They’re Heeeere…
These DSOs are groups who are looking to consolidate the dental industry similar to what has been going on with pharmacies, surgery centers, and hospital systems for many years. In fact, as a side note, two-thirds of pharmacy revenues come from corporate-owned pharmacies. The DSOs, especially the large ones, are backed by private equity money looking for good returns on their money. Smaller group practices are typically backed by local or national banks. The private equity groups like the dental market as there are good margins in owning a dental practice. I’ve heard they can typically get a return of 15% to 20% after paying an associate salary and all other overhead. They don’t require financing, so they don’t have the debt service payments that individuals may have. They often consolidate the “back-office” functions – Human Resources, accounting, and billing to save money. They also can negotiate better insurance reimbursements and dental supply prices than the solo practitioner. For staff, they can offer decent benefits packages as a result of economies of scale. However, they may not pay staff wages as well as solo offices. The larger groups range from 30 practices under ownership up to several hundred locations with groups like Heartland Dental.
What are they looking for when they acquire a dental practice? Many of them claim they will pay a premium for a practice. I’ve been working as a practice broker for almost 15 years, and I’ve never seen a group, DSO, or Private Equity investor purchase a practice for an above market price. Most have purchased practices at market, or even slightly below. They like larger practices doing at least $800,000 and up. That doesn’t mean they won’t buy smaller practices, but the larger ones are more appealing. They like to acquire smaller practices in the area where they already have a larger practice so they can consolidate the smaller practice into the larger practice. Most of them want the selling doctor to stay on and work in the practice. Many of them want the seller to stay for up to 3 years. Most will negotiate down to 2 years. They usually do not give you your entire purchase price upfront. They’ll give you 80% of the purchase price at closing, you will have to wait for the other 20% to be paid out upon certain conditions being met. Those conditions include serving your agreed-upon employment term, the practice production staying at where it was before or even growing, and other conditions may be possible such as hiring an associate, managing the practice, etc. If you don’t meet your conditions, the DSO may pay none or only a part of the last 20% of the purchase price. And, if after a few months you decide that working as an employee for the group isn’t what you thought it would be, or you decide to move out of the area for health reasons, or for some other reason you decide to leave the practice and not meet your term, then too bad for you. You forfeit the 20% that the DSO owes you.
The small groups, DSOs, etc., will also tell you that they prefer you not get someone to represent you. That includes an attorney, a consultant or a practice broker. They want to use their experience, their sales tactics and their gaggle of attorneys to negotiate a great deal, FOR THEM! Yes, they’re not looking out for your best interest. They could care less if most of your retirement nest egg is in your practice. They care about building their market share so that they can make as much money for their investors as possible.
My advice if you have received a letter in the mail from a DSO or small group is to don’t go it alone! You’ve been a dentist for quite a few years for crying out loud and haven’t negotiated a multi-million-dollar deal, dealt with aggressive attorneys or a large corporation. Whether you use a broker, attorney or consultant, get someone on your team to represent you. Our group at Omni has negotiated many deals ranging from $500,000 to $7 million and up. This is what we do and have expertise. Feel free to call us anytime to discuss your transition, an offer you received, or anything else where we can provide knowledge. We’re always glad to help.
*Footnote: “Dental Service Organizations – The What and Why of DSOs – Part 1 of 6” Posted on May 13, 2019 by Sara K. Stock. www.stocklegal.com/blog/dental-service-organizations-the-what-and-why-of-dsos
Value vs. Price – Choose Wisely
Price is the consideration (cash, note, barter, etc.) paid to a seller to acquire an asset. Sellers receive price. Value is the benefit received by the buyer from the use and ownership of the acquired asset. Buyers receive value.
I illustrate this point by asking buyers to consider four similar practices:
Practice A grosses $400,000 and is priced at $275,000. All too frequently, buyers zero in on price as the primary practice purchase issue while ignoring the issue of value. However, buyers stand to benefit much more by receiving high value than by paying a low price, since the primary practice value is the net income the buyer takes home from the purchased practice. I ask buyers if this is a good deal. Most buyers admit they do not know.
Then, we look at Practice B, which grosses $400,000, of which the hygienist produces $100,000 and the seller produces $300,000. After paying all the overhead expenses and all of the purchase payments, the buyer will have a net income of $140,000. Without even knowing the price, most buyers believe that Practice B is a good opportunity. Knowing the price and gross alone does not make for a well-informed decision. Knowing the cash-flow derived value, or net income, received in return for work performed by the buyer, does allow for a well-informed decision.
Consider Practice C, which grosses $400,000 and is priced at $300,000. After paying all of the practice-overhead expenses and all of the purchase payments, the buyer will receive value, or net income, of $150,000. Now examine Practice D, which is very similar to Practice C. It also grosses $400,000 but is priced at $250,000. After paying all the practice-overhead expenses and purchase payments, the buyer will receive value, or net income, of only $125,000.
This comparison shows that it is possible to pay a higher price for a practice and still receive more value, or net income. Differences in fixed expenses, such as rental cost, can cause such differences. Which practice would you choose?
While we do not suggest overpaying for any practice, we do point out the old saying, “You get what you pay for.” Since “what you pay for” is net income in the case of dental practices, higher-priced practices generally will yield higher net incomes, even after making the payments. In the case of purchasing a practice, it often is safer to pay slightly too much than too little.
We strongly suggest that if you are considering buying a practice and are seeking professional advice on price, be sure that you also receive a practice cash-flow analysis to learn all of the important facts — especially the answers about practice value, the net income you will earn.
How to Buy a Practice
This is a very important decision and time for you and your family, so it’s critical to build your team of trusted advisors, such as veterinary specific broker (with a commercial real estate license), lender, CPA, attorney. These professionals have done many unique transitions, and often with each other, so they work well together and know how to provide you with a successful transition. You can use your relative or friend in these professions, but they can’t know the things veterinary specific advisors know. Experience and knowledge in a select niche are worth its weight in gold.
Can I afford a practice and associated real estate?
Veterinarian-specific lenders understand the veterinary industry and understand that you may have student loan debt in excess of $150,000. If the practice cash flows and provides you with the money to pay your practice and student debt, plus living expenses, you may be good to go. If you are thinking about a start-up, you will most likely need to work part-time somewhere else as you grow your new practice. Your trusted advisors can provide you with ideas to assist with your startup as well as potentially referring to a veterinary-specific marketing company. So, the answer is, typically, yes, you can afford a practice and associated real estate.
Sometimes, depending on the seller and your finances, you may rent a few years. The things to consider here are that if you rent, you may still have the seller “visiting” when they want and still act as though it’s their building and try to deter you from making your own decisions. It’s hard to make changes and you will someday understand this! If you rent, you will want your attorney to ensure there are solid details surrounding future purchases.
Some veterinarians prefer to own their own real estate and that can be beneficial for those with property ownership goals. Leasing in a commercial space or strip mall can be worth the potentially high rent if you have the opportunity to gain increased collections.
What do I need to know when looking at potential practices?
Where do you want to live and work? Once you determine the general location, look for a practice with a good and visible location and parking.
Work with your broker or buyer-representative to assist you to review the formal valuation or the following statistics.
Last 3 years financials to see collections and expenses. Some expenses may be backed out that would not pertain to the new veterinarian, such as “large” continuing education, cars, 401K, and family members on the payroll that may not have an active/necessary function in the practice.
I want multiple offices.
Having multiple offices can be profitable if done correctly. Ensure you have solid processes in place that can be replicated. Consider doing a demographic study to determine where you want your locations. If clients may be going to more than 1 location, ensure your veterinary software is capable of being accessed by all locations.
What do I need to know/do before starting my first day in my new practice?
Work with your CPA to set up your entity, accounting system, payroll, and tax payments. Plan to have a confident first conversation with your new team. They will be anxious about the transition so you will want to put your arms around them and help them understand you want to continue the quality care and any small changes will only be for the better for clients and team. Be prepared for difficult questions such as asking for a wage increase, change in schedule, or complaints about other team members. Guide the team on how you want them to discuss you to the clients and how your goal is to retain clients.
Become familiar with your veterinary software. Most veterinarians and teams do not maximize the reports and statistics available to you. Remember, your veterinary software and accounting system are the 2 biggest tools you have to run your practice.
Purchasing a practice, with your team of trusted advisors, should be a pleasant process that leads to a profitable and enjoyable career!
Analyzing a Lease in a Practice Acquisition
When you get a copy of the lease, you or your advisor should contact the landlord. Be sure the seller has informed the landlord that they are selling the practice first. If there is a short time left on the lease, the landlord may be willing to do an extension on the lease. You can put conditions on the extension that can include getting a tenant improvement credit to cover new paint, carpet, etc., free rent for a few months, lower rent, etc., I’ve even had a situation where the landlord loaned money to the tenant to completely remodel the practice.
Remember that everything is negotiable. Don’t automatically assume the lease is set and you cannot change anything. At the same time, know how to negotiate. If you go for a home run right off the bat, you may turn the landlord off and they won’t be willing to negotiate.
If you’re working with a broker, it’s best to let them handle the negotiating. They’re the experts and can save you thousands if done right.
If you are coming to the Pacific Northwest Dental Conference, stop by booth 604 and talk to Steve if you have more questions about this. You can also email him at steve@omni-pg.com. If you’re in Oregon, email Megan at megan@omni-pg.com.
Ideal Practice Benchmarks
People love benchmarks. They want to know how many glasses of water we should drink each day. How much we should work out every week. Or, how many miles per gallon our cars can achieve.There are also benchmarks to look at when you are buying a practice. They may not necessarily be deal-breakers, but they help determine what you will need to do to get to your target. Here are some of the benchmarks you should look at and calculate when buying a practice:
- Staff overhead as a percentage of collections – 20% to 25%. If it’s higher, the practice is overpaying staff, underperforming collections, or too many staff.
- Facilities Expense – 7% to 9% of collections – Too high and the practice is either paying high rent, space is underutilized or production is too low.
- Supplies – 5% to 7% of collections – If this is too high, it could be that the practice is using high-end supplies, or the supplies inventory (or vendor) is not managed properly.
- Marketing expense – 3% to 5% depending on the growth stage. A practice that is looking to grow will have a high percentage. A static practice may not spend much on marketing at all.
- Collection Rate – Minimum of 98% for a well-run practice. A low rate means the front desk is not keeping up or managing the accounts receivables very well.
- Total Overhead (all expenses less owner and associate pay) – Ideally should be less than 85%.
These are just a few benchmarks to analyze when looking at a practice. Remember, if the practice you are analyzing does not meet or exceed these benchmarks, it does not mean it’s a bad practice, it simply means you have work to do in those specific areas.
Contact me if you would like more information – jim@omnipg-vet.com.