This is one of the most common questions we receive at Integrity Practice Sales. And it makes sense – you’ve devoted a huge part of your life to your practice! If you’re thinking about selling your dental practice, understanding practice value is key.
The first thing to note regarding practice value is that, just like the value of anything else, the basic rule of supply and demand applies. A glass of water isn’t worth much. I can get a cold water bottle for 25 cents at Costco – and I can turn on the tap in the office and get one for very close to free. So water isn’t worth much…until you’re lost in the desert. With the sun beating down on your parched skin, a single drop of water may be worth a fortune.
Our goal as practice brokers is to find that one buyer to whom your practice is worth the most. We do this by keeping a large and up-to-date record of buyers looking for practices. We pay attention to their specific criteria and overall circumstances, and we also widely advertising the practice to other prospective buyers for whom we may not have detailed information.
When we go to set a listing price for a dental practice, we are aiming to determine what a willing buyer would offer our seller. From there, we discuss strategies for pricing that depend on the seller’s requirements (financial, timeline, etc.) as well as the local market conditions.
There’s both an art and a science to arrive at the opinion of value for a dental practice. On the science side, there are several guidelines that can be fairly easily applied. You can plug the numbers in and…voila! The application of some industry-standard multiples to your top line collection figure or your bottom line profit figure give us a foundation from which we can begin valuing your dental practice.
Determining the profit figure can be a challenge for anyone looking to value a dental practice. Small business owners (dentists included) are economically incentivized to reduce their tax burden. The job of the CPA is, in part, to help the small business owner limit their tax liability through a set of perfectly normal and legal strategies. These strategies are designed to reduce the ‘profit’ that the business shows on paper without reducing the actual discretionary income available to the seller. When we look at the financial records of any selling doctor, we always consider these strategies and work to “re-cast” the financials as if none of these tax strategies were employed. There are many cases where the profit on a tax return may only be $20,000, but the total cash flow actually available to the seller is more like $250,000 or more.
The application of basic multiples, however, is not all there is to it. The art side of the equation is where things get tricky. Below, I’ll give examples of the formulas, and then show how these formulas can get more complicated.
What do you mean by ‘multiples’? Multiples are ratios that are calculated by dividing the value of an asset by some dental-practice specific financial variable. For example, if we know that practices collecting $1,000,000 per year are selling for an average of $850,000, then the multiple we can use is 0.85. We can then take this multiple and apply it to other practices.
Where do you get these multiples? Since there is no reliable and statistically significant data publicly available for recent transactions of dental practices, these multiples are derived from industry standards and our own private data sources. Additionally, they are regularly confirmed by dental practice finance lenders, who maintain some of the best privately-held data available.
How do you choose the right multiple? Initially, we apply a multiple that is based on location and practice size. However, the final multiple will be a function of location, goodwill, profitability, tenant improvements, equipment and technology, insurance accepted, and other factors.
The basis of this multiples approach is the economic principle of substitution, which says that one would not purchase a business asset for more than one could acquire an equivalent substitute asset. Basically, a buyer would probably not purchase a practice – even if the investment risk was relatively low and the projected reward was high – if that buyer could acquire a similar practice for less.
Valuing Dental Practices:
Simple Example: One of the simplest ways to come up with a value is to apply a multiple to your last year’s collections. For this example, I’ll use 80% – but, as I said above, this number depends on a number of market conditions. So if you collected $1,200,000 last year, this quick rule of thumb would value your practice at $960,000. How easy!
Why this doesn’t work: Not so fast. Imagine that there are two practices, Practice A and Practice B. In both practices, the total collection from last year was $800,000. So they’re both worth $640,000, right?
Let’s take a closer look. In Practice A, the overhead is at 50% of collections, which means that Doctor A takes home a profit of $400,000. Dr. B’s overhead, on the other hand, runs high at about 80%. Dr. B takes home a profit of $150,000. A practice where a doctor makes $400,000 every year is more valuable than a practice where the doctor makes $150,000. The percentage of collections method is helpful, but it does not always give you the whole picture.
Multiple Multiples: We always apply these multiples to both top-line (collections) and bottom line (profit or doctor income). Both of these aspects must be balanced to provide the most accurate value, but at the end of the day, the doctor’s take-home income is what provides a very substantial part of the value for a potential buyer. At the same time, you cannot rely on any single multiple alone. Remember Drs. A and B from the example above? Is Practice A really worth $800,000 and Practice B only worth $300,000? That’s a serious discrepancy in value when compared to the percentage of collection method.
Additional Considerations: In our experience, practice value is influenced by many different, dental-specific factors. These include curb appeal, location (city, neighborhood, professional complex vs shopping center, etc.), the age of the practice and resultant value of the goodwill, the age and condition of equipment, the level of technology in the practice, and the recent income trends of the practice (up or down). This is why it is so important to work with an experienced dental practice broker.
What does it really boil down to?
At the end of the day, cash flow is king. It only makes sense to buy a dental practice if you can make enough money in the practice to pay the overhead, pay the bank, and still generate a reasonable income for yourself and your family. If a practice is valued correctly, it will support the buyer.
Balancing these different valuation methods takes an experienced hand. At Integrity Practice Sales, we look at everything to make sure your practice or any practice you are looking to purchase is correctly valued. Click on the link below to get a free preliminary opinion of value for your practice to assist with your financial planning today.Read More
When most doctors purchase a dental practice, one of the big worries is always patient retention. Most of the value of a dental practice is in the goodwill with the existing patient base, and if those patients choose not to come back, you’re in trouble.
Fortunately, this ALMOST NEVER happens. At Integrity Practice Sales, we work hard to make sure that both buying and selling doctor work together to manage a successful transition.
Many doctors decide to write a letter explaining the transition to patients. This can be a powerful tool for controlling the narrative around the transition and can help patients feel at ease with the new doctor.[Why winning over your new staff is the key to winning over your new patients.]
As with all powerful tools, however, the transition letter can be misused and serve to confuse or worry patients. Remember that patients don’t really care who “owns” a dental practice. In fact, practice ownership rarely crosses their minds.
Instead, they want to know why their doctor is leaving (or becoming less available) and who the new doctor is. In fact, patients can be offended if they read that Dr Seller “sold” her practice to Dr. Buyer.
The transition letter should be used to thank your patients for their loyalty and friendship over the years, explain why you are transitioning (basics only), and then promote the new doctor. Preemptively thank the patients for continuing as patients at the practice and for supporting the new doctor.
Tips for a great transition letter from the seller:
- Have a professional photo taken of Dr. Seller and Dr. Buyer together to use in the letter.
- Write an introductory paragraph explaining the need for the transition and thank them for the years of commitment to the practice.
- Introduce the replacing dentist and include experience and qualifications.
- Dr Seller should become Dr Buyer’s patient and let the patients know this.
- Explain the reason you have chosen this doctor to take over your practice.
- Give a personal view of the new dentist, including hobbies and family.
- Keep this letter enthusiastic and share your optimism regarding the transition.
- Repeat your appreciation and confidence in the new doctor.
Send this letter out AFTER the close of escrow. This cannot be over emphasized. The deal isn’t done until it’s done. Once you close escrow and send out the letter, you’ll also want to call the patients that have scheduled appointments over the next few days since they will be at the office prior to receiving the letter.
A few months into the new practice, the buyer should send out a second letter.
From the new doctor (1 to 2 months after the transition):
- Greet and welcome the patient.
- Talk about your background and experience.
- Discuss common commitment and philosophies with the previous dentist and thank him or her for their support and for creating such a nice practice.
- Thank the patients for such a warm welcome and thank the team for being so supportive and encouraging.
- Encourage the patient to come by to meet you or call with any concerns.
- Express your desire to get to know the patients and promise to listen to their goals.
At Integrity Practice Sales, we provide samples and help the doctors draft ideal transition letters. But no matter who you list with or buy from, following these guidelines will help you retain the value of your new practice and build great relationships that will last for years to come!Read More
Happy halloween, everyone!
I cannot believe that we’re almost through October. This is one of my favorite times of the year. It’s always a relief when the days start to cool down, the leaves start turning, and the days begin to get shorter.
As we reflect on these seasonal cycles, I think it’s a good time to consider the traditional lifespan of a dental practice. Some of you are in your springtime, recently out of dental school, energized and ready to go. Some of you are enjoying the long, even days of summer. Maybe you’ve been practicing for 5 – 15 years, enjoying slow and steady growth and continuing to provide great care for your patients.
As the ‘autumn’ of your career approaches, you can (hopefully!) think back over an enjoyable and rewarding career. You’ve helped thousands of people smile a little bit wider. It’s during this time that you will probably start to think about a transition. It’s also about this time that you’ll probably want to start slowing down, practicing a little bit less, and spending more time with family and friends.
Often, when a doctor comes to us finally ready to sell, we look at the numbers and see a gradual decline year over year. This makes sense and is the natural result of working a little bit less. But it can have a dramatic effect on the value of the practice.
There are great options today for doctors to sell their practice before they start to work less. Selling doesn’t have to mean that you’re done seeing patients! There are some excellent strategies for getting the most value out of your practice before you’re ready to retire, and our great team of agents would be happy to sit down and discuss them with you.
And just because it’s Halloween, here’s a very silly video I just made.
Once you have a signed Letter of Intent, it’s time to take a closer look at your potential new practice. Due diligence is one of the most important aspects of preparing for a successful dental practice acquisition.
There are several important indicators that offer insight into practice performance. In this blog post, we will look at the financial side of due diligence.
Your banker is an important member of your transition team and will help with the financial side of due diligence. Because they are looking to avoid risk, they are naturally in your corner. Your success is their primary goal – when you succeed, you make your loan payments.
The first step in evaluating a practice that you think you want to purchase is to look at the finances. You should already have determined that – based on the practice prospectus – this practice could support you and your family after you pay all of the practice expenses and the bank loan. Now it’s time to double check all the figures.
Cash Flow Sufficiency: Monthly practice cash flow must be sufficient to cover practice overhead, practice loan/lease payments, and all of your living expenses. Sometimes with a smaller practice, it is advised to keep working at an associate position until practice cash flow increases. The benefit of buying a larger practice is that it should be able to meet all of your financial obligations.
So, what is sufficient? California Dentists make $164,000 per year according to the Bureau of Labor Statistics (bls.gov). That may sound good to you, or you may be looking for significantly more. The good news with purchasing a practice is that you’ll immediately start to take home a significant income (depending, of course, on the size and profitability of the practice).
Consider asking your Dental CPA to perform a “Review of Books and Records”: While the bank does a good job reviewing the practice books and records (to protect themselves), some buyers prefer to have their own CPA review the tax records, financial statements, and bank statements.
Financial Arrangements and Accounts Receivable (A/R): Review computer or manual reports that document patient payments as well as the accounts receivable percentages. A healthy A/R might be ½ of a typical month’s collections. A high A/R (over one month’s collections) might indicate poor financial arrangements. Even if you are not purchasing the A/R, doing an A/R review gives you insights into the practice.
Purchasing Accounts Receivable: Often the A/R will be included in the sale. Typically, the price for the A/R will be calculated using one or more of several popular formulas such as;
- 100% of current A/R and 50% of everything over 30 days, or
- 90% of current A/R, 80% 31-60 days, 70% of 61-90 days, 50% of over 91 days, or
- 75% of all A/R less than 90 days
Another option is to purchase the “first $____” of the A/R. This number might be 70% of the total A/R, in other words, if the A/R total is $100,000, then the A/R would be sold at “$70,000 for the first $70,000 collected”. In this example, the last $30,000 would be collected for the seller and given to the seller, once collected, for a typical 5% fee that the buyer would charge.
Property Taxes: Review the property tax bills for tangible personal property and also real property, if applicable. Personal property is anything that can be subject to ownership except land. Real property is immovable property, such as land or anything attached to the land. Bottom line: ask your tax advisor about this.
Payment Arrangement Balances: Examine any written patient financial agreements for balances due. Office policies vary drastically in this area, from verbal “agreements” (not recommended) to solid written payment plans that include interest.
Fee Schedule Review: Review the office fee schedule and compare it to typical fees in the area. IPS can help by providing typical area fees. How often does the office increase fees, and when did the last fee increase take place?
You generally don’t want to raise fees as soon as you purchase a practice – it is much better for the seller to have raised fees in the last year. However, as with so many items, this is unique for each practice. Ask your agent and other advisors about the pros and cons of raising the fees and be sure you understand how fees affect profit. I’m not kidding. Realizing that, with a 70% overhead and increasing the fees 10%, you will increase your profit by 33% … or you will make the same if you treated 33% fewer patients. (Google the Kodak Study that was done in the 80’s for more info on this).
These are some of the most important aspects of conducting due diligence on the financial side of a dental practice. If you are currently looking for a practice to purchase, please take 5 minutes to join our Inside Buyer list and be the first to hear about upcoming practices.Read More
You may have seen it in the news: interest rates are about to go up. And if you’re thinking about buying or selling a dental practice in the next few years, it’s time to pay attention.
This is the first in a series of blog posts exploring the market forces that drive dental practice values. Of course, the best way to increase your practice’s value is to improve its profitability. The more money you make in your practice, the more your practice is worth. But some of the variables that determine price are beyond your control.
One of these variables is interest rate. The basic reason is simple. When borrowing money is cheap because of low interest rates, buyers can afford to buy a bigger practice. Money has been cheap for almost ten years now, but it’s about to get more expensive. It’s therefore likely that practice values will be decreasing.
But things aren’t looking rosy on the buyer’s side either. While it might make sense at first to wait for practice values to decrease, this is probably not the best strategy. When interest rates go up and borrowing money becomes more expensive, the actual cost to buyers also increases.
Let’s explore this in more detail.
As you know, interest rates tell you how expensive it is to borrow money, or, in other words, how much you will have to pay to the person or institution with the interest in the loan.
The rates that regular folks receive when they go to borrow money depend on the rate at which banks can borrow money, and those rates are set by the Federal Reserve, an independent institution created by Congress in 1913 to address bank panics. These days, the Fed works to promote a healthy economy and banking system.
One of the roles of the Fed is to address inflation and stagnation by adjusting the rate banks can charge each other for overnight loans. These rates filter down, both directly and indirectly, to affect the interest rates attached to loans for dental practices.
While monetary policy is complicated and goes beyond the scope of this blog post, what you need to know is this: since 2009, interest rates have been set at historic lows. Now the market is bracing for them to go up.
What does this mean for practice values?
The interest rates attached to loans affect how much practice a buyer can afford. Higher interest-rates lead to higher monthly loan payments for buyers, thereby reducing the potential cash flow to a buyer of a given practice. This reduces buyer-purchasing power, disqualifying some, and reducing the overall number of available buyers in the marketplace.
Imagine that you’re looking to purchase a practice for $600,000. A 10 year note for $600,000 at 4% interest will cost you $728,964 over the life of the loan. The same loan at 8% interest will cost you $873,558.
That’s a difference of $144,594! The difference in monthly payments is $1,205. This means that the doctor who borrowed at 8% has to earn an extra $1205 each month to take home the same amount of money as the doctor who borrowed at 4%. These market forces clearly affect what buyers can or will pay.
When interest rates go up, monthly debt service increases. If debt service goes up by $1,000, the buyer’s net income decreases by $1,000. Lenders are acutely aware of the additional drag on cash flow due to higher interest rates and they loan correspondingly lower amounts, which also drives down practice values.
Here’s the bottom line. If you’re thinking about buying or selling a dental practice, consider selling it now, before the market starts reacting to the changes on the horizon. And if you’re ready to buy or sell now – or just have questions about your options – Integrity Practice Sales is here to help.Read More