The art of the Deal

by Tim Giroux, DDS

What they didn't teach you in dental school

For more on this topic, go to www.dentaleconomics.com and search using the following key words: scratch–start practice, network marketing, the art of the deal, Dr. Tim Giroux.

Most of us graduated from dental school with little or no training in basic business principles. Some of you may have taken a year or two of business classes like me, and others may have even graduated with a business degree. Even then, there was little practical training on how to evaluate the typical decisions all of us must make during our dental careers.

Perhaps our teachers knew we were too preoccupied with accumulating enough clinical procedures to graduate than to attend classes on future possibilities. This is proven by the low attendance I witnessed at some of my nonclinical classes. However, I feel most dental schools are negligent in adequately preparing students for the real business world.

When I graduated from dental school, I followed in the footsteps of a few graduates that had migrated to the Phoenix area. In fact, I replaced the associate position that my colleague vacated when he left to start up his own practice. I also left after two to three years to start my own practice.

At the time, I never even considered purchasing an existing practice. Even if I had, I had no knowledge on how to properly evaluate my options. This article will provide some basic concepts to help dentists think more like accountants and businessmen.

The problem that most dentists have is assuming that just having a DDS after our name will ensure our success. For the most part, this is actually true! For example, I ventured out, surveyed a new growth neighborhood, and selected a highly visible, easily accessible corner to set up my practice. Eventually, everything worked out and my practice became very successful.

However, an astute businessman would have “crunched the numbers” to ensure that he would get the best “return on investment.” When all things are equal, without extraordinary growth, the economic gains of a practice purchase outpace the gains of a new scratch–start practice.

Price, rather than cash flow, is often the major concern of most buyers. Some buyers will comment that a practice costs too much, without even knowing what the profit of the practice is. Cash flow and return on investment should be king.

Scratch start or buy?

The following discussion compares cash flow and profit between (a) a scratch–start practice (two operatory set–up) (b) a moderate practice (three to four operatories), and (c) a large practice (five or more operatories). Several assumptions based on historical data are applied in the flow chart, which is labeled Illustration 1.

The industry average loan for a scratch–start practice equipped with two operatories is $300,000. The purchase price of existing practices is usually between 50% and 75% of gross receipts. We have used the multiple of 65% of gross receipts for the purchase price of the $500,000 practice and the $1 million practice, resulting in a $325,000 purchase price and a $650,000 purchase price, respectively.

Most dental offices run at approximately 60% overhead expenses, so we have used 40% as our bottom line cash flow before debt service. A reasonable fixed rate loan in today's market is about 7.5% over seven years, which is reflected in the debt service column corresponding to the start–up cost or the purchase price of the practice.

The net profit (before taxes) is the cash flow minus the debt service. In addition, we will assume some fairly good start–up numbers and good growth for our scratch–start practice as compared to the existing practices. Illustration 1 reveals the net profit before taxes for each of the seven years the practice is in debt.

Note that we did not make any additional debt service adjustments to reflect additional leasehold expenses and equipment purchases for the scratch–start and moderate practices to actually produce the same numbers of the larger practice. It would cost well over $100,000 to build out and equip the scratch–start practice from two operatories to six operatories.

Therefore, we have given almost every advantage to the scratch–start practice. In fact, when I give this presentation to large groups, many dentists in their beginning years of a scratch–start practice despondently ask if they are supposed to be doing as well as the projections on Illustration 1.

Many of you are quick to point out the flaws in the assumptions of Illustration 1. That is not the point! Adjust the many variables to fit the complexities of your own situation. Perhaps you never want a million dollar practice or you feel that you can turn 1,000 patients into 2,000 patients relatively quickly. The point is to take this template and work up your own analysis for your particular situation.

Illustration 2 shows the total profits after debt service (before taxes) in this scenario at the three–, five–, and seven–year totals. The difference in potential lost income for the scratch–start practice is significant, and increases year by year until, theoretically, one reaches the full potential of the practice. Depending on circumstances, you can see how the decision may cost more than $1 million over several years!

We need to discuss another variable that further solidifies the case for buying an existing practice. The main reason for buying an existing practice is the patient base. Theoretically, the larger the patient base, the larger the gross receipts and the higher the practice purchase price. By experience, this has not always been the case, and we will discuss this issue in subsequent articles.

Many dentists, including very intelligent and seasoned ones, have a hard time paying “all that money for goodwill.” They may have established large practices from scratch and possess the vital skills and talent to do it again.

However, the essential attributes to start a practice from scratch and develop it into a thriving practice are exponentially more beneficial for a practice with a healthy practice base. These attributes may include personality, communication, and managerial skills, along with a host of other attributes.

Therefore, if you possess the special “people skills” that result in quick growth and success, it is advantageous to apply these skills to an existing patient base. If you do not possess these skills, you definitely have a better chance for success if you buy an existing patient base.

In any event, do not just assume that you are making the best decision. Work out your model based on an honest evaluation of your circumstances.

Let's examine this principle by using the following example. Many of us are familiar with network marketing, which is based on “friends telling friends” about a service or product. The premise is that if one friend talks to two people, and those two talk to four, and those four talk to eight, this will result in exponential growth and success.

The dentist in a scratch–start practice opens his practice with relatively few patients, and depending on marketing strategies, the practice will hopefully grow.

Using this same application with an existing practice, one can apply the same marketing strategies and techniques to a base of perhaps 1,000 or more patients right from the start!

Obviously, a network marketing phenomenon in this case would produce very high growth. In reviewing the profit analysis (Illustration 1), we assumed very small growth for the large practice, and that practice still showed the highest return on investment.

Just imagine the difference in net profit between the scratch–start practice and the practice with the existing patient base that is properly marketed and managed! In short, purchasing an existing practice historically leads to quicker growth than a new start–up practice.

This is not to say that buying an existing practice is a guarantee for success. There are many factors that must be addressed in a purchase as well as a scratch–start practice.

In subsequent articles, we will discuss the attributes of dental practices and the importance of proper due diligence based on the needs, expectations, opportunity, and personal qualities of the dentist. We will discuss essential issues on transitioning a practice, as well as the sale of your practice at retirement. Until then, do what you do best!

Timothy G. Giroux, DDS, graduated from Creighton University in 1983. He established a highly successful dental practice in Scottsdale, Ariz., where he and his wife, Mona Chang, DDS, practiced together. Dr. Giroux is now the owner/broker of Western Practice Sales, a dental practice broker in the western U.S. Contact Dr. Giroux at (800) 641–4179 or [email protected].