Whether you’re selling a car, a house, or your dental practice the ultimate question that everyone wants to know is…. How much do I get? After all the years of blood, sweat, and tears you have put into your practice and you come to the point of retirement, or just selling to take a break from ownership, you want to know, after all the fees and expenses, how much money will you be putting in your pocket. Or, hopefully, bank account. Of course, the answer varies from sale to sale, but there are some general expenses and fees that you can be sure will be part of your transaction.
Interest Rates Affect on Practice Values – Why now is a good time to sell
By Rod Johnston, MBA, CMA
Some of you may remember that in October of 1981, interest rates on home loans were 18.91%. Over the years, interest rates have gone up and they have gone down. In the early 2020’s, we saw some home mortgage rates go as low as 2.81%. If you were wise, you borrowed as much as you could at that time and bought a house, even though you may already have one. Coincidentally, home prices typically don’t follow interest rates. In fact, there have been periods of time over the past fifty years where interest rates have gone up and the average house price also went up. The same isn’t true for the value of practices.
When I first got into helping doctors sell their practices in the early 2000’s, interest rates for practice loans were about 7.5%. Most of the terms on those loans were 7-year terms. Meaning you had 7 years to pay off or amortize the loan. What does that mean for practice values? Banks determine how much they will lend based on cash flow after debt service. Debt service is the amount of your monthly loan payments.
To calculate cash flow, you start with the net income on last years’ tax return. Banks typically use 2-years tax returns, brokers when valuing a practice use 3 years of tax returns. I’m using one year’s tax return to keep it simple. You take the last year’s net income and then add back the non-operational expenses in the business. Those expenses are those that may not be necessary to run the business. Expenses could include gifts to employees, a continuing education class you took in Hawaii to get a vacation along with the CE, or meals you expensed for business. You can stop those expenses and still run your practice.
This gives you an adjusted net income. You then subtract your annual debt service to get the cash flow number. The banks then divide the cash flow after debt service by the annual debt service to get a debt service ratio number which should be above 1.2 times the debt service. So, if your cash flow is $120,000 and your debt service is $100,000, your debt service ratio is $120,000/$100,000 = 1.2 times your cash flow. Anything lower than that and the loan would be rejected, or you would need to figure out how to make the numbers work to get the debt service ratio up.
What does this have to do with practice values? Well, if interest rates go up, that’s going to cause a buyers debt service payments to go up. An increase in debt service will result in a decrease in cash flow after debt service. This will result in the debt service ratio going down and possibly dropping below the threshold of 1.2 times cash flow after debt service. The same goes for the term of the loan. Some banks now have 15- or 20-year terms on their practice loans. This reduces the debt service payments as the loan is spread out over more years. The result is a decrease in annual debt service payments which improves cash flow. A bank with a 7-year term may not get the loan approved, but a bank with a 15-year term may be able to do it.
Brokers know all this stuff. When good brokers do their valuations, they’ll do a check to make sure the bank will be able to finance the practice at a certain value. So, they’ll do a debt service ratio calculation and if it falls below 1.2 times debt service, then they should lower the value to price it correctly.
The good news is that there was a recent drop in practice loan interest rates. Interest rates on practice loans are between 5% and 5.5% at the moment. As a seller, this means values can be pushed a bit as the cash flow after debt service is improved with lower interest rates. A practice valued at $950,000, may now be worth over $1 million or even more. Because the lower interest rate resulted in lower debt service payments which helped increase the debt service ratio.
It’s good news for the buyers as well. Lower interest rates can lower their monthly payments as well. This may help them get into a practice that they may not have been able to purchase in the past as the ratio now works. This can be especially good in a startup scenario or in larger practices.
In summary, just remember that when interest rates are low, which they are at the moment, it’s a good time to have your practice valued and put on the market. It’s also a good time to be a buyer as your payments could be reduced.
If you would like a free consultation on the value of your practice, or to discuss a possible transition in the future, please reach out to one of the Omni brokers. We are always glad to help. Phone calls are always free and if you do a valuation with us today, we will update them for free in the future.
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Why Practices Don’t Sell
By Rod Johnston and Jim Vander Mey
Your practice has successfully worked for you for many years so why isn’t it selling? It could be the transition consultant (broker) you are using, or it could be your practice.
Working with an experienced transition consultant is important. We know where and how to advertise. It doesn’t work to simply advertise on a website. You will want marketing and advertising in schools across the country, veterinary journals, and county/state societies. An experienced consultant already has a list of potential buyers for your area or type and may have other creative grassroots ideas to find the right buyer.
The right consultant cares about you, your team, practice, and goals. It shouldn’t be just about the commission money. Your consultant should be responsive and professional to potential buyers and you.
A comprehensive valuation and prospectus are important. If you or your consultant price your practice too high, it can be offensive to potential buyers, and they won’t feel comfortable offering a lower price. Even if you find a buyer willing to overpay for your practice, the bank will not finance 100%, which means you have to become a bank for a specific amount of the purchase price.
Sometimes even when you have the right consultant your practice may have other reasons for not selling. Sometimes it’s simply not finding the right veterinarian at the right time. Often it is because your location is not desirable to new buyers and their families. Sometimes it’s the size of the practice. We all know practices with two exam rooms can be very efficient and profitable, but many buyers want 3 rooms or more.
Declining collections the last 3 years or simply low collections can be a deterrent to potential buyers and banks. They understand reasons such as more time off due to vacation or health issues.
Most buyers understand they may need to update style or equipment and technology, but if it’s a lot of cost and effort, they may keep looking for a better practice.
If your practice falls into any of these areas of concern, it will take more time than the average to sell. Lowering the price may help, but if there is no interest, it’s not the price that’s the problem. Don’t give up or get mad, just understand that while your practice may have been perfect for you, it can be a while to find the right buyer.
Read MoreHow Much Will I Get for The Sale of My Practice?
Valuation Fee – To calculate what your practice is worth, you will need a valuation. If you are using a broker, they will charge anywhere from $1,500 to $4,000. Many will waive the fee if you are going to list your practice for sale with them. Others will back the fee out of the commission when your practice is sold. If you do not use a broker, you will still want a valuation. I suggest using a broker that has some type of certification in valuing a business. Rule-of-thumb-valuations are back of the envelope estimates at best.
Attorney Fee – You will need an attorney to draft up the purchase and sale and other agreements necessary to close the sale of your practice. Be sure and use an attorney that specializes in, or has completed a lot of dental practice sales. Attorney fees can range from $4,000 up to $10,000 with the average being around $5,500. Of course, this depends on the complexity of the transaction, who is representing the buyer and how many changes are requested during the review phase.
Broker Fee – If you are using a broker, you pay between 6% and 12% of the sale of your practice. The range is typically due to the size of the practice. Smaller practices that are producing less than $400,000 per year are harder to sell, require a lot of money spent on marketing and require many more hours to get to the closing finish line; therefore, those are typically in the 10% to 12% range. Larger practices typically are in the 6% to 10% range depending on a number of other factors. You can decide to not use a broker if you choose. Bankers and attorneys estimate that 50% of the practices sold without a broker fall apart before the sale is closed. Buyers lose interest in the practice, another opportunity pops up, or a disagreement occurs – and without an intermediary, sellers and buyers clash and the sale falls apart. A typical transition from beginning to end can take 200 to 400 hours to complete. Be sure you have that extra time in your life if you decide to sell without a broker.
Taxes – Here’s the biggie. When you sell a practice, the purchase price is allocated between goodwill and tangible assets, such as equipment. Goodwill typically makes up 80% to 90% of the purchase price. It is taxed at the capital gains rate of from 18% to 24%. The tangible assets make up 10% to 15% of the purchase price. These are taxed at your ordinary income tax rate. Most dentists fall between 28% and 35% ordinary income tax rates. The average is 33%. So, you can see, you want as much allocated to goodwill as your accountant and the IRS will allow.
Equipment valuation – This is typically not required, but occasionally requested by a buyer. This is commonly around $400 for the equipment valuation.
Letter to Patients – This is the letter that is sent to your active patients to inform them you have sold your practice and to introduce them to the new doctor, who is a wonderful person. This is split between the seller and buyer. An average practice may have 1,000 or more active patients. You can typically get the letters printed and mailed for $1.50 to $2.00 including paper, postage, stuffing envelopes, etc.
When the dust has settled and the ink has dried on the agreements, you should walk away with approximately 70% of the proceeds in your bank account after all fees have been paid. As always, we advise you seek advice from your team experts before making the decision to sell your practice.