Having recently appraised a practice that experienced a slow and steady decline in the gross income over the past four years, the owner asked us to explain why the appraised value was lower than the one we had calculated for him years earlier. Our answer was as follows:
The key indicator for determining the fair market value of goodwill is the weighted average of the last three years’ cash flow. In this particular practice, cash flow began to experience an even larger negative trend than the gross income, because as the years passed, the fixed overhead was consuming a higher percentage of each dollar earned. The end result was an appraised value much lower than it would have been four years earlier, because the dentist was now earning 40 per cent less. It was obvious that he did not have the passion he once had for dentistry, and he admitted to working fewer hours each week.
The dentist was nonetheless prepared for the appraised result, as he had made inquires about what effect his plan would have upon the value of his practice. Other experts advised him that his plan was foolish. We believe consultants should never tell you what you must do with your practice. However, you may want to investigate the consequences of your choices prior to putting a plan into action. We encourage dentists to “follow their heart, not their chequebook.”
Can You Afford to Slow Down?
Despite the lower appraised value and the consequences of the plan, this is one of the happiest dentists I know. He did what he wanted, not what the consultants told him to do!
Was it a bad plan? And what is the cost to a dentist if he or she follows the same plan?
The most notable cost will be that the goodwill will be appraised at a minimum of 10 to 15 per cent lower than it would be at the peak of performance. Moreover, the decline could be much worse if the trend continues. For example, the practice above will sell for at least 50 per cent less than it could have four years earlier. On the other hand, the dentist earned a respectable income, considering the total hours worked and the time spent in practice. He has enjoyed a relatively easy workday (on a part-time basis) in the environment with which he is most familiar, and he has no associates or partners who “push” him for action.
The practice only recalls the longest-term patients; those who trust and respect the staff, and this makes them very happy. They have accepted very few new patients lately and they refer out everything that is remotely complex. The income this dentist earned over the last four years has more than made up for the lower practice value. Most importantly, he has peace of mind and is very relaxed and healthy.
Beware of Those Who Promise the Moon
I met a dentist recently who was advised to follow a completely opposite plan. He was told to build the practice up as fast as he could, then bring in an associate. The plan was to have the practice appraised at its absolute peak, then sell it to the associate for the highest possible price. While this makes good business sense, we discovered an unfortunate side-effect: The owner was compromising his ethics in order to “meet the budget” set by the consultant. If he wanted to get that targeted sale price, he had to work harder (and faster) and he was told to motivate the staff to meet production quotas for bonuses.
In the end, the stress got to the owner, and the associate quit due to a foolish argument about who was responsible for the growth of the business. The consultant no longer advises this practice. The gross income is back down to where it was two years ago and the owner is happy again. Our advise is to watch out for schemes that promise an inflated selling price only if you follow a certain business plan. There are some who have a great deal to gain by promoting these aggressive strategies, but it is the dentist who usually ends up paying the bill.
If we consider the dentist who let his practice decline, ask yourself if you could do the same. We have found that some dentists will not purposely “de-construct” something they have built up over many years. Some want to go out on a high note, and they would only sell when their practice was thriving or at its peak. Such practices often sell for the highest possible fair market value – assuming the owner has it appraised and sold when the trends are in positive stages of growth. However, the owners typically work fewer years, as they sell at a younger age.
We are often asked about “just slowing down a little” and utilizing associates to maintain the gross income. This technique rarely maintains the fair market value of goodwill because purchasers are very skeptical about the long-term intentions of the associate. In comparison, a solo practice usually sells faster and for a higher value due to the simplicity of replacing only one dentist.
It is also common for a dentist to ask us if they can sell and associate with the buyer. In answer, we suggest this rough guide to determine if you can support both a new full-time dentist and yourself in your practice.
The average purchaser is confident they can produce $20-$25,000 per month working at 40 hours a week. If your practice can support more dentist time, you may be needed as the associate. Each purchaser has a unique set of skills and they will guide us towards their intentions. Rather than setting a schedule for yourself, as the associate in your practice, it is advisable to wait until the purchaser’s skills are discussed. In many instances, they will propose some terms.
We believe that it is now customary for the purchaser to document the terms of the association in conjunction with the offer to purchase. The vendor will then have a reasonable time frame to respond. This is a fair and appropriate practice.
Emerging Trends to Consider
After reviewing a number of recent transactions, we have identified several emerging trends. We have witnessed some incredible growth rates after a traditional solo dental practice was sold to a well-trained and confident young achiever. Many of the buyers thought they would lose patients and suffer hardship. Just the opposite is true in most practice sales. Some other developments include:
|
Alternatives
There are several methods of selling a practice, including in shares, or over a five to 10-year term. However, we find these are not popular because most sellers want to complete the sale much faster. Once they have decided to let go of ownership, most dentists are ready to act quickly. In the typical transaction, the cash sale price is received in full on closing, and the entire process – from appraisal to closing date – usually takes six to 10 months to complete. We suggest every dentist plan a one-year timeline to exit ownership. Rural practices can take up to two years.
We have found some dentists are not prepared to make this immediate change in pace after many years of routine busyness. Would an immediate sale be too sudden for you? If you want to transit out of ownership, yet want to continue practicing, there is an alternative form of work: locum tenens.
There are many advantages to this type of work, such as freedom, travel, and no fixed schedule. However, income is usually reduced and time away from home is common. Prior to accepting an assignment, you must consider non-competition clauses, which are frequently contained in the agreement of purchase and sale for your practice.
Those dentists who allow their practice to decline often struggle with their pride. This fact prevents many dentists from letting patients go, reducing staff wages, and paying a higher and higher percentage of gross to rent, supplies, lab, and other costs. Everyone has a limit for how far they will let their business decline.
How to Measure Your Worth
If you want to find your limit, my advice is to calculate your billings stated as gross income per hour. Be realistic about the hours you work in the operatory only. Deduct ‘laboratory’ to get true gross income per hour. Then do the same for the hygiene department. If you do some complete recalls, leave that figure in your gross, not in the hygienist.
Once you know your hourly production, you can measure your worth. Most dentists keep a minimum hourly rate in the back of their mind. If you can prove your hourly rate is a constant, the practice can be viable on a reduced overhead. You may be comfortable with this knowledge and could consider working another year or two, then think about selling again.
Everything has a price. What’s the price of your time? Once you know that, you will know when it’s time to plan on selling.
Ontario Dentist – April 2001