by Greg Auerbach, MBA
Originally published in the September 2010 issue of Dental Town Magazine.
As a follow-up to my last article, which covered purchaser-related questions [Editor’s Note: See page 89 of the July 2010 issue of Dentaltown Magazine], I have compiled a list of common seller questions. If you don’t see a question you would like answered, let us know and we will do our best to answer it in a future issue.
I have read that dental practices are worth 65 percent of their gross receipts averaged over the past three years. Is that true?
The simple answer to this question is no. The true value of a practice is a function of two things: risk and net income. The higher the risk of an opportunity, the less interest there would be for a purchaser. Higher risk usually translates to lower value. Wouldn’t you be willing to pay more for a sure thing? Simply put, a purchaser is willing to pay more for higher net income.
Procedurally, in determining the value of a practice we review at least three years of financial information, including tax returns and profit and loss statements. The value of a dental practice is ultimately a function of the previous year of cash flow. Specifically, you should be most interested in the net income of the practice after normalizing expenses and factoring out owner’s compensation, whether that compensation be cash (actual income) or non-cash (expenses paid for the owner by the practice, or amortization, depreciation, etc). With the true office overhead identified in this manner, a purchaser is able to evaluate the performance of the practice as a business, determining what he or she can afford to pay and make a reasonable living (after paying the debt service). Consistent with business appraisal methodology, we are able to provide several values that are then evaluated and factored to determine a final appraised value. The valuing process is fairly complex, but if done properly, yields highly accurate results.
What is a reasonable “covenant not to compete” and are they enforceable?
This is a question we get frequently from both purchasers and sellers. First of all, let’s discuss the definition of a restrictive covenant, or covenant not to compete. The covenant simply binds one party from practicing within a specific distance over a specific period of time. Obviously, in the sale of a practice this is a tool that is used to protect the purchaser’s acquisition of the goodwill (or patient production) from the seller. This is a vital component of almost every transition and purchasers know to look for this agreement within the transaction documents. The specifics of the agreement are very important and defined by local laws.
When properly developed and reasonable in its terms (distance and/or time), covenants are enforceable in most areas. The distance or area of the covenant is jurisdictional and can be different for each state or locality. A highly populated area like Manhattan, might only limit competition within a few blocks, while a rural area could limit competition upward of 100 miles. The final distance is usually correlated to the service area of the practice, from which most of the patients live, work or commute from (taking into account many local and regional factors including population density and geography). As for the time limits of the restrictive covenant, it is often established by a state statute or by jurisdictional rule and can be as short as a few months to a number of years.
Several states do not allow for restrictive covenants if not related to the sale of a business, meaning employees cannot be subject to a covenant. It is important to consult with a local transitions expert, as well as legal counsel to verify the statutes and legality of a covenant in the area of your practice.
How can I make my practice more valuable?
There are many things that can be done to make a practice more valuable–some aesthetic, some procedural and some financial. If you’re considering selling your practice within two to three years, be sure your office has up-to-date internal furnishings. You will experience a return of investment with new dental equipment, well kept flooring, wall paint and other accents, which will go a long way in the sale of your practice.
Some procedural and nearly all financial modifications to increase value may necessitate longer range planning for the changes to provide a return (usually they need to be implemented three to five years out). These changes can prove much more important in overall practice value and should not be overlooked.
It’s never too early to start thinking about increasing your practice’s value and an experienced transition specialist in your area can be extremely helpful in pointing out areas where you may be able to enhance your practice and its value.
Generally, it is best to look three to five years out from an ideal transition date so the changes you make can produce positive results. Changes made shortly before a sale will most often, result in less of a return on your investment. It is typically better to take advantage of the upgrades for a few years before transitioning, so you benefit from the purchase and capitalize on the value, too. Some studies have shown that just painting and refreshing an office interior will immediately result in 10 to 15 percent income increase. The procedural and financial modifications will yield even greater percentages.
How long will it take to sell my practice from the time I list?
The old adage, “location, location, location” does have an impact on a sale. In an active area, the transaction can happen in as few as six to 12 weeks from the time the valuation is completed. In a rural area or one that is in less demand, it can take much longer. In this situation it is realistic to assume upward of two to five years. The length of time depends not only on the practice location but also on many other variables, including how your practice is valued and marketed. Reducing this time and providing a reasonable expectation is one of the ways an experienced local transition expert can help.
Can you provide an overview of the transition process?
This is difficult to answer since every transaction is different and the timing and progression toward closing may vary. Many steps, if done incorrectly can adversely affect future success, so we always suggest consulting with an expert to facilitate and guide you through your transition. Generally speaking, the steps will include valuation, marketing, buyer visit, buyer offer, acceptance of an offer or negotiation on the offer, establishment of general terms, buyer application for financing, buyer due diligence (financial and in office), document preparation and review, buyer approval for financing, lease negotiation/lease assignment, final negotiations on documents and then closing. Again, this is a very rough outline.
Will my patients accept a new dentist?
Your patients will accept a new dentist if the introduction and transition are handled correctly. First of all, selecting the right purchaser is important. Also, your endorsement, coupled with staff acceptance and enthusiasm is key. The purchaser should resist making major changes in the apparent office procedures for a reasonable period of time. When only one variable in the office is changed–in this case, the dentist–patient acceptance of the transition becomes much easier.
Will I have to carry a note in the sale of my practice?
In most cases it is possible for the buyer to secure 100 percent financing for the purchase of a practice from a number of large national lenders that focus on dental practice acquisition financing, as well as from local lenders who have become interested in making these loans. In fact, purchasers can not only secure 100 percent financing, but working capital, as well. With recent economic issues, some purchasers have low credit scores or debt levels, which will preclude them from qualifying for financing. In these situations it may be necessary for you to make a decision about carrying the note on a portion, if not all, of the practice. A reputable broker should have quality contacts for lenders both nationally and locally.
Does my dental practice need to be a certain size before I consider hiring an associate?
There are generally recognized minimal requirements for a full-time associate, which include office size (square footage and operatories), production levels, available staffing, new patient flow and overall transition plans. This list is just the beginning and a careful evaluation is necessary to ensure whether there is a need or opportunity. If you are contemplating this, we suggest that you contact a transition specialist to determine your needs.
Tags: dental broker, dental practice broker, dental practice transitions, dental practice value, dental staff, practice valuation, retirement, selling a dental practice, selling a practice, selling your dental practice, selling your practice