More Tips, Negotiating, Great Staff — and My Own Story
You don’t learn to walk by following rules. You learn by doing and falling over. — Sir Richard Branson, Virgin Group founder
More Fun with Overhead and EBITDA
When talking about overhead, make sure everyone is defining the term the same way. A private equity group with a management team will define it differently than a dentist. A general dentist typically says overhead is all the bills paid before they take home any money. Private equity looks at EBITDA (gross collections minus all operating expenses and dentists’ compensation) because they have to pay the dentists to do the work — you should think the same way. So: gross collections – (all operating expenses + your 30 percent compensation) = EBITDA.
Why 30 percent of collections? A typical associate agreement is 30 percent of collections minus the lab bill. For example, if an associate produced $40,000 in a month with a $3,000 lab bill: ($40,000 – $3,000) × 30% = $11,100 for the month, or $133,200 for the year. When evaluating the practice you’re buying, make the same calculation without subtracting the lab bill (for a bigger margin of safety): $40,000 × 30% = $12,000/month, or $144,000/year, before paying your practice loan. You should take home 30 percent of your personal production and have enough left to pay principal and interest — this is the key point of this whole series.
Is the current fee schedule well below average? Check the fee schedule relative to surrounding zip codes. Raising fees significantly affects overhead and net profit — if a practice has 75 percent overhead, raising fees just 5 percent increases net income by 20 percent (all else equal); a 10 percent fee increase yields a 40 percent increase in net.
Production Reports
If the hygiene ratio relative to total collections is very high (35 percent or more, versus an average of 22–25 percent), it could mean there’s a significant amount of dentistry waiting to be completed — a retiring dentist may have slowed down to the point the practice is primarily a hygiene practice. This could be a gold mine for a new buyer.
The opposite can also be true: a practice doing huge numbers that everyone, including the broker, is excited about. Look closely — the production mix might be driven by surgical implants or cosmetic dentistry rather than a broad hygiene base. If that’s the kind of dentistry you want to do, keep digging; if not, be cautious, especially if the seller does all their own endo, implants, orthodontics, etc. — there could be a guaranteed revenue drop after the sale unless the seller stays on for a while. The more the seller refers out, the safer it is for you. Conversely, if the seller does zero endo, no dentures, and only conservative crown-and-bridge work, there’s nothing but upside for you. Always look for practices where you can expand revenue.
Also check how much advertising is happening (airline magazines, cable TV, radio, etc.) — sometimes the selling dentist is something of a “personality,” which can be a hard act to follow. Consider working as an associate for a couple of years first to make sure it’s a good fit.
Low collection ratio. A well-run practice typically has around a 98 percent collections ratio. A lower ratio (say, 90 percent) might point to an undertrained front-desk person or PPO fees not being properly entered, distorting the numbers.
Seller with one foot out the door. A dentist nearing retirement will often show gross revenues sloping downward over the last three years, while the hygienist’s production becomes a larger share of the practice. Many banks see declining numbers and hesitate to lend, viewing the practice as “dying” — but ironically, this kind of practice can be one of the safest purchases for a buyer and the bank.
Last-minute upgrades. Sellers sometimes want to “put lipstick on a pig” to boost the price — new paint, carpet, small equipment. That’s fine if it matches your taste; if not, the seller has wasted the money, and it can become a point of contention. Buyers should remember they can always change paint and carpet themselves — what matters most is that the practice is clean, organized, and producing cash flow.
Diamonds in the rough. In Monopoly terms, sometimes you find the cash flow of Marvin Gardens for the price of Baltic Avenue. Remember you’re competing with other buyers, and the market for a given location drives some prices up while leaving others unsellable.
Buyer and seller perspectives. A seller might say, “I have no debt on this practice” — that should mean nothing to a buyer, since you’re buying the assets, not assuming the seller’s debt. Sellers may also boast about how tightly they run the practice and wring every dime to the bottom line — not necessarily good news for you, since it may mean less room to find savings. Conversely, if there are obvious ways you can save money relative to how the current dentist runs things, the income approach may be understating the practice’s value to you, building in extra safety. But if the seller has been cutting corners (e.g., ordering from an unmonitored discount supplier), switching to properly regulated products at a higher cost will reduce the practice’s value to you.
Often there are personality differences between buyer and seller — make sure you can fill the seller’s shoes, especially if you’re buying the practice of a well-known local dentist.
You Need a Great Staff
If your actions inspire others to dream more, learn more, do more and become more, you are a leader. — John Quincy Adams
You shape your houses and then they shape you. — Winston Churchill
The most important asset of a practice is the staff. If people in the office aren’t treated well, they probably already have one foot out the door. Your staff should be your biggest fans, and you need to earn their trust as the new leader. If you want to keep existing staff, compare their salaries to the local average — if they’ve been historically underpaid, raising their pay will change the practice’s value under the income approach and what you should offer. If you like the personnel and want to keep them, make sure they’re compensated well, and build room for raises into your first-year budget.
As Warren Buffett says, only work with people you like — and that goes both ways. You don’t want staff who are afraid of you and walking on eggshells. Establish yourself as a leader with a vision for your employees and the practice, not a boss to be feared. There’s a real difference between a leader and a boss, and the tension a “boss attitude” creates can make an office feel cold — patients notice how a dentist treats coworkers, and it defines the culture of the practice.
Use the Cap Rate to Negotiate
Use the cap rate as another, less personal way to talk about price. If you want or need to pay less, raise the cap rate you require. Instead of saying the seller is asking too much, say you need a higher capitalization rate to make the numbers work; instead of criticizing worn equipment or furniture, say you need a higher cap rate to cover your risk with the bank.
If you’ll be working alongside the seller, keep the relationship respectful — negotiating directly over carpets and X-ray units can sour things. It’s easier to have your CPA calculate how much you’ll need to invest in the practice in the first year, then translate that into a higher cap rate and a lower price. Make sure the numbers work for you before delivering a letter of intent.
Conclusion
If you change the way you look at things, the things you look at will change. — Unknown
Try to build a stand-alone business and see yourself as wearing two hats — an employee in your office, and an owner of it. By separating the two, you can consistently assess the value of the business. Paying yourself 30 percent of your personal production means treating yourself as an associate working at the business; the money left over as cash flow, or EBITDA, is what you receive because you own it.
Why think of your practice as a business at all times? Because it gives you a realistic picture of how you’re spending your valuable time and makes it easier to move between your two hats. I hope this view helps keep things in perspective and creates more fun and freedom for you — at the very least, it should leave you with a lot of extra money.
Epilogue: Why I Wrote This
Why did I write this series? Why would you spend the time to read it? Because I’ve been through this process as a new graduate, as an employer hiring associates, as a seller moving to another city, and as a partner in a private equity firm. I think I’ve made most of the mistakes one can make.
For the first practice I bought, we had a one-and-a-half-page contract — basically a handshake agreement. Not a good idea, but I liked the seller and was in a hurry to own my own office. We didn’t use a broker or a CPA, and the attorney was only brought in at the last minute to draw up an agreement. It wasn’t that I had no interest in the business side of dentistry — I love analyzing numbers and the art of putting together a deal, so much that I eventually got an MBA while continuing to practice. But I was young, in a hurry, and afraid the opportunity would slip away, while also using every ounce of focus to get my dental skills up to speed as a solo practitioner.
I bought 49 percent of the practice and worked as a partner for a year until I could buy the other 51 percent. If it hadn’t been the right practice for me, I’d have been in a bad negotiating position — no one would have bought a 49 percent share. Fortunately, the seller wanted the deal to work as much as I did, and it worked out. Looking back, I’m shocked the bank loaned me the $109,000 to do it. The practice was grossing $351,612, and we used a “magic formula” of 62 percent of gross revenue, divided in half, so I could buy just under half. It was a colossal error on my part in hindsight. The seller agreed to finance the other 51 percent starting a year later, with the whole deal financed over seven years. Because I didn’t like being in debt — I was also carrying significant student loans at outrageous interest rates, some over 12 percent at the time — I ended up paying it all off early.
This is a journey from innocence to experience — my “Hotel California,” as Don Henley might say. I was naïve and thought that if I treated the seller fairly, he would too. The problem with that philosophy is that when no one in the deal understands how the process works, you end up reinventing the wheel while working through the inevitable issues. We reinvented the wheel about once a week over racquetball games and a cold beer. Everything turned out fine — great, actually. I doubled the size of the practice and moved it to a better location ten miles away (a common distance for a seller’s restrictive covenant, so I wasn’t too worried about it). What I did have was a great staff I could trust and rely on, just as dedicated as I was to serving our patients. So, I got lucky. This all took place around 1990 — from the outside, a comedy of business-transition errors that somehow worked out fine.
Many of us get into dentistry for the artistry of the profession, and it can feel inauthentic to think about business while focusing on doing great clinical work. I remember a classmate who said he didn’t want to think about money at all — he’d just do dentistry and hire a manager to handle the financial decisions. That “rock star” mentality — just keep putting out gold records and everything else takes care of itself — might work when you’re single with no responsibilities, no kids, no mortgage. But for most of us, that phase of life doesn’t last long. (Plenty of actual rock stars wish they’d had an advisor review their contracts before they signed away their royalties — but that’s a different profession.)
The goal of this series was to give you the how-tos of buying a dental practice, and to introduce the basic terminology and concepts so you can speak the same language as the broker, attorney, CPA, and seller. You likely know more about the process now than 99 percent of dentists. My hope is that the information here earns you hundreds of thousands of dollars that would otherwise have floated away, unnoticed, as water under the bridge.
The dentist who understands these concepts will be the rare exception. Reviewing them every couple of months will keep your confidence high as a business owner, and understanding the basics of dental practice valuation opens the door to other ventures — any business can be valued using these same basic concepts, and sometimes you’ll find one that’s valuable to you, at a great price, if you’re open to the opportunity and understand it. There are business brokers selling all types of businesses, with financials available to study; you can get into any industry if you take the time to understand the numbers and obtain financing. It just takes some motivation and intestinal fortitude, as they say.
If you’re a dentist, you’ve chosen a profession with unlimited potential — independence, an excellent source of disposable income, and control over your hours, freeing you to invest your time in opportunities outside the office. Learning the basics of business valuation opens many doors and helps you see things you wouldn’t have seen before (and realize how much you still don’t know). Dentistry also lets you do what you probably hoped for when you chose the profession: contributing to your community, helping people, making personal connections.
Perhaps it is being an artist in a profession in which you are actually paid to be one.
Contact the author at: wellmint.hub@gmail.com.
This is the final post in the 6-part series. Catch up on Part 1 through Part 5 if you missed them.