As a veterinarian, “EBITDA” is not a term you come across in your day-to-day work. Maybe you’ve never heard of it until now. Regardless, it’s a word you must know if you want to sell your practice.
At its most basic, EBITDA is a measure of profitability that is used in the mergers and acquisition world to help determine your practice’s valuation. Let’s take a deeper look at this acronym: what it means, why it’s so essential in the sales process, and why corporate buyers are so intent on it.
What is EBITDA?
EBITDA (ee-bit-dah) is an acronym in accounting that stands for:
EBITDA = Earnings before Interest, Taxes, Depreciation and Amortization.
EBITDA ultimately approximates the cash generated by your business from its day-to-day operations. It does not include one-time costs. Let’s clarify why we do not include interest, taxes, depreciation, and amortization as part of this metric:
- Interest is a cost of financing your business, whether it’s interest on loans used to buy your veterinary clinic or interest on equipment. EBITDA looks at the cash or profits generated by your business irrespective of how you finance the practice. So, if you have $1 million of debt from purchasing the practice, or no debt because you’ve owned the practice for 20 years: it does not impact the EBITDA calculation. A buyer does not look at how much debt you have because the buyer expects you to pay off all debts at closing. Therefore, we add back interest costs.
- Taxes in EBITDA relate to your income taxes (state and federal), which can vary based on your corporate structure and your personal tax situation. A buyer of your veterinary practice will have their own tax situation that they consider, so they will ignore yours. However, there are a couple exceptions to this rule: EBITDA does include real estate taxes if your lease requires the veterinary hospital to pay these costs. It also includes sales taxes you pay on products. These are taxes that do not change based on who is the owner or how the business is structured.
- Depreciation is a non-cash cost that accountants may add to your income statement. It spreads the purchase of equipment or improvements to your building (leasehold improvements) over the useful life of the asset. For example, digital radiography equipment costs are spread out over a five or seven year period.[i]
- Amortization is also a non-cash cost that is like depreciation but relates to intangible assets.[ii]
Why is EBITDA So Important?
EBITDA is an estimate of the cash generated from the day-to-day running of a business. Especially in the veterinary profession, it’s a useful proxy for cash flow where there are few accounts receivable.
As it relates to selling, buyers will typically apply a purchase price multiple to your EBITDA to arrive at the value of your veterinary practice. In 2011, the average purchase price multiples were 4-6x EBITDA for an individual practice. From 2016 to 2019, these multiples rose to 7-12x EBITDA. In 2021 and early 2022 saw multiples of EBITDA expand to 12-18x depending on factors like geography, growth rate, size, specialty or general practice, among others. Since early 2022 multiples have come back down but remain slightly above pre-COVID levels at 8-13x EBITDA. Read our guide on practice valuation to learn more about what’s considered when determining your practice’s worth and EBITDA multiple.
By using a multiple of EBITDA, buyers can see how many years of current cash flow they will pay for your business. If you generate $500,000 of EBITDA today and a buyer pays 13x (or $6.5 million), they are paying for 13 years of current cash flow. Note that in future years, they would expect to grow that $500,000 in EBITDA to $700,000 or more. The faster you have historically grown your revenues and EBITDA, the higher the purchase price multiple a buyer will pay for your practice.
What is Normalized EBITDA?
Normalized EBITDA adjusts the revenues and costs that you have actually incurred for a twelve-month period to the revenues and costs that the business would have likely incurred IF it were run by a corporate group (but with your vendor contracts still in place). The way to think about this is: What expenses would a corporate group not incur that you had for the business? Some of the typical items we look at as ‘add-backs’, or expenses that we eliminate, include:
- Auto expenses and auto insurance
- Repair and Maintenance or Capital improvements: large equipment expenses (DR, new surgery lights) or building costs (new floors, new cabinets) are typically add-backs since buyers view them as capital improvements that do not go on the income statement. General repair and maintenance costs, like an HVAC maintenance agreement, are not add-backs.
- Travel and meals that are not directly related to the business
- Family members that are helping the business but will not remain employed by a corporate group
- A market rent rate for the building (and if you are over or under-charging rent relative to market, we adjust to market)
We will also make ‘market’ adjustments in some expense categories. For example, we will include what the ‘typical’ corporate group pays for health insurance, continuing education allowances, staff meals, and other standard expenses. Buyers will make their own adjustments for these, and other items, based on their specific approach.
In Summary
Normalized EBITDA is the key figure we use to market the practice to potential buyers. Why? Because it tells corporate groups what they likely would have achieved over the past year if they bought your practice. In a partnership with Ackerman Group, we work closely with you and your accountant to determine all the relevant ‘add-backs’ that increase your EBITDA (as well as add-back expenses that probably won’t continue).
Having someone with extensive experience in calculating Normalized EBITDA put this analysis together for you is incredibly important to securing the best deal for your business. Sellers that forgo an advisor will inadvertently have buyers do the calculation and form a proposal. While this seems fine, we can assure you that most buyers miss addbacks when there is no advisor present. Your normalized EBITDA is critical to obtaining the best price for your practice, and having a trusted source perform the analysis will lead to a higher valuation.
Ackerman Group offers eValuations of veterinary practices that include a quick analysis and estimate of your normalized EBITDA. After you sign an Engagement Letter with Ackerman Group, we will immediately start working to finalize your “Normalized EBITDA” for the trailing twelve-month period (which may be different from the EBITDA on your income statement and slightly different from the eValuation results). This normalized EBITDA analysis will provide the basis for negotiating the valuation of your practice.
To get started with your complimentary and confidential eValuation, click here.
[i] Depreciation: For example, if you buy digital radiography equipment for $50,000, you may deduct that expense on your income statement. All your potential buyers use accrual accounting which does not put capital equipment purchases on your income statement, rather they go to your Fixed Assets on the Balance Sheet and then there is an expense to reduce the asset over the useful life (7 years for digital radiography equipment). So, the $50,000 will result in $7,143 per year of non-cash Depreciation Expense until its ‘useful life’ of seven years has passed. For EBITDA calculations, we do not include the depreciation expense because the capital purchases (like the DR) are one-off non regular expenses. Veterinary practices have relatively low capital purchases relative to other businesses.
[ii] An example of Amortization includes — when a veterinary practice is sold, the buyer will allocate costs to a covenant not to compete that will last five years and the portion of the purchase price allocated to this covenant will be amortized over five years. The cash is paid today but the intangible asset has a five-year life, so the non-cash cost is expensed over that timeframe.