales and valued an additional 300 businesses. Beyond doing the legwork to prepare for a sale, he cautions that it's equally important to be realistic about the state of your practice and its marketability. Owners need to understand that not every business is saleable—and even a family sale is never a sure thing.
"This can be a huge dose of reality for those owners that have been in the industry for 30 years and were around for the good old days," Smith says.
It's also important to consider how changes in the O&P profession are affecting the marketability of private practices, he says, citing factors like competitive bidding under Medicare, and the fact that many physicians and hospitals are bringing O&P in-house versus referring patients out to specialty clinics. All of these things have put pressure on privately owned practices, impacting both profitability and saleability.
"There are currently about 1,200 or 1,300 private practices, and the average O&P shop is doing about $1 million in business each year—so they're making a living, but they're not thriving," he says. "When you look at those that are extremely profitable, that list falls to about 200."
Family and outside buyers alike want to invest in something that moves their needle, and they're likely to steer clear of practices that have been declining or unprofitable for two years or more.
"If they buy something that's just marginally profitable, they've accomplished nothing," Smith says.
That is not to say that moderately successful practices can't be sold, but private practice owners must become more open-minded and consider options they might not have before in these scenarios, including selling to a larger clinic.
"There are those people that say they would never sell their family business to a Hanger, for example, but when the money is on the table, those types of sales quickly become an option for many."
For a reality check, Smith advises taking a good look at the P&L to determine how profitable your firm actually is. Then he suggests working to boost the bottom line by reviewing your cost of goods and scrutinizing your payroll.
"These two factors together account for 60 percent of the sale," he says. "And the owner isn't the best person to objectively look at where costs and pricing can be scaled back. But an outside consultant can come in and say, ‘Here's where you can save $100,000,'" he says.
Keeping It in the Family
For many practitioners heading into retirement, keeping their O&P business in the family is extremely important. Ideally in a family succession, you've been prepping your successors far ahead of your retirement based on the knowledge that this would be the eventual outcome. Still, it's important to consider the fact that circumstances can change. This can leave you looking to family members other than those you'd planned to sell to, or even to someone outside of your family to step into your business.
While it can be tempting to let some of the details slide, it's critical not to allow preconceptions, expectations, or emotions to cloud your ability to treat the transference of your practice to a family member as a business transaction. Experts advise that family succession plans adhere to the same rules and advice as if you were selling to an outside party.
"My advice on selling among family members would be the same, but of course you also need to consider family dynamics," Gustin says.
Rachel Friddle-Johnson and her sister Rebecca Friddle took over their father's O&P distribution and central fabrication business in 2015. With plenty of family history behind the company, and both sisters having been raised in the business, they can attest to the need to approach a family sale from a business perspective.
The now-fourth-generation business dates back to 1929, when the women's great-grandfather was involved with the O&P division of the Shriners Hospital in Greenville, South Carolina. From there, the seeds were sown for what would eventually become Friddle's Orthopedic Appliances, the company established by his son—Rachel's and Rebecca's grandfather—Frank Friddle Sr., in 1976. The business, based in Honea Path, South Carolina, began as a raw materials distributor and eventually evolved to specialized fabrication for spinal orthotics.
"My dad grew the business, and I became a CPO working for a private practice in Tennessee from 2005 to 2010," Friddle-Johnson says. "In 2010, my husband and I decided we wanted to be near family so we came back to the family business. My husband had been working remotely for Friddle's since 2001, and my sister since 2008."
In 2013, their father told Rachel and Rebecca he wanted them to have the practice when he retired. Both agreed they wanted to purchase it. The family recognized the importance of working with outside parties to ensure objectivity so that the sale and the new ownership roles were fairly and equitably established.
"Once we figured out what the sale price would be and how we could work through those details, our accountant played a big role," Friddle-Johnson says. "My dad had bought the company from his father, so we knew what we wanted to do, and what we wanted to do differently."
"After the sale we looked at physical property and location, and we also wanted to own the building and the property," Friddle-Johnson says. "As a business owner, I would advise everyone to be aware of that; you don't want be paying rent to someone else."
The building and property were still owned by their grandfather and father. Therefore, Friddle and Friddle-Johnson subsequently purchased the property in a separate transaction in 2018.
Currently, Friddle-Johnson is president and CEO, and her sister is vice president of the company. Each has 48 percent ownership and their father retains 4 percent ownership. Ultimately the percentages will change to a 51/49 split between the two.
"Setting it up this way gives our dad a vested interest and he will still have benefits," she says. "And it gives my sister and I time to be partners and see how we want to do this."
Friddle-Johnson says there are definitely unique challenges to transitioning a family practice from one generation to the next, and that all parties involved should expect that and go into it with eyes wide open. "Of course, you all love each other, so it's not always easy to keep emotion out of the equation. But you also have to think about business and what is best—and ultimately, we're all looking out for each other."
Additional Tips for Succession Planning
Whether selling your business to a family member or an outside buyer, there is no foolproof way to guarantee a problem-free transition. Besides all of the back-end preparedness required, there are a few additional things to keep in mind when devising your succession plan to ensure the best outcome for all parties involved.
Understand the difference between ownership and management/leadership. There is a big difference between owning and managing a business and it's crucial to understand the nuances when planning for each of these roles.
Whether you're selling to a family member, an employee, a former competitor, or an investment group, succession planning for ownership includes buy and sell agreements and other legal matters. Succession planning for leadership, however, includes prepping and training the people that will be stepping into various roles in your practice.
Know when to sell. Smith cautions that to get the most out of a sale, selling at the right time is paramount—and that time isn't when you are at retirement age and burnt out, he says.
"The time to sell is when you're profitable, growing, and the future is bright. It's not typically the time when you think you should sell it, but it probably is."
The bottom line is that if you want to have a successful transition, you can't rush it.
"I am selling businesses now that I have been talking to for 20 years—and if you've held it long enough and been smart and you're running a tight ship, you'll fare better when it comes time to sell," Smith says.
Get the professional expertise (and objectivity) you need. It's nearly impossible to handle your own business sale objectively. Accountants, lawyers, financial advisers, and business consultants will be invaluable in helping you establish a successful succession plan.
Selling a business you built from the ground up will inevitably be an emotional decision. But careful planning can help to replace some of that emotion with logic and ensure that both you and your successor reap the greatest benefit—and that your legacy thrives for years to come.
Tara McMeekin is a writer and editor based in Parker, Colorado.