Buying a Practice: FAQs
by Greg Auerbach, MBA
Originally published in the July 2010 issue of Dental Town Magazine.
At ADS Florida, as transition specialists, we work with all types of transitions, practices and doctors. While we have specific methodologies for practice valuation and proven practices for successfully transitioning a practice from a selling to apurchasing doctor, we understand that for most doctors you will only buy and sell once. This major career step brings many questions and we wanted to take the opportunity toanswer just a few of the most frequently asked. This article we will cover purchaser related questions and those more specific for a seller will come in a subsequent issue. After reading either, if you don’t see a question you want answered, please let us know and we will be happy to do our best to answer it.
What’s the first thing I should consider when looking for a practice?
Think about and determine where you want to live. From there, if you are currentlylooking to associate, stay as far away from that area as possible to avoid any possible restrictive covenant concerns. The more specific you can be about the location where you’d liketo live and how far you’d be willing to travel to your practice, the easier it will be for youto understand your options.
What’s the second thing I should consider when looking for a practice?
Think about what kind of dentistry you want to do and how much money youneed, or want, to make. Most everybody wants to make as much money as possible, but how much is necessary to support a comfortable lifestyle and fund your retirement? Obviously, consider your student loans, but also mortgage or rent, car payments, insurances,and anything family related. Because most dentists start very late in their career to fund retirement, include the funding of your retirement as part of your initial plan. The sooner you start, the bigger the benefit as those savings can grow.
What should I look at when looking at a practice?
Look at the gross production of the office to determine if you can produce or have produced that amount of dentistry. Also look to see if collections are close to the level of production, what the overall overhead of the office is and what makes up that overhead. For the physical office, look to be sure the location is in an area that will support your vision of your practice and that the building is in good condition. Within the office, note the quality and age of the equipment and whether anything is in major disrepair. Eventually, you will review patient charts and reports to verify statistics like new patient flow and the amount of active patients. You will want to get some idea of what kind of treatment patients are accustomed to and what has been done for them. Despite the importance of working equipment, do not over emphasize its value. You are primarily purchasing goodwill, or the ongoing patient flow and production of the office. Equipment is easily, and affordably, replaceable. A quality patient base, skilled staff and working office systems are not.
What’s the value of a practice?
The value of a practice is a function of two things: risk and net income. Risk is an inverse factor as the higher the risk, the less interest there would be for a purchaser to purchase. Higher risk usually translates to lower value. Wouldn’t you be willing to pay morefor a sure thing? Cash is a factor in that a higher net income becomes more valuable.
How do you appraise a practice?
The appraisal process includes several different methods of correlating value to the residual net income of a practice after reasonable expenses, including all those to produce the dentistry are deducted from the gross income. There are methods that are generally accepted in the business valuation profession, the legal community and the banking industry that can be applied to valuing a dental practice. A report should be produced that properly employs and reviews these factors. In addition, appraisals should have detailed documentation that support the report and the final determined value.
I have read that I shouldn’t pay more than X percent of collections for a general dental practice. Is that true?
The simple answer to this question is “No.” The percentage of gross methodology to determining a purchase price is overly simplistic and generally detrimental to a true analysis of the worth of a practice. As a purchaser, it is most important to understand that you are buying the opportunity to make money. With that, most often, you are acquiring this opportunity without any personal monetary investment (most often, for a good practice with a good buyer and a good transition specialist, financing of one hundred plus percent of the purchase price can be obtained). Taking that into account, you have made almost no immediate investment in a business that you are uniquely qualified to run that will, from day one, pay for itself and produce a personal income. You are essentially buying cash and future cash.
So, again, how much do you pay? Really, you should pay as much as you feel you and the practice can afford. Essentially, while not specifically a practice expense, the practice should “pay for itself ” and leave you with ample residual personal net income. A good financial proforma should consider the true practice overhead (removing any owner’s buried compensation). From there, the practice’s net income can be determined by subtracting the amount of overhead (in dollars) from the gross collections (collections minus refunds). Subtracting out the cost of the debt service payment from there, leaves your personal take home for the given year. Evaluate that personal take home income (most often pre-tax) and determine if, after paying taxes, you will have enough to live on.
There are times where you may have to pay the asking price to get a great practice; especially in very desirable and competitive areas. Ultimately, no matter what the price to gross or other metric indicates, what is important is that the price of the practice fits into the overall expenses of the office leaving you with a reasonably acceptable net income.
Will the staff stay after I purchase the practice?
Typically, staff members are as worried about keeping their jobs as you are about keeping them. If they leave, they have to start working for a new doctor anyway, so why wouldn’t they give you a chance? With a proper transition strategy, the staff should stay in place unless you let somebody go or somebody was already set to retire. In the case that they were ready to retire, this should be disclosed throughout the due diligence process.
Will the seller’s patients accept a new dentist?
The patients of the practice will accept a new doctor if the introduction and transition are handled the right way. The seller’s endorsement, coupled with staff acceptance and enthusiasm, is key, but your participation in creating a steady environment over a period of time will enhance acceptance significantly. Generally speaking, we see that patient retention is in the mid to high 90 percent range knowing that those that travel from out of the area and some others may not return, but the vast majority will and give the new doctor a chance if the transition is handled correctly.
Can you provide an overview of the transition process?
Generally speaking, after finding a practice, the purchaser will make an offer to which the seller has the ability to accept, decline or counter. The initial offer should establish the general framework for the larger purchase agreement that will be developed. It should set the price, anticipated closing date and, often times, the restrictive covenant terms. This document may also include whether or not it is expected that real estate will be transferred as a part of the transition. Once the initial parameters are established, the purchaser will apply for financing (if applicable) and complete his or her due diligence in the office. Concurrently, purchase agreements (and lease, where applicable) will be developed and submitted for review by both the seller and purchaser’s council. Once the documentation is done and financing is secured, a final closing date will be established and the staff will be notified. Many steps, if done incorrectly can adversely affect future steps if not jeopardize the sale so consulting with an expert to facilitate and guide you through your transition can be extremely helpful if not also financially beneficial. There is additional information on our website showing the general flow of a transition.
What is “dual representation?”
Dual representation is the practice of representing both the seller and purchaser in a brokered transaction and being paid by both. In many states, this practice is illegal. Not only is it illegal, it is unethical. Why would you allow the seller’s attorney, your attorney or any attorney (or accountant) to represent both of you in any transaction? How can someone realistically represent potentially conflicting points of view? Most attorneys and accounts will not allow themselves to represent both parties due to the inherent conflict of interest.
What is a reasonable covenant not to compete and are they enforceable?
The covenant not to compete/restrictive covenant is one of the more important pieces of the transition documentation. The agreement should establish a time and distance within which the transitioning doctor agrees to not practice or participate in a practice after a sale. For example, the agreement may stipulate that a selling doctor may not practice dentistry for anybody but the purchasing doctor within five miles over threeyears or seven miles over two years. Further, the seller is usually restricted from soliciting patients or staff and is subject to a lawsuit if found to be in violation.
The area of the covenant is jurisdictional and can be different for each practice and practice location. The distance for the restrictive covenant is usually correlated to the service area of the practice, which is where most of the patients live and/or work taking into account many local and regional factors. In all states but Alabama (others does not allow them for employees), covenant not to compete/restrictive covenant contracts are enforceable and care should be exercised when drafting them.
This is a sample of the frequently asked questions concerning practice transition. Do you have other questions? Contact us and we will answer the question for you in an upcoming issue of Dentaltown Magazine.
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Author’s Bio
Greg Auerbach, MBA, is a transition specialist with ADS Florida and a financial analyst for Pride Institute. He has consulted with, appraised and transitioned dental practices locally and nationally and has been the featured presenter at dental associations in Florida as well as dental schools in Florida and nationally. You can reach Greg at greg@adsflorida.com or 941.746.7959 or 800.262.4119 x13. You can find more about ADS Florida at
http://www.ADSflorida.com.
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