With the advent of corporate dentistry, dentists today face dental practice transitions options not available to their predecessors. If you are extended an offer from a corporate buyer, how will you evaluate it? Michael McAninch, CPA, CFP, has this advice.
Let's face it—you will eventually stop practicing and “pass the torch” to a new generation. For some, this will mean the sale of your practice to another individual dentist. However, with the advent of corporate dentistry, dentists today face transition options not available to their predecessors. If you are extended an offer from a corporate buyer, how will you evaluate it?
In my experience advising dental professionals, I’ve found there are five key steps in assessing an offer:
- Recognize the value of your practice
- Know your buyer
- Understand the buyer’s goals
- Clarify when and how you get paid
- Acknowledge the risk
Recognize the value of your practice
Practice profitability resulting in net cash flow to the owner should be the primary driver of practice value. A second and closely related driver of value is geographic location. Practices located in economically thriving areas will have higher values than those that are not. A good approximation of practice value would be 65% to 75% of average net collections for the last three years.
If the buyer’s offer is significantly above or below this value, you should seek to understand why. The buyer may be offering noncash elements to the deal that seemingly increase the offer price (e.g., equity in the company). Noncash elements are very difficult to value and warrant caution (more on this later).
Alternately, the buyer may suggest a lower price for some perceived deficiency in the practice. For example, the buyer may require new computer hardware and software and wants you to pay for it. It is important to note that investing in new equipment prior to a practice sale usually will not increase the value of the practice. Assuming your practice has relatively current office technology, newer technology is the buyer’s obligation. Sometimes, a corporate buyer may offer you less than your practice is worth because they cannot obtain their required return on investment. In these situations, look for another buyer!
Know your buyer
You can be sure a prospective buyer will carefully investigate a number of important indicators of value before buying your practice, including but not limited to a practice appraisal, financial statements, and practice tax returns - even your personal tax returns and credit report.
In the same way, you would be wise to investigate the financial strength of prospective buyers.
In the case of a corporate buyer, inquire about their overall earnings goals for the company, and have your accountant evaluate the reasonableness of these earnings expectations and analyze the financial statements and tax returns of the corporate buyer. If available, review third-party financial analyst reviews of the company. Request references of dentists who previously sold their practices to this entity to find out if the company fulfilled their transition commitments. Finally, does this company have a track record of successfully purchasing practices and selling off the new combined entity? Be an informed seller!
Understand the buyer’s goals
Too often, I find the seller unaware of or unconcerned with the buyer’s goals. This can lead to frustration for both parties and may jeopardize the ultimate completion of the sale.
Corporate buyers are primarily interested in acquiring the existing patient (revenue) base with the goal of growing practice profitability. These organizations have a transition process built around retaining the current owner for patient retention and integrating corporate cost controls and revenue enhancing processes for growing practice profitability. A corporate buyer ties your economic goals to its economic goals.
Clarify when and how you get paid
Purchase financing is a key element in virtually all practice transitions. Corporate buyers usually have their outside financing in place. However, once a price is determined, they often structure the deal with cash (deferred and contingent) and equity payments.
The most common method is to make a portion of the purchase price contingent upon achievement of future practice financial objectives over a number of years. Typical objectives include retention of existing patients, new patient growth, production growth goals, targeted high revenue dental procedures, and implementation of cost reduction measures. These measures may include staff and salary reductions. It is important to realize that the corporate buyer will not send a manager in to run your practice. Instead, the selling dentist remains responsible for managing the practice. Achieving these objectives could require significant effort by the selling dentist in order to realize the full potential selling price.
Corporate buyers may also fund a portion of the purchase price in corporation equity instead of cash. The seller, in effect, is now part owner of the entity that bought his practice. Typically, the sale of this equity is restricted until the sale of the company. In my experience, the future value of this equity is often a key “selling point” by the corporation. However, it is important to understand there is no requirement nor guarantee that the corporation be sold nor that it be sold at a profit. Unlike debt, equity owners have no recourse against the corporation.
An interesting wrinkle in the equity funding option is to encourage or require the seller to buy additional equity in the company over and above the equity issued as part of the sale. The argument goes something like this: “If a 3% ownership will ultimately grow to x dollar amount, a 6% share will double this amount!”
Acknowledge the risk
By agreeing to finance, make contingent, or delay some of your sales proceeds, you have in effect invested these funds in the new practice. As with any investment, it’s important to analyze your ability, willingness, and need to take on that risk.
- Ability - The longer your investment horizon, the more risk you can take. Assuming you do not need your sales proceeds in order to retire, you may have the ability to take this risk.
- Willingness - The willingness to take risk is determined by what could be called the “stomach acid” test. Are you willing to risk your hard-earned practice value on an individual or company you cannot control or know that well?
- Need - The rate of return required to achieve your goals determines your need to take risk. You must distinguish between real needs versus desires. This is particularly true when accepting equity from a corporate buyer. Representatives from these entities often indicate the possibility of double-digit returns upon the sale of the company. While you certainly desire double-digit returns on your investments, do you truly need this high of a return (and the high risk that goes with it) in order to meet your investment goals?
A closer look
You have devoted your professional life building a well-run and profitable practice. At transition, you will need to decide how best to realize and reinvest the fruits of your labor. The sale of your practice may also involve your continued financial and operating involvement in the practice. I hope that the advice in this article will assist you in making one of the biggest decisions of your professional life.
Michael McAninch, CPA, CFP, is a practice integration advisor at Buckingham Strategic Wealth, a wealth management firm with a niche practice area focusing on financial solutions for dentists and their families. Buckingham is a member of the BAM Alliance, a community of more than 140 independent firms across the United States. To learn more and find an advisor near you, visit thebamalliance.com or contact Buckingham at (888) 470-3064.
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