Optometric Practice Valuation Insights and Strategies

Optometric Practice Valuation Optometric Practice Valuation Bob Schultz President and CEO Vision One Credit Union

Vision One Credit Union, President and CEO Practice Management Center, Board Member Lecturer: Lecturer: Bob Schultz 2018 / 2019 Benedict Professor University of Houston College of Optometry

Vision One Credit Union Not for profit banking organization Founded in 1951 by independent ODs for private practices only All volunteer, all OD Board of Directors Mission Perpetuate independent optometry through an exclusive banking organization Tactics - Take deposits from the independent optometric community and reinvest the funds into private practice purchases, startups, and practice investments (relo, remodel, equipment, additional locations, building) to grow and build value. Provide value added services due to more knowledge of private optometric practices than any other banking group Have financed over 500 practice transitions worth over $400 million Ask yourself - How would you direct $125 million to help private practices and independent optometry?

Practice Valuation Is It Complex? Yes

Current valuation methodologies Base level data required for valuations You Will Learn About: Optometric practice value drivers Variations that impact valuation

Economic v. Strategic value Economic reasonable market return on investment (ROI) Strategic - Value is situational i.e. last piece of the puzzle Current Valuation Methodologies Methods to determine economic value % of Gross Capitalization of Earnings Inverse is Multiple of Net What someone is willing to pay Supply and demand

Practice cash flow fully loaded (aka EBITDA). Derived from Profit and Loss Statement A reliable and functional accounting structure Base Level Data Required for Valuations

Basic Accounting Structure Profit and Loss Revenue (collected) - Cost of Goods Sold (COGS) = Gross Profit - Overhead Expenses = Net Income

Basic Accounting Structure Profit and Loss Revenues collected Clinical Dispensary Frames Lenses Contacts Other (if any) Cost of Goods Sold (COGS) Use same structure as above to track Gross Profit Collected Revenue less COGS 40% 20% 20% 20% % of revenue is for a typical OD practice. All percentages may change based on setting, state laws, and empanelments 28%

Basic Accounting Structure Profit and Loss Overhead Expenses Compensation (comp = salary + all benefits) Non-Owners: Non-OD staff wages OD wages (W-2 or 1099) Taxes and benefits (see benefits detail below) Owner ODs compensation: Salary Taxes Benefits PTO, auto, medical, 401k, continuing education, dues, etc. Occupancy Rent, utilities, common area maintenance, triple net charges, % rent if any, etc. Other Itemize (interest, depreciation, card fees, advertising, consulting, etc.) Total Overhead Expenses (sum of expenses above)

Converting the Practice P&L to Cash Flow Net Income from tax return or interal P&L if tied out to the return Normalizations: additions or subtractions Interest Expense + Taxes on Corporate Income + Depreciation & Amortization + OD Owner Compensation + OD Associate Compensation + Equipment Loans & Leases in P&L + Spouse - compensated, not compensated + or - Rent - to market for OD owners + or - Total Normalizing Adjustments 1. Operating Cash Flow - No OD expenses Less OD Associate Compensation Less Market Rate for OD Owners 2. EBITDA Earnings before interest, taxes, depreciation, amort Less Lease and Loan payments 3. Practice Cash Flow Net Income + Total Normalizing Adjustments. >= 30% of revenue Used for appraisals, buyers & bankers. >= 15% of revenue Principal and interest payments Actual - Used by bankers & practice owners

The value of a business is derived from EBITDA. For optometric practices there are two key components of EBITDA Operational efficiency Practice Value Drivers Practice EBITDA less OD expense / collected revenue 30% or greater OD efficiency One FTE (full time equivalent ) OD produces > $750,000 collected revenue Calculation for OD efficiency OD days per week to operate the clinic (seeing patients, not managing) / 5 (days in a work week) I.e. 7 OD days / 5 = 1.4 FTEs. $1,000,000 collected revenue / 1.4 FTEs = $714,286 per FTE OD

Putting it all Together

Historical Financial Analysis Performance to Industry Metrics Average Below Above Practice Cash Flow Illustration Statement Type # of Months in Period Period / Avg. Weight P&L 12 20xx % P&L 12 20xx % P&L 12 20xx % Target % Industry 1 3 5 Range % Sales Growth (%) 0% 0% Gross Collected Revenues $ 1,000,000 100% $ 1,000,000 100% $ 1,000,000 100% Each practice has: 1. Proper accounting 2. Multiple cash flow calculations 3. Unique operational & OD efficiencies resulting in different valuations given the same revenue Cost of Goods Sold $ 280,000 28% $ 320,000 32% $ 260,000 26% <=30% 25% - 36% Gross Profit $ 720,000 72% $ 680,000 68% $ 740,000 74% >=70% 64% - 75% Overhead Expenses OD Owner(s) Compensation Associate OD Compensation Non-OD Staff Compensation Occupancy Expense Interest Expense Depreciation + Amort. Other Expense $ $ $ $ $ $ $ 155,000 33,150 200,000 80,000 7,000 25,000 139,850 16% 3% 20% 8% 1% 3% 14% $ $ $ $ $ $ $ 120,000 66,300 225,000 90,000 12,000 25,000 121,700 12% 7% 23% 9% 1% 3% 12% $ $ $ $ $ $ $ 140,000 14% - 180,000 70,000 18% 7% <=20% <=8% 15% - 24% 5% - 9% - 25,000 170,000 3% 17% Calculated Total Overhead Expenses $ 640,000 64% $ 660,000 66% $ 585,000 59% Net Overhead Expense $ 419,850 42% $ 436,700 44% $ 420,000 42% <=44% 41% - 55% Other Income Income Before Tax Income Taxes $ $ $ - $ $ $ - $ $ $ - 80,000 8% 20,000 2% 155,000 16% - - - Net Income $ 80,000 8% $ 20,000 2% $ 155,000 16% Practice Cash Flow Adjustments (Normalization) Interest Expense (+) Taxes on C Corp Income (+) Depreciation & Amortization (+) OD Owner Compensation (+) OD Associate Compensation (+) Equipment Leases in P&L (not interest) + Spouse Compensation (+ or -) Occupancy - OD owner Adj to market (+ or -) Selling OD Adjustment OD Associate Adjustment $ $ $ $ $ $ $ $ $ $ 7,000 $ $ $ $ $ $ $ $ $ $ 12,000 $ $ $ $ $ $ $ $ $ $ - - - - 25,000 155,000 33,150 25,000 120,000 66,300 25,000 140,000 - - - - - - - - - - - - - - - - Total Practice Adjustments $ 220,150 $ 223,300 $ 165,000 1. Operating Cash Flow - No ODs $ 300,150 30% $ 243,300 24% $ 320,000 32% >=30% 12% - 40%

Practice Cash Flow Illustration Cash Flow & Efficiency Calcs 1. Operating Cash Flow - No ODs Less OD Associate Compensation Less Market Rate for OD Owners 2. EBITDA Less Loan and Lease Payments 3. Practice Cash Flow $ $ $ $ $ $ 300,150 33,150 118,235 148,765 18,000 130,765 30% $ $ $ $ $ $ 243,300 66,300 118,235 58,765 30,000 28,765 24% $ $ $ $ $ $ 320,000 32% >=30% 12% - 40% - 118,235 201,765 15% 6% 20% >=15% 0% - 20% - 201,765 Market Rate for OD Owners Practice Cash Flow 4. Total Compensation Available to Owner $ $ $ 118,235 130,765 249,000 $ $ $ 118,235 28,765 147,000 $ $ $ 118,235 201,765 320,000 5. Valuation % of Gross (for reference only) Financing available $ 620,000 62% yes $ 225,000 23% $ 818,000 82% yes no (yes @ $125k) OD Efficiency Calculation # of OD Clinical Days per Week Owner OD works in clinic Days per Week Full Time Equivalent ODs (OD days in clinic / 5) Revenue per FTE OD 6.50 5.00 1.30 8.00 5.00 1.60 5.00 5.00 1.00 1,000,000 Associate Avg. Comp per day $425 $ 769,231 $ 625,000 $

Setting Variations That Impact EBITDA &/or Valuation Urban / Suburban or Rural Office or Retail Bldg, Vacation area Capital Expenditures & Taxes used in some EBITDA models Lease issues or practice appears run down Debt Service Coverage Practice Efficiency Supply & Demand Value drops disproportionately if increasing inefficiencies Its not linear

The valuation methodologies used in Optometry today It s not % of gross! How to construct a meaningful accounting structure and calculate multiple views of cash flow including EBITDA You Have Learned Practice value drivers Variations that impact cash flow and value