Don’t Buy A Dental Office Before Reading This!
Buying or selling a dental practice might be the single biggest decision of your professional career. This task requires a mix of financial and non-financial information such as local customs.
As a husband of a dentist and a financial professional, I have been constantly asking buyers, sellers, brokers, banks and other lenders, CPAs and any other person I find, how (they) to value a practice and related questions. I have also studied business valuation technics and taken formal education and exams to sharpen my skills and technics such as the ABV (Accredited in Business Valuation Exam) review course offered by AICPA and I was able to find my own methods and ways.
First, I want to tell you how I started my journey to understand Dental Office Valuation. I was asking many professionals in the dental industry. These are some of the answers I got.
- You disregard all cash collected and offer 70% of all other collection.
- Never more than 70% of last year’s collections.
- Between 60-80% of last year’s collection.
- Between 2 and 3 times of net income.
- Between 80% and 120 % of last year’s collections for an HMO Office.
- A three-factor formula based on 1/3 collection, 1/3 new patients and 1/3 quality of equipment.
- 60% of last year’s collections for a bad area, 70% for an average area, 80% for good area, 90% for a great area.
- Income-based valuation methods.
- Capitalized earnings method.
- Discounted cash flows method.
- Market-based valuation methods.
- Excess Earning Method.
Well, let me stop at this point with all of these so-called methodologies which might not make sense to you. In my opinion, after reviewing over 500 offices, these are all incomplete descriptions of a very complex task. None of these completely and accurately describes this task. Before I get to the actual description of dental office valuations, I need to write a bit about what I usually observe while a practice sale/purchase is going through (Or Not).
Sellers are much advantaged when it comes to selling their practices.
On average they are more experienced in the dental industry and dental business.
They hire a Broker to protect their interests and sell their offices. Usually, a Broker’s commission is between 8% to 12 % of selling price.
They have been the business and have the financial means to retain Attorney’s and CPAs and other consultants to help them.
They know their business very well.
Buyers on their other side are a bit disadvantaged.
They have no brokers to represent them.
New dentists have not the experience and financial means to add professionals to their team.
They have a limited time to go through the process.
All stakeholders benefit when a practice gets sold. The seller gets his money. The broker gets his commission. Consultants get paid. Bank makes a loan. The only person who might lose a lot is the buyer. He/she is stuck with a bad practice and big loan.
Well, one more thing I can add at this point is, I helped my clients walk away from 100s of bad deals. I assist my clients to search for months/years until they find a suitable practice. The more you know going into the sale/purchase of your practice, the better off you’ll be both financially and personally.
All of these sound confusing and is filled with some false beliefs and differences of opinion. There is no single standard methodology. Depending on the people’s profession, you would get a different answer in this regard. Sellers and Brokers would like to assess a higher value to the practice. Buyers and lenders might be more inclined to assess more risk and value to a practice and be cautious. People trained in valuation technics might use a more algebraic and systemic approach to valuation. On the other side people who know the industry might go with a much simpler way to value a practice. Unlike residential real estate, there is no multiple listing services (MLS) or dental database of dental practices that have been sold.
Now let’s go to the process and define the task. My concentration is on the buyer’s side of the deal since the majority of the people I represent are buyers.
OUR TASK IS TO FIND A SUITABLE OFFICE FOR BUYER AND DETERMINE BUYER’S INVESTMENT VALUE:
Investment value is the value of a property to a particular investor. In the U.S. and U.K., it is equal to the market value for the investor who has the capacity to put the property to good use—its highest-and-best-use, its most valuable use. For other investors with limited capacity or vision, investment value is lower because they cannot put the property to use in a way that is maximally productive. THIS IS DIFFERENT FROM FAIR MARKET VALUE.
A practice might be worth $300,000 as its fair market value, but Buyer’s Investment Value might be higher or lower, depending on his/her needs and plans. That’s why our concentration on valuation as Buyers is not what sellers, brokers and other consultants believe the practice should be sold for. A buyer might offer a way higher price or lower price for a practice. In simple terms, a practice investment value might vary between different buyers depending on their prerequisites.
No two buyer and no two dental practices are identical. Each dental practice and Buyer are unique. Our challenge is to find as many details about a practice and match them to a Buyer needs until we go forward and make an offer. I also put some emphasis on finding the right seller. If your seller is a bad seller and not helpful, the process will be a nightmare.
Our due diligence starts with an evaluation of the information that the sellers and brokers are willing to provide before an offer is made. We take a look at the location, revenues, insurance revenues and types, expenses, procedures that are provided, rent, selling doctor’s profile and all and any other items and public information that can be evaluated. This process already eliminates most offices before even a further step is made. We try to find out if the production and expenses can be duplicated, will decrease or if our Buyer is able to expand and add additional services. In some of the practices, there might not be much dentistry left to be done on the current patients. Some might not have any room to grow due to seller already providing all specialty services, especially if the Buyer does not personally provide these dental services.
Additionally, a good office lease is critical. Before any offer is made, it’s evaluated if annual rent expenses would even allow building a profitable office. Rent Expenses should be preferably about 5-7% of annual revenues and not exceed 10-12%. Later after the offer is accepted and Buyer goes through its due diligence, an attorney should defiantly be retained to take a much thorough review of all lease terms.
There are many other factors that must also be considered, such as location, equipment, appearance, staff, longevity, reputation and reviews, patient mix, procedures performed, growth trend, parking, visibility, and any and all available information. The main question is if the production and profitability will be continuing for the buyer.
Please see below a short list of information that needs to be reviewed to value an office accurately.
Recent profit and loss statements, balance sheets, and income tax returns (at least three years).
Percentage of collections used to cover overhead.
Equipment valuation; typically, this should be performed by an independent dealer. The present value of all usable clinical supplies and hand instruments should be assessed, as well. In addition, does the practice owner or lease the equipment?
A detailed physical description of the office, including, by way of example, the number of operatories. Does the selling dentist own the underlying real estate?
A production and collections report and a breakdown by each dentist and hygienist.
An accounts receivable and aging report. In addition, what percentage of the accounts receivable is actually collected? Further, compare the aging report to the production/collection reports to verify that these reports are consistent and accurate.
A description of any contractual relationships of the patients, employers or, insurance companies including HMOs, PPOs, DMOs, and capitation plans.
A breakdown of practice expenses for insurance, retirement benefits, employee benefits, payroll taxes, medical reimbursement, telephone expenses, and continuing education. How much does it cost to run the practice?
A total number of active patients and the number of new patients per month. This number will help the dentist and his/her advisors estimate an expected amount of cash flow for the practice. If the target practice is a specialty practice, a list of referring dentists would be extremely helpful. Where do new patients come from?
How much revenue is based on insurance reimbursements?
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