Navigating your retirement - Part Two

Give-and-take method - Creating a win-win situation

To derive the best value out of part two it is important to be aware of the points made in part one.  There are two realities embedded in this scenario to note. Selling a practice outright will never be enough to provide the same lifestyle derived from a thriving practice as a going concern. For a prospective buyer, raising the funds to buy a practice will be near impossible without very demanding surety. 

The ideal optometric practice setup is in a building owned by the optometrist, who employs a junior optometrist. This should ideally happen after 10 years in practice. In the long term, rent and salaries in a mall practice will slowly but surely throttle the business as a prosperous concern.

Banks traditionally treat optometric deals as asset-based finance. They will value your debtors, equipment, stock, furniture, and fittings according to their formulae, which will amount to a percentage of the value on your books.

Moreover, if the sales price is, say, R3m they will demand that the seller gives R1m of the sales price back to them as a collateral investment until the loan is paid off. This is a ridiculous idea, but the bank will push for this to minimise its risk. 

Over the past twenty years or so, optometry has acquired a less than favourable reputation with banks. Some big deals with optometric groups have gone bad, and such bad news is circulated among banks. 

Banks are only interested in two things:

• How are you going to pay the monthly installments?

• If the business fails, how will they get their money back – so they will want surety.

They naturally, want the sales price as low as possible against the asset value of the business to reduce the risk, which is not in the seller’s interest.

This makes it virtually impossible for most young optometrists to raise the money on their own to buy a practice. However, for most retiring optometrists, the money raised from selling the practice will form a big part of creating an income stream in retirement. 

The Give-and-Take method was devised to offer the retiring optometrist a huge financial benefit and provide a great opportunity for a young optometrist to acquire equity.

My pricing formula

In my opinion, a business with a history of delivering a good net profit over time is a thing of beauty and must be seen as a money-making machine. I'm only interested in the net profit it makes. My formula for pricing an optometric practice is annual net profit before tax X 3,5. Any pricing formula must involve net profit, otherwise, it is useless. If it is a good business, this formula should enable the buyer to pay the sales price over five years. It is worth noting that sales price will always be determined by a willing buyer and a willing seller with an intuitive component.

Selling outright

Example

Turnover - R6 000 000 pa. (R500 000 pm)

Net Profit @ 20% before tax - R1 200 000

Selling price - Net before tax X 3,5 = R4 200 000

R4 200 000 invested for a yield of 12% (debatable) = R504 000 = R42 000 pm

Income derived from the investment falls way short of what was derived from the practice as a going concern. From R100 000 to R42 000 pm. Whilst these numbers may be challenged, the principle is indisputable.

The scenario that will suit the Give and Take Method is as follows:

A willing seller who wants to retire and a willing buyer who does not have the means to raise the asking price. The seller has employed the potential buyer for some years and they know each other well. The practice makes an annual net profit of R1 200 000 before tax. Based on the formula net profit before tax X 3.5, the equity value is R4 200 000.

The buyer can raise 10 percent of the asking price, for which she gets 10 percent of the shares. This is not a deal breaker, but it locks the buyer in to see the deal through to the end. The seller retires and agrees to give away five percent (or more) of the value of R4 200 000 each year for five years. After five years, the buyer will own 25 percent plus the 10 percent of the business she bought. The seller has sacrificed 25 percent but has also enjoyed a profit of R1 080 000 (90%) over the five years, which comes to R5 400 000. To simplify matters, we assume that the net profit remains the same every year, but in reality, it should increase, placing the seller in an even better position. In the example above, an outright sale would have yielded R4 200 000, but giving shares away while still reaping the benefit of the practice's profits has yielded R5 400 000 and she still owns 65% of the equity. The buyer now owns 35% of the business without having paid a cent for it. To boot, the buyer's annual income will now take a big jump after the first five years, when she qualifies for a share in the profit.

The agreement would read like this:

The buyer buys 10 percent of the business for cash (better, but not a deal breaker)

The buyer will carry the patient load, manage and grow the business for a market-related salary.

The buyer will enjoy shareholder status for the 10 percent and receive a dividend.

The seller retires and does not work in the practice any longer.

The buyer will only take the transfer of the free shares after five years.

The buyer will only start to share in the profits of the pledged shares after five years.

Should the buyer decide to leave, she will forfeit all the shares promised, except the 10 percent she owns. 

Should the seller sell after say, three years, the buyer will be paid out pro-rata: 15 percent of the sales price, plus the 10 percent she owns. 

After five years, the buyer has the option to buy more shares based on the abovementioned formula or a formula to be negotiated.

Conditions:

• The seller must have a history with the prospective buyer

• The seller must be ready to retire and hand over the reins

• The incumbent must accept a market-related salary

• The practice software must provide detailed monthly financial reports

• An effective employment agreement must be in place.

• Practice must not be in decline

There are huge benefits to both parties. The seller steps into retirement while the buyer steps into equity for free, in exchange for hard work. The seller will receive greater financial gain than from an outright sale, and the buyer is in a much stronger position to go to the bank. The buyer’s return on equity (10 percent share) should also come close to covering the cost of the funding (interest plus capital repayment) to purchase the 10 percent shares. The seller will benefit further if the business has shown some growth and the net profit has improved, increasing the total value of the business. This benefits both parties and it would be short-sighted for the buyer to claim that should she grow the business, she would effectively must pay more for it in the future.

Growing the business benefits both parties. The seller still owns the business and can draw a monthly income, but this should be done responsibly with the well-being of the business at heart. Lastly, the key to engaging in this option is long-term planning. The seller should think about such a strategy several years before the time comes to execute it.

The same approach can be applied if you employ a junior optometrist, and you still want to work for 5 years. This will work provided that the addition of an optometrist increases the turnover.