THE DENTAL TRANSITION NEWSLETTER
Published on
- 06-14-2024
Practice Appraisals
PRACTICE APPRAISALS require the collection of volumes of information in order to properly analyze and assess the value of a dental practice.
It is not only important in order for the appraiser to form an opinion, but also for the potential buyer to properly evaluate if the practice is a good fit.
In performing an appraisal, it is customary to incorporate three years’ worth of financial data. The most current year is the most significant and relevant, not only to a buyer candidate but also to the lender that will be financing the practice.
Other information required for the appraiser review includes: accounts receivable aging report; patient demographics report; participating insurances; fee schedule; insurance write-offs; list of technologies; ADA code report by provider, production and collection reports by provider; staff list with wages and hire dates; equipment and leasehold improvement expenditures; and a copy of the office lease—if applicable.
An experienced appraiser will use two to three different methodologies in arriving at the ‘value’ of your practice. As these methodologies tend to focus on different financial aspects of the practice as the basis for the value, it is a good idea to use more than one in determining the value for purposes of determining the highest sale price. Most qualified appraisers will incorporate ‘valuation standards’ in their appraisal consistent with the Institute of Business Appraisers and/or be members of a professional valuation organization. In this respect, you will know that the standards for your appraisal meets the protocol of a professional appraisal and as such will offer further credibility to a buyer candidate.
Not every ‘appraiser’ is actually preparing an appraisal, although they may call it an appraisal. They may, in fact, be preparing a ‘report’. A report will summarize your practice information and will merely conclude on the value without using any methodology.
Therefore, it is not a true appraisal. If you are paying for an ‘appraisal’, all things being equal, the end product should in fact be a true appraisal, or if you are ‘shopping’ based upon fees charged for an ‘appraisal’, you should also be aware of the differences; a true appraisal requires much more time to prepare. Appraisals are not just for placing a practice on the market for sale, they can also be requested for future financial planning; estate planning; pre-death and disability planning; transition planning; or a practice ‘checkup’.
Financial Planning
Quite often, financial planners will request 5-10 years of projections in advance of a dentist’s goal retirement age, so that they can obtain a practice appraisal to determine the practice value and its potential impact on their ‘assets’ – sales proceeds available upon retirement. Of course, this would also require that the financial planner factor in the taxes due to determine the net after-tax sales proceeds. Sometimes, the practice value is a considerable asset as part of a dentist’s overall financial plan.
Estate Planning
Many times, an attorney engaging in estate planning services will also request the appraisal of a dental practice. This is an example of the absolute case wherein a factual ‘appraisal’ needs to be done and not simply a ‘report’, as all values in an estate have to withstand the scrutiny of the IRS, as all federal estate tax returns are audited. The value of the practice will help the attorney determine how to ‘split’ the value of the assets of the estate between spouses to equalize the assets and minimize estate taxes.
Pre-death & Disability Planning
It is highly recommended that once a dentist turns 50, they consider pre-death and pre-disability planning, which would require a current appraisal of the practice followed by annual tax returns provided to the appraiser at the end of every year.
These documents should be stored by the appraiser for ‘immediate access’ to quickly reassess the value when the time comes to place the practice on the market. This is necessary due to the rapid decline of a practice value when a dentist is suddenly disabled or unexpectedly dies. In connection with a pre-death and pre disability plan, there may also be a directive in place notifying the spouse of the dentist, the appraiser and the broker to contact one another to expedite the marketing of the practice.
In determining what the dentist’s options are for transitioning, a dentist should consult with a transition consultant 5-10 years in advance so that they may first educate themselves on the different options and secondly, determine what options exist within the dynamics of their particular practice. In order for the consultant to make this determination, an appraisal will have to be completed.
Financial Planning
It is a good idea to get a ‘checkup’ for your practice, by having appraisal done five years in advance of your goal retirement date. This leeway affords you the opportunity to clean up your financial information, if necessary. The appraiser will also advise you as to what the strengths and weaknesses of your practice are in general; review your overhead and advise you on where you stand on these overhead items in comparison to ‘normal’ overhead ranges; provide direction on technology to consider and also technology/updates ‘not to consider’ depending upon the time frame of your retirement; and also, possible recommendations on your facility. This allows you, then, to consider and take action or corrective measures prior to your practice going on the market, and, in the end, maximize not only the ‘value’ of your practice but also the marketability.
The benefits and knowledge gained from an appraisal clearly outweigh the cost and should be considered by dentists in many contexts other than simply at the time that they are ready to place their practice on the market.
Keys to Successful Multiple Practice Ownership
Start with the End in Mind
When beginning your journey toward owning more than one practice, we find it best to start with the end in mind. Identify your long-term goals for this type of business model. Most buyers interested in multi-practice ownership say they are looking to acquire 5-20 practices over a certain period of time, which they hope to resell the group of practices at a premium. Other practitioners are looking to make additional income over their career by having associates work for them, and some are looking to phase out of clinical dentistry or pursue other goals.
Selling to an Investor
If the goal is to resell to an inventory group at a premium, we find it helpful to know what investors are paying and what they are looking for in a group of practices. Many well-known DSO’s are open to buying a group of practices for 60-100% of last year’s collections or 150-200% of adjusted earnings. However, investors are often willing to pay a “multiple” anywhere from 5-10 times EBIDTA (Earnings Before Interest, Taxes, Depreciation, and Amortization).
Before you get too excited, an investor is only willing to entertain practices with a minimum annual EBITDA of $250k, though over $300k is more ideal. To resell your group of practices to an investor buyer, all of the practices will need to have an EBITDA over $250k, respectively. Additionally, they are going to want a minimum of a 5-year work-back by the seller at an associate-rate of compensation, and will likely withhold 20% of the sale of the practice to be paid after the work-back period, contingent on the practice meeting certain fiscal benchmarks during the hold-back period.
To calculate your EBITDA, first calculate your adjusted earnings for the year. This is the total profit after paying all operating expenses (you will include staff wages and all discretionary expenses in the adjusted earnings number).
Then calculate what you would pay an associate to replace you and subtract that amount from your adjusted earnings number. Here is an example: if I have a practice with gross, yearly collections of $1,200,000 and overhead of 60%, adjusted earnings would be $480,000 (or 40% of $1.2 Million). If the percentage of gross revenues attributable to hygiene is 20%, doctor wages would be calculated on the remaining 80% or $960,000. If the going rate of compensation for an associate dentist in the area is 30% of clinical production, doctors’ wages would equal $288,000. So, after subtracting operating overhead and fair-market doctor’s compensation, the EBITDA is $192,000.
Based on the numbers, even though this is a healthy practice and would be attractive to a wide array of prospective buyers, savvy investment buyers may not be interested due to the EBITDA. Or, if they are interested, they may not be willing to pay more for this practice than any other private party purchaser would be.
Having a Longer-Term Associate
If the goal of having multiple offices is to provide an added source of income, we find it best to establish a plan at the onset to attract, hire, and retain good associates. Turn-over with associates is one of the most challenging aspects of owning multiple locations. You may have to offer a high performing associate some form of profit sharing or equity ownership in order to retain them long-term.
Additionally, as you increase in size, we recommend hiring a business manager to assist in managing your growing team. This person can help implement systems while you run the business remotely. When you are ready to resell, you are likely looking at a DSO or independent buyer, unless your EBITDA is high enough in all of the offices to catch the interest of an investor buyer, as discussed above. Many DSO’s will still require a seller and/or associate dentists to continue to work in the practices after a purchase, so make sure to plan for an additional 3 to 5 years of clinical work after you sell.
How to Prepare for the Purchase of an Additional Practice
Before you consider adding another location, it is imperative that you evaluate the performance of your primary office. Each time you purchase another practice, make sure you are assessing the health level of your existing business. First, have clean financial records and keep separate records for each office location. This means avoiding rolling personal expenses into your business and co-mingling expenses between offices. Make sure your primary office has positive cash flow above your needs. Evaluate office systems and protocols to ensure they are effective and easy to sustain. Get pre-qualified for lending options or save enough cash to purchase the next practice. If you need to hire an associate, make sure they are hired, trained, and integrated into your business before moving on to acquire a new location.
When preparing for the purchase of multiple offices, acquire as much knowledge and experience as possible. We recommend taking as many practice management courses and workshops as possible. We also recommend hiring a great team to help advise you through the process; a consultant, an attorney, a CPA, and a bookkeeper, etc. Read books on business leadership and management. You need to become an expert on running an effective dental practice and managing people!
Finding the Right Practice Opportunity
As you begin your search for a second location, it is important to identify characteristics in a practice that are ideal for your business model. Once you have your list of requirements, remember to be flexible as you may never find the perfect practice and therefore may have to take a practice that is close and make it into the perfect practice. When you do find an ideal opportunity, remember most buyers—including DSO’s—are looking for similar opportunities. Also remember, not all sellers are open to transitioning their practice to someone who will eventually have an associate assume the care of patients.
Some are only interested in selling to another dentist who will be working the practice as their sole practice. For this reason, you will need to be patient with the process and consider opportunities for growth that may not match your initial business model. Consider practices that are smaller and could be relocated, or practices that are lower in volume but are in a market with a healthy dentist-to-population ratio and could easily grow.
When you find an ideal opportunity, take into consideration the seller’s transition plan. For a second office, the most ideal scenario is a seller who is willing to work back and allow you time to plan a transition with an associate. This is not common, though. If a seller wants to exit after closing, you need to prepare for how you or your associate will take over the new office schedule.
How to Maintain a Successful Business
One of the first issues many multi-practice owners face is a lack of loyalty from staff. It is challenging to make a connection with individuals you only see or work with once or twice a month. Building trust and loyalty with your staff is the key to smooth systems and lower stress.
Do not overlook the small things like OSHA, HIPAA, and practice management training. Ongoing training and CE take time out of the schedule, but it can save you from major misunderstandings. “An ounce of prevention is worth a pound of cure.” Staying organized with systems will foster a loyal team to help you improve business management as well as dental systems. As noted above, keep your finances clean and separate for all offices. Finally, continue to improve your communication, leadership, and business ownership skills throughout your career.
Our hope is that you will take extra time to thoroughly plan the growth of your business. Start with your end goal in mind and make each step strategic so you can manage the risk associated with multiple practice ownership and enjoy the process!
Recommendations for books to read:
- Start your Own Business, by Entrepreneur Media
- Start with the Why, by Simon Sinek
- Leadership and Self Deception and Outward Mindset, by the Arbinger Institute
- Getting to Yes, by William Ury & Bruce Patton
- The Happiness Advantage, by Shawn Achor
- Good to Great, by Jim Collins
- Seven Habits of Highly Effective People, by Stephen R. Covey