In order to obtain the greatest rewards the dental profession has to offer there is no question ownership is key. One of the best ways to get there is to purchase an existing office. But in order to be successful in this exciting new venture, there are some key concepts each party needs to understand in order to be successful.
#1 Both parties need to understand the dynamics at work and how different each point of view can be.
I haven’t yet heard of a seller who thought her practice was worth less than it actually was. I’m sure there is somebody out there, but this is not normally how the seller looks at it. For the seller, this practice doesn’t just represent a certain amount of cash flow or active patients or an office location. For the seller the practice represents the blood, sweat and tears they but into building the practice and for many sellers this may lead to an unrealistic idea of what the value truly is. The fact that the seller is interested in buying the practice only reinforces to the seller how wonderful this practice must be. In short, the practice is the seller’s baby, and they aren’t just going to let it go without what they feel is “fair” compensation.
The buyer, on the other hand, has an entirely different point of view. They are normally willing to pay a fair price, but they want that price to be grounded in reality. The problem is that if the buyer is a recent graduate, then they lack not only the experience to make judgements about what is fair, but they lack the resources to make sure their side is represented with equal force. If the recent graduate has a couple thousand dollars in the bank and a mountain of student loans staring them in the face, then they might not be too excited about going out and hiring an attorney, accountant, or other professional practice transition specialist. This difference in terms of experience and resources creates an imbalance that can become an issue during the negotiating process.
One item to note here is that most practice transition specialists cater primarily to sellers. Why? Simply because the seller is the one with the money. Often the fees practice transition specialists charge can run into the $20,000 to $40,000 range. It’s also normally the seller who takes the first steps to get the practice evaluated and put on the market, so to speak, so it falls to them to seek out a professional to appraise and, perhaps, to market the practice.
#2 A successful transition requires mutual respect and understanding.
As I discussed in section #1, the selling dentist and the buying dentist come at things from different points of view and with different experiences and goals. These differences will may present some challenges to a successful transition, but they can be overcome with mutual respect and a real effort to understand one another.
Does the buyer understand that the seller has a lot of emotional and psychological capital invested in the practice? Does the buyer understand that acknowledging this fact, and giving the seller his due deference as the one who started and built the practice will go a long way toward putting the seller in a more open and cooperative mindset?
Does the seller understand the inherent disadvantage of the buyer in terms of the unequal position of the two parties in terms of financial resources as well as experience? If the seller can try to put himself in the shoes of the buyer to understand the anxiety that comes with taking on the risk (both financial and professional) of buying a practice then he or she can begin to build a bridge of understanding that will help make the buyer much more comfortable and secure.
It’s never easy to look at something from another person’s point of view. It becomes even more challenging when money is involved. On the one hand the seller sees the practice as the product of his life’s work and wants to not only be compensated for that, but often times wants to be given credit and acknowledgement for that. The buyer has just completed many years of education and training and is looking to begin a new life and journey, both professionally and personally. The buyer doesn’t want to make a mistake in buying a practice that will haunt him for the rest of his career. He also has limited resources to help him make decisions and analyze practice data and at the same time likely has a large debt burden which only adds to the stress and anxiety.
Stephen Covey would admonish both parties involved in a practice transition to “seek first to understand, then to be understood,” and that is excellent advice!
#3 Nobody really knows exactly what a practice is worth. Ultimately, it needs to cash flow for the buyer and it needs to provide the seller with a reasonable compensation.
There are many dental practice transition experts out there who will be happy to tell a seller what his/her practice is worth. Is it 2X net? Is it a certain percentage of production? Should a CAP rate method be used? How about a discounted present value of perpetuity formula (Say what?)? What about receivables? What about the equipment and tangible assets? The methodologies employed vary significantly and the resulting conclusions about fair price vary accordingly. So what is a seller or buyer to do?
The two most important factors that will determine fair market value are: (1) Net cash flow to the buyer after expenses and (2) The likelihood the buyer will be able to keep the cash flowing through the course of the practice transition. A good rule of thumb (even though I hate to use an “rules of thumb”) is that the price is fair if the buyer is able to pay off the practice within about 5 years while having adequate cash flow to cover the debt payment on the practice as well as to live a reasonable, modest lifestyle. To figure this out, you need a competent accountant or someone who is qualified to determine actual net cash flow. This professional should be able to take gross income, overhead information and debt service information for the practice purchase and put it all together in a cash flow table (for example, using excel). Both the buyer and the seller should be able to look at the pro-forma cash flow table and see that the seller is going to get his money and that the buyer is going to reasonably be able to pay off the debt to buy the practice. If it doesn’t cash flow then something is wrong.
In addition, there are more subtle things to consider that affect the ability of the buyer to keep up cash flow. For example, what if the current lease agreement on the office space expires in two years. How will this affect the ability of the practice to stay in the current space and at what cost? Economic factors in the area, to the degree they can be evaluated are also important. For example, if a major employer in town is being bought out in a hostile takeover will that impact the employment and insurance situation for patients and their families? If equipment and office decor are outdated and will need to be upgraded soon, this will lead to a significant expense for the buyer which could adversely affect cash flow. Is this factored into the agreement?
There are many things to consider, but net cash flow to the buyer and the buyer’s ability to meet the debt obligations incurred while maintaining a reasonable lifestyle are critical factors to a successful transition.
#4 Don’t try to force it if it isn’t the right “fit.”
Sometimes we just want something to work out so badly that we think we can “will” it to happen. I think this is not a good idea when making a big decision about buying or selling a practice. This is particularly important when it comes to a practice transition that involves a period of time when both buyer and seller will be working together in the practice, and of course it is absolutely critical in cases where we are talking about a buy in to partnership situation.
It’s not always easy to pinpoint exactly why a situation or opportunity just isn’t the right fit. Sometimes everything looks perfect on paper, but your gut might be telling you otherwise. Personally, I am a believer in following your gut instincts. On the other hand, I think in most cases there are red flags that will appear and sometimes we have to overcome our tendency to overlook these problems.
For example, there might be a significant personality difference that could doom a potential partnership to failure. There might be a practice in a location you are in love with, but the projected cash flow just doesn’t add up. In these types of situations you have to discipline yourself to take the long view and to make the best overall decision for you and for your family if you have one.
Be honest with yourself and do your best to look at things in a dispassionate, logical and systematic way…then follow your gut if it doesn’t feel right.
#5 Educate yourself on the subject of practice valuations and practice transitions so you can be an informed participant.
If you become informed well enough about financial markets and investing then I believe you can be your own financial advisor. This is important because nobody cares as much about your financial well being as you do. Why entrust something so important to the care of others when, with some basic education, you can do it yourself? Even if you decide to employ a financial advisor, having some knowledge about investing and personal finance will help you tremendously in choosing the right advisor and discerning good advice from bad.
The same concept applies to practice transitions. Some (definitely not all) practice transition specialists, like certain financial advisors, thrive on the ignorance of their clients. I hate to put it so bluntly, but I have seen with my own eyes cases where this was clearly the dynamic at play. At times they can also play on your fears. “This is a transaction with huge financial implications,” they will remind you. “You can’t afford to get it wrong,” they say. Maybe that’s true, but to the extent that it is, you need to educate yourself. You need to know enough to hold any professional advisors you might employ accountable.
There are a number of published articles out there that will at least give you a flavor for how these practice transitions can be structured, and how practice valuations are often done. Keep in mind, most of the published articles you will find are written by the practice transition professionals I am referencing. I am not saying they are bad people or that they don’t serve a real purpose, but you do have to be careful. Often their goal is more in the vein of promoting themselves than trying to arm you with useful information. You also need to know enough to make sure you are getting your money’s worth. If you are going to spend tens of thousands of dollars on professionals to help you in a practice transition then it better be worthwhile.
Take some time to explore the different methods of computing net income. Learn about things like capitalized earnings, discounted cash flow and net asset valuations. As I described earlier, the methods that focus on real cash flow and realistic cash flow projections are the ones that work in the real world. If it doesn’t cash flow, then the buyer should look at alternative options such as a different practice or starting from scratch.
Do any of you have stories of success or failure when it comes to practice transitions? Any other ideas about how to make a transition successful?