Advice from a Dental CPA & Business Valuator before Listing a Practice for Sale

Nov 11, 2020 | Finance

If you are thinking about listing your dental practice for sale, one of the first things you need to do is retain a qualified dental CPA, if you don’t already have one working for you. To show how invaluable dental CPAs are when it comes to everything from business valuations through asset allocation in the finalized deal, we talked to Matt Howard of Blue & Co. about his advice for sellers.
(courtesy of DDSmatch Mid-Atlantic)

Matt is a dental CPA, an accredited business valuator, and a certified valuation analyst at Blue & Co., the third-party, non-biased valuator DDSmatch  uses. Their team is able to give a doctor a true market test for what their practice is worth (currently, during the pandemic, valuations are being based on a practice’s 2019 numbers). Basically, he and his team will look at a practice from an industry perspective, trying to help both the seller and the buyer know what is the true and fair market value price. Below, Matt walks us through some of the key services a dental CPA can provide someone looking to sell their dental practice.

Understanding Business Valuation
One of the first things your dental CPA will do is to walk you through all of the items that help you understand the true market value of your practice. Blue & Co. does this through a 70-page business valuation document that breaks down each financial aspect of your practice.

The business valuator collects all of the financial information about your practice, evaluates it, and enters it into their models. They ask very specific questions around that data and about any aberrations in the financial performance over time. For instance, if a dental supply category jumps 10% over a year, they will want to understand what caused the change.

As Blue & Co. reviews the financial data, they will prepare a draft report to discuss with you, the seller. This draft is used as a guide to discuss all of the variables their business valuation team has taken into consideration, the market factors that impact valuation price, and to help you understand their process in reaching this conclusion. After that initial process and any additional input from the selling doctor, they then refine the report further to make a final version that will be shared with the buyer considering a purchase of their practice. It is very important to note that this document is intended to reflect the true market value of a dental practice and reflect how its resources are being used, which are often not the same thing.

As Matt notes:
“The biggest noise in [the business valuation of a] . . . dental practice would be the owner’s noise. And what I mean by that is anything that’s inside the practice that is not necessarily operational, or is basically something that the owner has decided to do at the practice that doesn’t exactly reflect the operations of the practice . . .

“Often, a seller will own the building, and in owning the building, they’ll pay themselves a leased rate for that building. And sometimes that isn’t a market rate. Sometimes it’s a little bit above, sometimes it’s a little bit lower. And so our job in this process is to really help work through the practice financials, the historical financial statements, and just basically help sanitize or normalize the numbers as we see them [so] the true operations of the practice are reflected.”

When Should a Dentist Start Preparing for a Sale?
The short answer on when to start preparing is around five years before you want to sell, and maybe even a little before that. The key is to know when you want to sell and have a good sense of that timing before you start to slow down in your practice.

Too often, a doctor will wait until they’ve slowed down some to consider a sale, at which point the practice shows a decreasing revenue stream, where the collections have slowed over time. While that is simply reflective of the seller wanting to slow down, and there is of course nothing wrong with that, a problem can arise when this choice causes the practice to look like it is beginning to underperform.

When such a downturn appears in a business valuation, the buyer’s lending bank will see the decrease and not necessarily know the reasons behind it. They will simply consider the decrease in revenue stream, which is not what they want to see in a practice they are lending on. Matt explains that what banks are looking for is “a very mature practice that’s either consistently growing by inflation, or at least steady in the collection perspective.”

What this means is that as you think about how you want to wind down your career, it is important to consider when is the right time to sell and consider making that choice before you start decreasing your output or decreasing hours. Whenever possible, the best course is typically to keep your foot on the gas until you would get through the valuation and transition the practice to maximize its value.

If I’m Not Ready to Place My Dental Practice for Sale, What About Bringing on a Dental Associate?
Often a busy doctor who is not ready to place their dental practice for sale but who is interested in slowing down may consider bringing on a dental associate to help increase collections. Perhaps they may even be hoping to put in place a doctor who will eventually take over the practice. When the doctor, office, and practice are ready for this addition, it can be a smart move. But being clear about whether you and your practice are well-equipped to take on an associate is a complicated question, and one many doctors have gotten wrong.

As Matt observes,
“Every practice has a limited amount of resources, of ops, of time for the staff to not hit overtime. So there’s a lot of variables at play here. Typically, we like to see over a $1.2 million collection practice in general. That way there’s plenty of room for an associate to come in, inherit some of that revenue stream, as in, hopefully the seller wants to back off a bit and transfer some of their patient base over to the associate.”

From the seller’s perspective, the dental associateship will benefit the practice by growing the practice’s value and continuing to serve their patient base. If, for instance, you are booked two to three months out, that usually is not great patient experience. So a dental associateship can be seen as a constructive way to service more patients faster to keep patient satisfaction and retention high.

From the dental associate’s perspective, a mature practice that is consistently growing by inflation, or, at least, remaining steady in its collections, gives the dental associate the ability to earn money right from the start. They benefit from not having to build up new business themselves while helping you support your patient load.

Typically in this kind of instance, the dental associate may get some sort of guaranteed earnings for the first several months, or even a year, and then move into a production or collections-based compensation after that. Generally, an associate is a young doctor with student loans to consider and their income is going to have to be sufficient to cover their debt and reasonable living expenses for a doctor.

The key here is that you have a formula in place that makes financial sense for both the practice and the associate. Blue & Co. has come up with a program they call the Associate IQ.

Matt explains how this program helps dentists considering an associate:
“[We] systematically go through the practice. We have about ten different areas that we look at to make sure that it makes sense for the practice to bring this on. Does it make sense from the owner’s side, and does it make sense from the associate’s side?

“Some things we’ll look at, is if you only have three ops, and you want to bring in two dentists a day, that doesn’t make a lot of sense. So after looking at a bunch of these different variables and intricacies of the practice, we will come up with basically a quotient of how you rate on a scale of zero to 100 for being a good candidate for having an associate.”

Too often, doctors rush into a dental associateship without making these careful considerations. Then, after a while, the dental associate leaves and the owner-doctor is left with the expenses (attorneys’ fees and other professional costs) but none of the benefits. This can be hard on a practice, especially if the practice has grown and the remaining doctor cannot keep up with all of the patients coming through the door.

In sum, if you are considering a dental associateship, it is imperative that you consult with a dental CPA to take close look at your practice to ensure this step is one you are ready for and that your practice can support in the long term. A team of experts in these transition experiences helps you to consider all of the variables in play, as they can have a major impact on both the practice valuation—and your stress levels.

Do Practice Upgrades Help with Valuation?
The short answer is, while you do need to make your practice attractive to the buying doctor, most upgrades won’t necessarily pay off in the sale.
Matt explains:
“If you’ve still got the shag carpet in the practice, that probably needs to go away before you start marketing it. So those types of considerations will bring it up to standard of care and that could make it more valuable.

“However, you’re probably not going to get a one-for-one payback on your investment. So my end-all, be-all recommendation is, five years before the practice sale, unless you’re really making your practice digital or doing something that’s bringing it up to standard of care, any other significant remodels at that point would probably not be a complete one for one return on your money.”

An important note here is that many younger doctors only have experience on newer equipment. If your equipment is so outdated that the younger doctors have no experience with it, they will likely pass on considering your practice as one to buy.

The Question of Asset Allocation
As Matt succinctly puts it, “It’s not just the price, it’s the overall deal” when it comes to a sale. “And what I mean by that is this: the million dollar price is great and all. However, it’s not about what the price is, it’s about what you keep. And obviously what I’m referring to here is taxation.”

Most everything in the sale is essentially going to be allocated as an asset, or as goodwill. The sale of tangible assets are taxed as normal income. The sale of intangibles, such as goodwill, is taxed at the more favorable capital gains rate. As the seller, the more of the practice value you can allocate to goodwill, the better that is for you—the more money you keep.

Typically this is an issue that is more important to the seller than the buyer. Eventually, everything in the sale, for the buyer, can be depreciated over time. So, in the long run, the financial aspect of asset allocation has less of an overall impact on the buyer. For the seller, however, when that tax bill hits, it is a one-time hit.

The good news is that how the assets are allocated is really just a subject of negotiation between the buyer and the seller to agree on a mutually beneficial arrangement. Rather than a fixed formula, this ratio is determined by the agreement of the value between the parties to the sale. However, this is where you really need the expertise of experienced dental CPAs and lawyers to be certain that your interests are properly represented and important details are not overlooked. Contact us at DDSmatch to see how can help.