Evaluating a practice for possible purchase is both an exciting and frightening process. Carefully considering the hard facts involved should eliminate most of the anxiety about a purchase, leaving only the excitement of owning your own practice. This article and accompanying lists of items to be considered are intended to assist in the logical assessment of a practice purchase opportunity. They will serve as an outline and springboard to assist in the evaluation of the practice.
Welcome to the Platinum Age
You are fortunate to be entering practice during a great age for dentistry. Aging and growing population, plus dental insurance has created an increased demand for and appreciation of what dentistry has to offer. The dental industry has become a financially profitable profession.
Today, the U.S. population is increasing, people are keeping their teeth longer, and the demand for care is growing. Pre-fluoride baby boomers want to look and feel good, and they will spend the money to accomplish that goal. All of this is occurring at a time when the number of dental school graduates has significantly decreased, resulting in an unprecedented opportunity in dentistry.
Marketplace opportunities and the future seem promising for a new dentist considering the purchase of a practice or building one from the ground up. Both options have their pros and cons. However, despite favorable demographics, new dentists starting their own practices still lose productive years attempting to build a patient base. It can be demonstrated that acquiring an existing practice and patient base will put the existing practice from $300,000 to $700,000 ahead (pre-tax) after the first five years. Considering all expenses of both methods, acquiring a practice comes with a significantly lower risk than an offer to start from scratch.
The First Step
The first step is the decision as to whether you and your family will be comfortable living in or near the community where the practice is located. Ownership of a practice makes this decision a long-term commitment.
The personal needs of family members (like a spouse’s career requirements, available education for children, lifestyle options such as availability of sports, and cultural activities) must be met. The second step involves the choice of operating through a partnership or as an independent businessperson. There has been a growing trend favoring group practices, but the solo practice has been and continues to be the primary method of practice for dentists today. New dentists often begin as an associate and later end up buying the practice. The senior doctor then becomes the associate. He retires shortly thereafter, and the practice returns to a solo practice.
Analyzing the Appraisal
The next step is an analysis of the practice numbers and should be carefully reviewed. A well-done practice appraisal will provide an abundant source of information about the business side of the practice. The benefit in purchasing an existing practice is access to an established patient base as well as subsequent cash flow. The historical revenues and expenses of a practice can be accurately ascertained and used to project future results. Conversely, starting a practice from scratch carries with it a host of unknowns and risks, such as whether the practice will attract enough patients to make it financially successful.
The appraised value should be based on a 3-5 year average of a practice’s historical revenues. The appraisal should not be based on possible income, but rather on demonstrated past performance. If the practice has been under producing, this becomes the “buyer’s advantage” and may be justification for purchasing the practice—but not for paying a premium price beyond what historical revenues can justify.
Questions asked about the appraisal process should include: the qualifications of the appraiser, the records reviewed to determine appraised value, and the methods used in determining that value. And, finally, does the appraised value, regardless of the appraisal method used, pass the required “sanity” test? This parameter will help determine whether the final appraised value makes sense, or specifically—will practice cash flow support the purchase price? Using this rule of thumb, it is indicated that the annual principal and interest payments required to purchase a practice should generally not exceed 12–16% of the practice’s historical gross annual collections. Of special note here is that the appraised value should already have been downgraded for old/limited-use equipment. If major equipment upgrades will be required to make the practice functional for the new owner, these costs must be subtracted from the net to be certain that the purchaser income requirements are met. Remember, the previous owner was producing the numbers with the existing equipment. Therefore, only needed equipment upgrades should be considered.
The appraisal process should also involve a determination of what the practice’s operating expenses are, which will yield the actual net value. This should exclude the current owner’s allocations for depreciation or amortization, interest, and/or items that have directly gone to the benefit of the present owner and are not related to the actual cost of production of services. A practice with a higher percentage of receipts for operating expenses should appraise for less than one with a lower overhead, given the same gross revenues. Also, remember that the final allocation of assets for sale purposes frequently works to create the best tax result for the parties, and rarely is it directly related to actual values of the individual components.
Placing the Appraised Value in Perspective
In assessing appraised value, the appraised value is not as important as the bottom-line cash flow after paying operating expenses and debt retirement for the practice purchase. This bottom line should support the personal financial needs of the purchaser, including household expenses, personal debt repayment, and professional/school debt. If it does meet the requirements, the only other question should be, “Is the purchaser reasonably capable of producing at least the same income that the seller has historically produced?” There are many reasons for choosing a healthcare career as a means of earning a living and providing for retirement. A practice takes you to where you want to be financially at retirement. This determination comes down to an assessment of the bottom line. There will be other questions, but the outcome of the answers will not have nearly as much weight as these first considerations.
Additional “Disqualifying” Questions
If the practice is primarily or significantly dependent upon outside referral sources for new patients, the purchaser must carefully assess whether these referral sources will be transferable to the new owner. If they are not, the purchaser must assess compensating sources.
Another critical question regards the existing office space lease. Access to a lease of at least five to seven years—and, if bank financing is involved—it will generally be insisted that the lease lasts for the term of the loan.
A major question is whether all or some of the staff will remain during and after the transition process. Frequently, patients have as much loyalty to the staff as they do to doctor. Retention of staff insures a high patient transfer base to the new doctor. Loss of staff can be overcome and should not be an automatic reason for non-purchase, but it should also be carefully considered. As much of the old staff as possible should be hired initially by the new owner.
A Word of Caution!
All of the above represent logical, factual reasons to consider or reject any given practice purchase opportunity. The items that follow are issues and matters that may need to be addressed but are not necessarily “deal breakers.” If the numbers are acceptable and the patients are there, the business is sound.
NEVER FORGET THE MOST IMPORTANT THINGS YOU ARE BUYING ARE THE PATIENT BASE AND FUTURE INCOME FLOW THAT THIS BASE WILL PROVIDE!
All other things become secondary; they are cosmetic and generally replaceable/correctable in the future. A practice’s greatest asset, the patient base, requires the most time to develop and is the most expensive to generate through advertising/marketing. The majority of what follows are individual matters which can be changed and many times reflect the needs, professional training and perspectives, and personalities of the individual, whether buyer or seller.
Concerns should be addressed to your practice transition consultant/advisor and, if necessary, forwarded to the seller through that individual.
Additional Business Related Questions
Assuming the practice has passed the above issues, there are several additional matters that must be considered relating to the business evaluation of the practice. Does the practice follow any specific philosophy? Is this a practice that uses a holistic approach? Is this primarily a cosmetic practice, extensive TMJ practice, or does it provide orthodontic treatment? Does the purchaser have the clinical skills to continue providing these specific services?
Other questions include: What has been the historical treatment mix provided by the seller? Has this been an amalgam or crown and bridge practice, fixed bridgework and implants or extractions, partials and dentures?
How efficient is the hygiene and recall (re-care) program? Are patients scheduled in advance, or at recall time? How many active patients are there compared to the number of available hygiene appointments? Typical practices have an active patient base of 1.5 times the number of hygiene appointments available in a six-month period, and the optimum number is at least 1,000-1,400 active patients. How many new patients are seen monthly, and what are their primary sources? An ideal number is 15-25 per dentist, excluding any “plan or discounted” dental program—patients are likely to disappear if the new dentist does not accept that plan.
Does the practice participate in any capitation/HMO programs? Are these contracts transferable, and how much of the practice revenue is derived from these programs? Does the practice accept and/or treat medical assistance or welfare patients, and what percentage of revenues is derived from them? If the new dentist does not plan on carrying these plans and providing care to these patients, the practice price to the new dentist should be carefully reconsidered, since the practice has been appraised to include the receipts these programs provide.
The present and future status of the office lease and/or building ownership needs to be addressed. As previously discussed, the unavailability of an adequate lease and subsequent need to move a practice may be one of the specific reasons not to purchase a practice. Will the building be available for purchase; on what terms and when should this be addressed? Will it be in your best long-term interest to own this real estate? The difference is whether you want to pay the additional principle plus two times the principle amount in interest, or whether you would put the extra interest money to work in your pension plan. While it is the dream of many practitioners to have their own building, you must consider whether this building will service your needs at a considerably reduced price for years to come? Is the present office location desirable? Is the neighborhood stable or in decline? Will this be a suitable area in the immediate and long-term future?
Evaluation of the Physical Plant
The cosmetics of a practice are changeable. This is generally not a reason to refuse a specific practice. Granted, outside building aesthetics are much more difficult and expensive to correct, and problems here should be carefully considered. Another consideration is whether there is room for future expansion. The age and condition of the present equipment should also be noted. Is it right-handed or left-handed, and is it functional and usable for the new buyer?
Evaluation of the Clinical Practice
Your consultant will help you evaluate whether there may have been a recent increase in revenues or some other indication in the treatment mix which might indicate that the selling doctor has recently done an unusual amount of major revenue-producing procedures, thereby using up the normal backlog of work found in the practice of a retiring doctor. If this has been the case, a careful determination must be made to ensure that the patient base can still provide the level of production anticipated by the new owner. A consideration that needs to be recognized and identified is whether there may be any major difference in philosophy of practice between you and the current owner. Patients who have come to expect a non-amalgam, holistic approach to treatment will quickly leave the practice if offered conventional amalgam restorations. This must be recognized, and an appropriate response must be planned for.
The new owner will not be expected to replace work at no fee, and with the proper communication skills, the needed replacement meets little resistance from existing patients and can actually be turned into a positive for the new owner. While the dream of most new dentists is to have a high-end cosmetic/crown and bridge practice, dollar for dollar the low end, sub-standard care practice represents the better value and best future profit opportunity.
It is the prospective new owner’s responsibility to verify the approximate number of active patient files, how often the files are purged for inactive patients, and when files were last purged. Records can be upgraded with new forms, X-rays can be updated, and the new owner is not responsible for the completeness or lack of completeness of the prior owner. The level of OSHA and HIPAA compliance needs to be identified, but again is correctable if it is not up to standard. Another important factor is the present recall system effectiveness. How many patients are actively involved in recall? How many hygiene appointments are available in a six-month period? How full is the available hygiene schedule? How much of the practice revenue involves X-rays, recall examinations and prophies? These answers will give the clearest indication as to how many active patients are truly available.
Future Plans of the Seller
Selling doctors are recommended to totally depart in less than one year. In that case, the patients will generally give the new doctor at least one chance out of respect and trust for the departing doctor’s recommendation. All that is required is a letter from the departing doctor announcing his/her departure and introducing the chosen successor.
If the departing doctor remains, and continues to treat patients, there is a tendency on the part of patients to get all the work they need completed by the retiring doctor, subsequently buying time before the patient seeks out the services of their “neighbor’s doctor.” When faced with an on-the-spot decision regarding the scheduling of an appointment, whether it is a recall or emergency appointment, most patients will try the new doctor. However, when given time to investigate alternatives because their treatment has been completed and they have had the opportunity to say “goodbye,” patients frequently leave.
Will the seller carry all or part of the financing? Will you need to consider SBA financing? Will a combination of lease and loans be in your best interest? Is there anything in your credit history that might interfere with your ability to obtain financing?
The repayment term should relate to the gross purchase price. A practice with a higher gross (supported by an appropriate net) will require a longer repayment term. This will provide a more comfortable level of available compensation after operating expenses for the purchaser. This also means, however, that the purchaser is building a larger equity position as the reward for higher productivity, and once paid off, the practice will provide a higher net to the owner. Typically, we see a purchase price of less than $200,000 repaid over five years, $200-$700,000 over seven years, and over $700,000 in seven-to-ten years. In today’s marketplace, 100% non-owner financing is readily available. The rates are competitive, and the terms are reasonable. Non-owner financing has several significant advantages over seller financing. Which type of financing to take should be carefully discussed with your transition consultant.
This article deals with some of the questions surrounding whether the practice you are considering purchasing is the right practice for you. The past accomplishments, including receipt and expense history, will give the necessary information as to whether this is a sound business decision. It will further indicate whether the after-debt cash flow is reasonable and will meet your personal needs. A careful analysis by experts has proven that after five years in practice, the party who buys an existing patient base and cash flow will have netted two to three times what a similar individual in the same geographic area has done while beginning a practice from scratch.
While a state-of-the-art, recently-modernized and equipped practice may be more appealing, it will also be priced higher to compensate for the capital expenditures made by the present owner. Therefore, older but functional equipment will usually work until the new owner makes his/her own capital improvement expenditures. A new purchaser only needs to be aware of and plan for these future expenses while enjoying the lower purchase price, to which the “antiquated” equipment has contributed.
Whether you will need to spend the money for equipment now or later should not be a reason you pass up a good patient base for the area in which you would like to live. Ultimately, the most important thing you can purchase is the patient base. All other areas should be viewed in their proper perspective as secondary factors.
Thomas Snyder , DMD, MBA