THE DENTAL TRANSITION NEWSLETTER
Published on
- 02-07-2024
COVID-19 & Practice Transitions
How is the closure of dental practices due to COVID-19
affecting practice values?
Should I sell my practice now or wait?
These are big questions. These are important questions. These are questions we are being asked a lot lately, as you can imagine. While there is no definitive answer, we have insights that will be useful to you if you are contemplating a sale of your practice currently, or in the near future. Your practice is one of the most valuable assets you own. The answers to these questions are critical for you. Now is the time to rely on the experience and knowledge of a trusted professional who specializes in practice transitions to guide you through these unchartered waters.
Call us to discuss the impact COVID-19 is having on your market specifically and practice sales in general. We are presently offering a no cost, no-obligation consultation by phone to address your specific questions and concerns as they relate to the effect this pandemic may have on the value and sale of your practice.
In the meantime, here are some thoughts to consider:
The forced closure of dental practices to all but emergency care should have little to no negative impact on practice values, at least not in the short term. That is the prevailing sentiment among practice brokers and appraisers nationwide. Whenever a practice is closed to patient care for any period of time due to duress of any kind, there is risk of patient attrition. Specifically, there is concern over patients of that practice seeking treatment elsewhere rather than waiting for the practice to open again. That risk of attrition results in a loss of practice value. However in this instance, where are patients going to go? All other practices to which patients could turn as an alternative are also closed, which effectively eliminates the risk of attrition during closure.
The bigger concern, then, is the pending economic impact created by the widespread closure of businesses during the COVID-19 pandemic. Unfortunately, we simply do not yet know what that impact will be, nor how it will directly affect dental practices, nor do we have a comparable event in history to turn to in order to make an estimated guess. This is simply unprecedented. While economic forecasts vary widely, there is one thing we are certain of: uncertainty. Among the myriad problems with uncertainty are: A) it cannot be quantified, and B) it affects perceptions. This means when it comes to valuing practices specifically, the potential risk associated with the future economic uncertainties cannot be converted into a dollar amount or even a discount percentage.
So, all other quantifiable factors being the same, practice values will be subject to the subjective perceptions of value found in the minds of prospective buyers. Right now, those perceptions are being influenced by the fear and risk of the unknown. This is causing some prospective buyers to abandon the idea of purchasing altogether.
Others are taking a step back, adopting a wait-and-see strategy. And yet others are prepared and interested in moving forward with practice purchases as usual. They are optimistic for the future and share little concern about the uncertainty it holds. Finally, there are some buyers who see this as an opportunity to pick up bargains. This group is relying on fear and panic among sellers to result in deeply discounted prices. We are seeing several DSO and corporate dental buyers taking this approach.
Some sellers are falling victim to it, while others are keeping their wits about them and staying the course, realizing their timetable for a sale may need to be adjusted a bit, but confident in the knowledge there are buyers out there who recognize practice ownership is still the best option for most dentists in terms of providing a higher level of job satisfaction and higher income. The buyers who understand this, also understand their success is not reliant on external factors, including the state of the economy.
Most economists agree the economic fallout from the COVID-19 business closures will not reach the severity or extent of the economic recession initiated by the collapse of the sub-prime mortgage lending market in 2008; however, if that recession provides in any way a pattern for the economic impact to be anticipated in dentistry, we have reason to be optimistic. Based on our informal survey of clients during the years following the 2008 recession, the majority of practices were flat in terms of revenues during that period of time. They did not grow, but they did not shrink.
While this was not ideal, it was certainly survivable. Some practices did decline however, and quite considerably, but we found most of those practices were heavily focused on providing elective, cosmetic and aesthetic dental treatments to a largely fee-for-service patient base. Other practices actually saw growth during the time of the recession. These were practices with strong patient relationships, good reputations and effective internal systems.
Additional optimism can be found among lenders who specialize in practice acquisition financing. The prevailing attitude among lenders is that things will snap back to a relative normal quickly and practices will continue to perform as well or better than they have historically. Many of these lenders are still processing applications for financing and approving loans for practice purchases, with the caveat that funding of those loans will be contingent on monitoring practice performance through a pre-determined period of resumed operations after the forced closure is lifted. If the practice performs at or above its pre-closure levels during that monitoring period, as anticipated, then the loan will be funded as planned, allowing a sale of the practice to take place.
As stated, there are many unknowns in the marketplace right now and there are a number of factors to consider. Every market is different, every practice is different and every seller is different. What might be right for you and your practice may not be right for another, so call us to discuss your specific needs and objectives. We can discuss current challenges and opportunities and tailor a transition plan for you, despite the uncertainties of the time.
Pros and Cons of Selling Your Practice to a DSO vs.an Individual Dentist
One of the hot topics in dentistry today is the expansion of “corporate dentistry” or Dental Service Organizations (“DSO’s”). It is estimated that, nationally, 15-20% of all practicing dentists are affiliated with DSO’s. In recent years corporate investors such as private equity firms and venture capital groups determined that dentistry was ripe for their involvement because of such things as: (i) rising overhead costs, primarily those related to staff and health insurance expenses; (ii) a trend among new dentists interested in part time employment and seeking for lower risk job opportunities; and (iii) economies of scale associated with cost volume discounts on supply purchases and marketing campaigns, as well as leverage when negotiating dental insurance reimbursement rates.
So when it comes time to sell your practice, should you sell to a DSO or to an individual dentist? Let’s consider the pros and cons of each, beginning with DSO’s.
DSO’s are generally looking for practices with annual gross revenues in the range of $800,000 to $1,000,000 or more in offices with 5 or more operatories located in specific areas. As such, your practice may or may not be a practice a DSO would be interested in. If they are, one of the biggest advantages at least on the surface–to selling to a DSO is the potential to receive a price for your practice that is substantially above market; however, when we look more closely at most offers, we find the “premium price” may actually be less than what the practice could be sold for to an individual. Almost universally, DSO’s take the approach of catching a prospective seller’s attention with a very large number.
On the surface, it may look like they are paying a big premium for the practice; however, a careful consideration of the other elements of the offer usually reveals the opposite. Unfortunately, many sellers fail to consider all of the details of the offer and focus only on what appears to be a big purchase price upfront. Typically, these offers come with conditions and “catches.” Some of the most common we see are:
- The DSO will frequently require the seller to stay and work for them as an employee in the practice at a reduced compensation of 28-35% of collections for a period of 2 to 5 years. Many sellers fail to factor the loss of profits during this period of time into the overall equation of the offer. The sum total of profits that would have otherwise been retained by the seller during this period (but instead go to the DSO) when offset against the “premium” purchase price, results in a price that is at or below a going market price, one that would have allowed the seller to walk away at closing.
- The DSO will commonly hold-back 20-30% of the purchase price for 1 to 2 years after the closing, making its payment contingent on practice performance during that period of time.
- The DSO will have a lengthy and involved due diligence process, which will require you to take the practice off the market and forego other prospective buyers while they pour over every detail of you and your practice with a fine toothed comb. This process often prolongs the practice sale by several months as compared to a sale to an individual. At the end of that process, they may elect not to buy your practice, leaving you to start over from square one.
- The DSO may require the seller to accept a portion of the purchase price in the form of equity in their “parent” company with the promise that when they eventually sell that parent company, the seller stands to make a tremendous amount of money. While that may work out for some, it has not worked out for others. This approach comes with significant risk and does not allow the seller any control over the timing, price or other terms associated with the sale of the parent company. Some sellers have completely lost that portion of their practice value when the company they agreed to take equity in as part of their practice sale goes bankrupt or is otherwise deemed worthless due to mounting company debts.
- The DSO may require your account receivables to be included in the purchase price without any additional compensation being paid for it.
Aside from a potentially favorable offer, the other most recognized advantage to selling to a DSO is being able to absolve yourself of any further risk or responsibility associated with management and ownership of the practice. For some, this is appealing; however, in turning over that risk and responsibility, you also relinquish any decision making control and autonomy. This can be a significant disadvantage.
Some dentists struggle to grow their practices and make them profitable. These dentists may benefit from selling to a DSO who can market and grow the practice, making it more profitable than it would be otherwise due to their expanded resources and economies of scale. Ironically, if a dentist is struggling to grow their practice and make it profitable, the DSO will not be interested in buying the practice in the first place. What these dentists may not realize, though, is they could hire a marketing and management firm to accomplish those same practice growth and profitability objectives for them for a fraction of the cost of giving up all of their profits, which is what they would have to give up if they sell to a DSO.
We recommend those who are considering selling their practice to a DSO obtain the names of dentist who have previously sold to the DSO as references; then call those dentists to inquire about how the transition worked. Were the sellers happy? Did the DSO change the staff, the practice management software, the dentist’s schedule and hours, the mix of insurance participation, and/or the philosophy of the practice?
A long-standing alternative to selling to a DSO is selling your practice to an individual dentist. The transition will often take less time than a sale to a DSO. While the stated price may be lower, the effective price is often as much or more than the DSO’s offering once all of the contingencies and other terms of the DSO offer are factored in. In most cases, the seller is also paid the full purchase price in cash at closing, without any requirement to take equity in a parent company. After closing, the seller is frequently allowed to walk away from the practice, or if desired, can negotiate to stay on as an associate at a rate of compensation typically higher than what most DSO’s are willing to pay.
When all is said and done, for most sellers, the most important thing is knowing your staff and patients are taken well care of after the sale. Most dentists do not want to hand their practice over to just anyone, not after they have spent years developing close relationships of friendship and trust with their patients and staff. They want to be sure their legacy lives on. This is very difficult to do when selling to a DSO since there is a high likelihood the DSO will experience a turnover of associate dentists. The seller will not know, nor have any say in who they are turning their patients’ dental care over to. If your patients and staff are important to you, the only way to ensure those relationships continue is by selling to an individual whom you are able to hand pick, who shares your practice philosophy, who treats people the way you treat people.
There are plenty of options available when you are ready to sell your practice. It is best to consult with a reputable practice broker who knows your local market and works with the players in that market. If you are contemplating a sale of your practice to a DSO, make sure you confer with a professional who can help you analyze and assess the various elements of the offer they are presenting you. It is important to know if the offer is as good as it may seem on the surface or not. And above all, it is important to consider what legacy you want to leave with your practice.