RK: Randy Kinnison with DDSmatch Southwest, just wanted to thank you for being with us today and answering a few questions that we’d like to share with our potential clients and customers. If you would just please introduce yourself and kind of describe the relationship that DDSmatch has with Blue & Co. and the business valuations that you guys prepare for us.
MH: Good morning Randy, and thank you for the time. I’m Matt Howard with Blue & Co. I lead our business valuation team. We do approximately over a hundred dental evaluations a year for DDSmatch and other dental needs. We’ve just really carved out a nice niche in it and have a lot of fun with it. I am a dental CPA and also an accredited business valuator and a certified valuation analyst. So, I have certain credentials that are specific to valuation. Our relationship with DDSmatch Southwest is, we are the third-party, non-biased valuator that comes in and gives you a true market test for what your practice is worth at the date of our valuation. We’ll be looking at the practice from an industry perspective trying to help both seller and buyer know what a true fair market value price is for the practice.
RK: Thank You, Matt. Just describe a little bit about the BV [business valuation] and what it entails. I know the first part of the business valuation always has the historical numbers of the practice as well as the performance. So, if you would just tell us a little bit more about the BV and what it entails.
MH: Certainly. With any small business or personal service company, the biggest noise in the practice would be the owner’s noise. 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. A lot of times a seller will own the building, and in owning the building, they’ll pay themselves a lease rate for that building. Sometimes, that isn’t a market rate. And sometimes, it’s a little bit above; sometimes, it’s a little bit lower. Our job in this process is to really work through the practice to make sure it shows the historical financial statements. Basically, we help sanitize or normalize the numbers as we see them and as the true operations of the practice are reflected. So, our part in the valuation process is we will collect data. We’ll go through the data. We’ll enter it into our models. We’ll ask very specific questions about that data about maybe aberrations and the financial performance over time. Sometimes, a dental supply category jumps ten percent over a year. We want to really understand everything that’s going on inside the practice. Then as we go through it, we would release a draft document for discussion with the seller. That document would be completely … a conversation piece to talk about the variables that we took into consideration, the market effects that impacted the valuation price to really just helped you understand exactly how we came up with that number. And then after that conversation, with any input from the seller, we’ll move it to a final, and then that will be the piece to share with any potential buyers as they consider the practice.
AE: That’s great, Matt. Hey Matt, Andy Edmister here jumping on the call with you. I have a few more questions. Thanks for joining us today. Matt, when would you recommend a dentist start preparing for a sale? And, why would you recommend him at that time?
MH: Yeah, a great question. I wish it’s a question that a lot more sellers kind of investigated not the year before they’re considering the sale. So, some things to take into consideration is knowing yourself and knowing what your aspirations or your goals are for the practice transition. What I mean by that is, a lot of dentists will wait until they’ve slowed down some, and we have something called a decreasing revenue stream, that’s where the collections slowly over time have started to decrease. That’s just basically reflective of the seller or the owner wanting to start to slow down. There’s nothing wrong with that if that’s an intentional decision you want to make. Unfortunately, when we see that in an evaluation, and even when banks see that in our evaluations as they consider financing this for a buyer, it does have to be taken into consideration. So, a decreasing revenue stream in the valuation world is not exactly ideal. More of what we like to see is if they’re an immature practice that’s either consistently growing by inflation or at least steady in the collection perspective. So, as you understand who you are and what your goals are, I do think it’s an important thing to consider when to sell and maybe selling before we start decreasing your output or decreasing your hours. That’s the first key. I would say anywhere from five, maybe even a little bit over five years, would be a good time to meet with your DDSmatch Southwest broker and start discussing what you want to do in the future and what does that look like in your mind from an ideal perspective taking all the different desires that you have into consideration. They’ll be able to help you walk through when may be a good time to even bring in an associate; or maybe when it’s a good time to think about something; maybe a couple of years before you thought you would; just so that we don’t run into that decreasing revenue stream which would impact the valuation price.
AE: Okay, that’s great advice. Basically, to sum it up, keep your foot on the gas until you get through the evaluation and the transition of the practice to maximize the value of the dentist’s practice.
MH: Precisely, I couldn’t have said it better myself. Yes, trying not to minimize the fact that yes, you want to slow down; however, you also want a good price for your practice. Obviously, those two things go hand in hand.
AE: Okay, well, thank you. I’m gonna move on to another question. The question pertains to purchasing in a practice or doing a de novo or startup practice on your own. What do you see is the benefits of each or the cons of each; and what would you recommend to a new dentist client of yours.
MH: A great question. And, a question that comes up quite often. As a person coming out of school, the ideal part of buying a practice is the fact that you’re walking into cash flow day-one. What I mean by that is, you are paying a fair market value price for the practice; and then, you’re making money. You’re walking into, hopefully, a three hundred, four hundred, five hundred, and up thousand dollar collection practice which helps pay your bills day-one. That’s an obvious benefit of buying a practice. The problem with starting a practice is this: it’s a three to sometimes seven-year journey to maturity or average collections of a de novo. So basically, the first year you’re probably going to feed the business as in bring money to the table to keep it going as you build up that collection stream. The second year, you might break even or maybe pay yourself a little bit but definitely not up to industry standards. The third year, between the second and third years, during these startups is where we see you making some progress towards paying yourself a reasonable wage. Still probably not what you could get out being an associate at another practice. But you’re on your way. And then, that fourth, fifth, six, maybe up to seven years could get you, hopefully, up to average. An average is somewhere around nine hundred thousand dollars of collections, hopefully, dropping somewhere about to two hundred and fifty to three hundred thousand dollars bottom line. These are all guesses. Every marketplace is a little bit different. Every geography is a little bit different, but that’s just in general.
AE: Okay, well, good answer, thank you. I’m sure that will be useful for a lot of people watching. Next question. When would you recommend or what do you think is the best time for a dentist who is where he wants to be, but he’s not sure if he’s ready to bring on a new associate. What would a dentist do to say, “hey am I ready, or am I not ready to bring on the associate.”
MH: Again, a great question enough, and a complicated one sometimes. Every practice has a limited amount of resources, of ops, of time for the staff to not hit over time. So, there’s a lot of variables that play here. Typically, we like to see over a 1.2 million dollar collection practice, in general, that way there’s plenty of room for an associate to come in, inherit some of that revenue stream as the seller wants to back off a bit and transfer some of their patient-base over to the associate. Let’s just look at this from both angles. A seller wants to have an associate for the benefit of growing and continuing to serve the patient-base well. If you’re booked two to three months out, that’s not a very good patient-service quality for your patient. So, you need to come up with a constructive way to service them quicker and have a better overall experience for your patients. A lot of times that’s where an associate will come in. Therefore, you can help address the backlog and give to the associates. From the other angle, the associate has the ability to make money day one, not build up a new business inside of a practice. They might get some sort of guarantee the first year, but you’re gonna move them to some sort of production or collection-based compensation after the first couple of months or even maybe after a year at the most. It’s important that it’s a formula that doesn’t only work for the seller, but it also makes economic sense to the buyer. Typically, buyers these days have quite a bit of student loans that they need to address, so they need to make a certain amount inside the practice. Associateships work great if there are enough collections and the seller wants to slow down a little bit and maybe back off a day, and open up some collections to the associate. And then obviously, there’s a lot of other variables, but those are just some general thoughts.
AE: Okay, well that’s great. What kind of tools could you offer as part of DDSmatch Southwest? What could you provide to help dentists decide if they are ready for an associate or not on an analytical side just on the numbers besides a gut feeling and wanting to slow down.
MH: Yeah, that’s also something that we’ve seen over and over again coming up is, “am I a good candidate for an associateship? Does it make sense for my practice to do this?” So, what we’ve come up with is an associate IQ or quotient that helps walk you systematically through the practice with 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 side? Does it make sense from the associate 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 does not make a lot of sense. After looking at a bunch of these different variables and intricacies of the practice, we will come up with a quotient of how you rate on a scale of 0-100 for being a good candidate for how many associates. We’ll walk you through the entire process. Does that answer your question, Andy?
AE: Yeah, I think that’s great, in that way, they can make an educated decision on where they’re at currently and if their business can support another dentist. But also, it shows them what they would need to do to grow to get to that point.
MH: Exactly, the last thing that anybody wants, and we run into this occasionally as well because people jump into associateships, is after a year the associate goes away. We’re stuck holding the bag here–of all the attorney fees and the professional fees to get that to happen, and then have that asset, have that partner walk away. That’s really tough for a practice, especially, if you’ve grown it significantly and can’t keep up with all the work coming in the door. It’s very important that an owner of a practice considers all the variables in play as they consider this major decision that can affect the valuation of the practice and can affect your stress levels as well.
RK: Very good Matt, thank You. Randy again. We have another question. We get a lot from dentists that are preparing to sell their practice, and even if they are a few years out, they ask a question, “should I invest in any major equipment purchases? Or, what should I do to make the practice more attractive to a buyer?” What does that do, normally, to evaluation? Does that help evaluation or not?
MH: Yeah, you’re absolutely right. That question comes up quite often. I’ll use a house as an illustration here. There’s a couple of different types of upgrades for remodeling that we can take into consideration. When you’re buying a house, you fully expect the roof to be leak proof. That’s just part of the standard price of the house. It doesn’t add anything if you find out the roof has all sorts of problems that need to be replaced before I pay you the price that you quoted. So, with that kind of consideration inside of a dental practice, certain things like x-ray heads, chairs, and normal standard-of-care type assets at the practice, you absolutely need. If you redo them a year before selling the practice, it’s not really gonna make a significant difference in the value of the practice. Some things that would make a significant difference in the practice, let’s say two months before you sell your practice, is adding a cerec machine or something that’s not been in the practice previously that hasn’t affected the income or the collections of the practice. There’s a couple of different things to consider, to remodel the practice. If you still have shag carpet in the practice, it probably needs to go before you start marketing it. So, those types of considerations and things that will bring it up to a higher standard-of-care could make it more valuable. However, you’re probably not going to get a one-for-one pay back on your investment. I guess 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. Does that make sense?
RK: Yes, that makes great sense. Thank you for that clarification and answer. One other question we’d like to ask you, Matt, once we get down the road matching a buyer and seller together and negotiating the asset purchase agreement, there’s always the question of asset allocation which plays a pretty important part for both sides. Do you mind touching on that a little bit?
MH: Yes, so what we’re talking about here is let’s say we come up with a price, and the price is one million dollars for the practice. The practice price is set, and we’ve negotiated that. At the end of the day though for both parties at play, really even more acutely to the seller is, it’s not just the price, it’s the overall deal that makes it a good or bad deal for you. What I mean by that is this, the million dollar price is great; however, it’s not about what the price is. It’s about what you keep. Obviously, what I’m referring to here is taxation. As you come up with the purchase price, and it’s an asset sale, inside that sale you would have two different buckets to place things in that the IRS expects you to fill out on a certain form. How much of the price is going to be assets? And, how much of the price is going to be goodwill? Those two buckets are very important. For the goodwill side on the seller’s side, amount that is going to be potentially subject to capital gains. Capital gains is a big deal because the difference between that and ordinary income can be significant. We can talk about over ten percent difference here. That’s a big deal for a million dollar price. Ten percent is a hundred thousand dollars. It could be that important. The asset side is anything that’s called an asset in the sale. That would be more advantageous to the buyer. That means they can depreciate those assets quicker than goodwill. Goodwill they can amortize over fifteen years as under current law. To the seller, goodwill is important. To the buyer, assets are important. It’s a little bit more important to a seller though. To a seller, that difference between capital gains and ordinary income can be quite significant. To the buyer, it’s a difference of when can I depreciate something; when do I get the tax write-off for this asset or goodwill. It’s the difference between five years to 15 years. They still get it. It’s just a question of when. For a seller, it’s a one-time deal. It’s either goodwill or it’s either assets. The more that’s goodwill, the better for the seller. And really, that is just subject to negotiations. It’s not really mandated by the IRS in any way. It’s based on what are the negotiated rates allocated to each bucket.
AE: What would you advise a young dentist in an associate for a couple of years, or two to five years out of school, paying off debt? They came to you saying, “I think I’m ready to look at purchasing my first practice.” What would you review with that dentist and how would you prepare him to be ready to engage with Randy and myself to find him a practice?
MH: Some of the first things here is have you spent the time clinically to get your hand speed up, to make sure, that whatever you’re looking at buying, you can actually do or can you document that you can do that in the that new practice? Something else or the bank will be looking at is have they been able to produce at the levels of the practice that they’re buying. That’s one important element. The second important element is taking a look at what does their world look like. Have they gotten in a couple years out of school. Have they been able to create some sort of emergency fund? Do they have some sort of margin in their life? That sounds very logical but a lot of times a buyer is not a good candidate because they don’t have any kind of safety net in their life. So, the third thing that I would talk about is do you know what you’re looking for? Do you know a geography? Have you really studied what area you want to be in and what that practice might look like? Having a clear direction and intentionality about the practice that you’re buying I think is an important thing for a dentist to address to a broker at DDSmatch Southwest because they really need to know that you’re fully vested in buying in a certain area, for a specific purpose, with a certain clinical skill set. Does that answer your question?
AE: Yeah, Absolutely I think that’s great. There’s a lot of young dentists out there that are just kind of on the edge, “am I ready?” It’s scary to start your own business.
MH: No doubt about it. I walk through maybe twenty buyers a year. and Some of the same elements that you’re just discussing here come up often. It can be a terrifying thing. You just need a really good board of directors to walk you through. I mean a great CPA like myself and a great attorney to help you understand the logistics of the transaction and how to structure it. Beyond that, if you have the right people on your team as advisors, we’ve been through this a hundred plus times just helping you through that is part of what we do.
AE: Well, thank you very much, and again we appreciate you taking the time today. You’ve been a huge partner and a huge help not only for us but especially for our clients, so thank you, very much, Matt.
MH: I think that this has been a great conversation and great questions. I think these are key elements to any transaction as these will come up at some point in the process. It’s nice to have a heads up for your sellers or even the buyers out there to understand the dynamics at play. Again, DDSmatch Southwest is a great brokerage. They really walk their clients through everything. It’s an open process. They invite your advisors in to help you through it. I’m a big fan.