Buying a Dental Practice
Purchasing a dental practice is one of the most important decisions you will make in your professional career and often unlocks the door to a considerable increase in compensation and personal freedom. Therefore, it’s crucial for you to begin preparing for practice ownership in advance, build a strong team of advisors, and have a clear understanding of the purchase process and how to evaluate potential acquisition opportunities.
Why Purchase a Dental Practice?
When it comes time to pursue practice ownership, dentists have two choices: purchase an existing practice or start their own practice from scratch. Here are several reasons many dentists chose to purchase an existing practice:
- Immediate Cash Flow – The primary reason that dentists chose to purchase practices is that a healthy, established practice will immediately provide the buyer with sufficient income to cover practice overhead, the debt service associated with their practice loan, and the buyer’s personal living expense needs.
- Established Patient Base – Dental equipment, carpet, paint, etc. can easily be replaced and/or upgraded. The true value of a dental practice is derived from its patient base and the recurring revenue stream generated from the practice’s existing patients.
- Experienced Staff – High performing practices typically have a well-trained staff that can serve as a tremendous resource to the buyer in a practice transition.
- Proven Location – If the selling dentist has successfully operated a dental practice at the current office location for an extended period of time then the buyer can be confident that the practice’s location will continue to be viable for the foreseeable future.
- Upside Potential – Many established dental practices have tremendous upside potential and provide the new owner with opportunities to significantly increase new patient flow and practice revenue shortly following a practice purchase. These growth opportunities may include implementing an external marketing plan, expanding doctor days and business hours, retaining specialty services that are currently being referred out, etc.
- Mentor Possibilities – In some cases, the selling dentist may be willing to mentor the buyer prior to or following the transition of ownership, which may include teaching the buyer to perform certain dental procedures and/or manage the practice from a business perspective (handling staff issues, marketing, bookkeeping, etc.)
Preparing for Practice Ownership
The process of preparing for practice ownership should begin during your third year of dental school and continue until the day you purchase or start your own practice. The better your credit and personal financial condition, the faster your hand speed and more diverse your skill set, and the more developed your business acumen … the more prepared and more successful you will be when it comes time to pursue practice ownership.
Since most dentists rely on third party financing to purchase or make capital investments in their practices, it is imperative that you understand the perspective of dental lenders and how to position yourself for success when applying for practice financing.
Specialized dental lenders have the knowledge and experience to recognize that dentists are a good credit risk and to properly analyze practice financing opportunities. Therefore, you can expect dental lenders to continue to aggressively pursue dental loans and offer competitive pricing. However, it is important to note that the recent financial crisis has caused dental lenders to tighten their credit standards and evaluate borrowers more closely in these key areas: Personal Credit History, Personal Financial Condition, and Professional Experience.
Personal Credit History
When you apply for a loan, it is often the first time you will be introduced to a dental lender. Due to the fact that the lender does not typically have a long-term personal relationship with you, the industry standard is to rely on your personal credit history as the primary character reference. While it is ideal to maintain a credit score above 700, most lenders will fund transactions for borrowers with a credit rating of 650 or higher. If your credit score is below 700, be prepared to answer questions pertaining to delinquent accounts, high credit card balances, or any other factors that may have driven your score below this mark. In order to ensure that you maximize your credit rating and present yourself in the most favorable light, we encourage you to employ the following steps in managing your credit:
- Check your credit regularly (every 6 months).
- Correct any mistakes or instances of credit card fraud. If any mistakes or signs of credit card fraud appear on your credit report, immediately contact the credit grantor to dispute the charge or correct the discrepancy. You should also contact the credit reporting agency to notify them of the mistake and submit supporting documentation so that the correction can be made to your credit report.
- Pay your obligations in a timely manner. A delinquency will appear on your credit report if a payment to a credit grantor posts over 30 days past the due date. Lenders look poorly upon current or past delinquencies because this shows an unwillingness or inability to repay your obligations as promised. If delinquencies do appear on your credit report, be prepared to provide the lender with an explanation of each delinquency.
- Limit your use of revolving debt. Revolving debt includes all debt relating to credit cards, charge cards, or home equity lines of credit. This type of debt can substantially reduce your credit score and is looked at unfavorably by lenders. Once revolving accounts have been paid off or retired, do not close these accounts, as availability (not use) of revolving credit will boost your credit rating.
- Avoid declaring bankruptcy at all costs. Most lenders will not consider anyone who has declared bankruptcy within the past 7-10 years as a financing candidate.
Personal Financial Condition
Unlike traditional banks, dental lenders understand that most dentists with only a few years of professional experience will likely have a substantial amount of student loan debt and may have a negative net worth. What these lenders are paying closer attention to is if a potential financing candidate is “living within his/her means”. Lenders want to verify that your lifestyle matches your personal income level at the time you apply for practice financing, as the lender can only assume that your current approach to managing your personal finances will continue into the future regardless of your income level. An interest only or adjustable rate mortgage and/or substantial levels of credit card debt are key indicators that a financing candidate is not maintaining a lifestyle consistent with his/her personal income level. This situation will often give lenders an uneasy feeling about a potential borrower’s spending habits. Therefore, you may want to consider postponing any major purchases – such as a home, car, luxury items, expensive vacations, etc. – until after you purchase a practice and can generate sufficient income to fund these purchases with cash or keep up with the monthly payments rather than utilizing revolving debt.
While dental lenders will often provide borrowers with 100% financing plus working capital to help supplement overhead expenses and cover the dentist’s personal financial obligations immediately following a practice acquisition, some dental lenders require that potential borrowers have liquid assets (cash, savings, investments) equal to 5%-10% of the loan amount on hand. Borrowers who are able to meet these liquidity requirements have shown the ability to live well within their means and will be in the position to fund any unexpected expenses that may arise shortly following closing with their own savings (once their working capital has been exhausted).
It is also important to note that lenders will often evaluate recent graduates from a different perspective than when considering more seasoned dentists. While it is understandable that recent graduates will be carrying large student loan balances and a negative net worth, a lender will expect established dentists to be in a more favorable personal financial situation due to the ability to save money and reduce debt obligations during their career. Experienced dentists with weak financial statements should be prepared to provide an explanation for their current personal financial condition in order to mitigate any perceived risk from lenders.
Professional Experience & Business Acumen
The majority of dental lenders will require that a potential financing candidate has one to two years of experience following dental school prior to pursuing practice ownership. The exact level of experience required to qualify for a loan can vary depending on the loan amount, size of the practice being acquired, type of practice being acquired, buyer’s production capabilities, buyer’s business acumen, and more. Lenders may require less experience if the financing candidate has been working in the practice that he/she is looking to acquire.
As a young doctor who is considering purchasing a practice within a few years following dental school , it is wise to search for an associate position that will allow you to produce a substantial amount of dentistry, quickly increase your hand speed, and expand the array of services that you are capable of performing. Obtaining your production/collection reports from your associate position can also be a useful tool in showing evidence to a lender that you are capable of producing at the level of the selling doctor and experienced at performing all of the dental services historically offered by the seller.
As a result of the myriad of changes that dentistry has experienced over the past few years (i.e. increased competition, PPO involvement, regulatory compliance, etc.), the burden of management associated with being a practice owner has reached an all-time high. Therefore, in order to be prepared to effectively manage the business side of your practice, it is crucial for dentists to develop their business acumen alongside their clinical abilities. While working as an associate, you should pay close attention to the responsibilities involved with owning/operating a practice and learn from the mistakes and successes of your employer. It would also be a wise decision to invest your time in taking business/management courses at a local community college and/or read several business-related books, such as Good to Great, The Art of the Sale, The Obstacle is the Way, The Tipping Point, Freakonomics, How to Win Friends and Influence People, and The 7 Habits of Highly Successful People. Possessing the experience and knowledge to intelligently discuss and apply both the clinical and business aspects of practice ownership will also impress your lender and increase your chances of securing loan approval.
If you take the time and effort to ensure that these three aspects of your personal and professional life are in order, you can rest easy in knowing that practice financing is readily available and you are in a great position to further your career by pursuing practice ownership.
The Importance of Building a Strong Team of Advisors
Buying a dental practice is typically a one-time event and the most significant purchase a dentist will make in his or her career. While McLerran & Associates usually represents the selling dentist in our transitions, our goal is to put together a win-win transaction for all parties involved. In addition to guiding the buyer through the process of buying a dental practice, we focus on helping the buying dentist build a strong team of advisors to obtain professional guidance on each aspect of the purchase (due diligence, purchase agreement and lease review, transition, etc.). Here is a list of advisors that we recommend a buying dentist have on their team:
- Dental Attorney – It is imperative to utilize an attorney who is experienced in handling practice transitions and understands the nuances involved with buying a dental practice. The attorney should represent the buyer’s interest in reviewing the asset purchase agreement, real estate contract and/or office lease, and any other documentation involved in the purchase. After consulting with the buyer’s accountant, the attorney should also assist the buyer with setting up the corporate entity that will be purchasing the practice. An attorney should be a deal maker, not a deal breaker, and work to protect the buying dentist’s interests without damaging the goodwill between the buyer and seller during the negotiation process.
- Dental Accountant – Hiring an accountant who is experienced in working with dental clients will also help to ensure a doctor’s success when buying a dental practice. A knowledgeable accountant should be able to assist the buyer in evaluating the practice financials, cash flow, and purchase price of the practice. They should also understand and advise the buyer regarding the tax consequences associated with the allocation of the practice purchase price and offer guidance on what type of corporate entity the buying doctor should establish to serve as the owner of the practice. The accountant’s role is not finished once the sale is complete, as they can continue working with the new owner to properly set up their financial books and put systems in place to monitor overhead and collections as well as prevent fraud and theft.
- Dental Lender – Buying a dental practice is typically contingent on the buyer’s ability to secure 100% financing for the amount of the practice purchase price. Working with a lender that understands how to evaluate dental practices and has experience in financing dental practice acquisitions can help to ensure a smooth and timely transition.
- Dental Consultant – A dental practice management consultant can help the buying dentist get “under the hood” of the practice by assisting with a chart audit and evaluating practice management systems, collection policies, treatment planning, patient base and new patient flow, marketing, etc. This analysis can allow the buyer to assess the health of the practice, identify strengths and weaknesses, and determine if the office is a good fit for them. A practice management consultant can also provide ongoing consulting during and following the transition to ensure the practice is operating efficiently.
When the time comes for you to take the step towards buying a dental practice, be sure to surround yourself with advisors who have the experience and knowledge to protect your interests throughout the transition process.
The Due Diligence Process
The process of evaluating a dental practice acquisition opportunity is often referred to as “due diligence”. Due diligence is an essential part of purchasing a practice, as it allows the buying dentist to fully examine the seller’s practice and confirm the material facts provided by the seller or practice broker. When learning how to buy a dental practice, buyers often ask us questions regarding how to go about completing their due diligence, so we offer this two-part article as a brief guide to this process.
First, let’s examine the meaning of due diligence. According to investopedia.com, due diligence is defined as:
- An investigation or audit of a potential investment. Due diligence serves to confirm all material facts in regards to a sale.
- Generally, due diligence refers to the care a reasonable person should take before entering into an agreement or a transaction with another party.
The due diligence process begins upon the buyer receiving the initial information regarding the practice and typically continues for 15-20 days following the execution of a Letter of Intent to purchase the practice. The staff and patient base are usually unaware that the practice is being offered for sale, so buyers are expected to complete their due diligence in a confidential manner and visit the practice after business hours.
There are several key areas for buyers to focus their attention during the due diligence process:
- Build a Strong Team of Advisors – As previously mentioned, building a strong team of advisors (accountant, attorney, practice management consultant, equipment rep., etc.) to assist you with evaluating practice acquisition opportunities and navigating the transition process is a crucial element to any successful practice transition.
- Practice Information, Reports & Financials – The buyer will need the following information to properly evaluate the practice: Practice Questionnaire (provided by the broker or lender), Office Lease, Fee Schedule, Accounts Receivable Aging Summary, Production by Provider, Category & Procedure Code Reports, Last 3 Years Profit & Loss Statements and/or Practice Tax Returns, and Current Year Profit & Loss Statement.
- Practice Visit – Once the buyer has reviewed the practice information and determined they have a strong interest in the opportunity, the next step is visiting the practice in person to evaluate the location, facility, equipment, décor, etc. During this meeting with the seller or practice broker, the buyer should ask any questions they may have regarding the practice information.
- Meet the Seller – Once the buyer has reviewed the practice information and visited the office, it is important for them to meet with the seller. During this meeting the buyer should get to know the seller on a personal and professional level, observe the seller’s personality, discuss the seller’s practice philosophy, review why the seller is selling the practice, discuss the seller’s involvement during the transition and following the sale, and ask the seller any questions they have regarding the practice, patient base, staff, etc. After meeting with the seller, the buyer should have a much better feel for the practice and be able to determine if the practice is a good fit for them.
- Chart Audit, Practice Management Software, Fee Schedule & Schedule – The buyer may want to pull a sample of active patient charts to review the seller’s notes, practice philosophy, and the type of treatment being provided. Some buyers will hire a practice management consultant to assist them with completing the chart audit, evaluating the seller’s fee schedule to see how it compares with other practices in the area, and reviewing the practice management reports/software to verify the information provided by the seller or broker and identify strengths and weaknesses of the practice. The buyer may also want to review the schedule to gain insight into the seller’s work flow and the historical and future busyness of the practice (particularly hygiene).
- Equipment Inspection – The buyer or a local dental equipment representative should inspect all of the equipment to ensure that it is in good working order prior to the sale. The buyer should also request a room by room equipment list, which should be included in the Asset Purchase Agreement.
- Verification of Information – The buyer’s lender will typically file a 4506 Form with the IRS to verify the seller’s practice tax returns are true and correct. The buyer may also want to peruse the practice management software to confirm the accuracy of the active patient count and other practice information provided by the broker and/or seller.
- Cash Flow Analysis – The buyer and/or the buyer’s lender or accountant should complete a cash flow analysis to confirm the practice generates sufficient cash flow to pay the overhead of the practice and the debt service associated with the practice loan while providing the buyer with sufficient personal income to cover their living expense needs. The practice broker may also provide a cash flow analysis to the buyer. Please note that a cash flow analysis may not be applicable to smaller practices that are priced based primarily upon the replacement value of the leasehold improvements/equipment and the future potential of the practice.
- Future Potential – The buying dentist should evaluate the potential for reducing overhead and/or enhancing practice revenue through decreasing expenses by switching labs or dental supply companies, increasing internal or external marketing, increasing operating hours, retaining services that are not being provided by the seller, increasing the fee schedule, etc.
- Ongoing Expenses – The buyer needs to have a firm understanding of the overhead and ongoing expenses of the practice, including the major overhead expenses such as office rent, staff, dental supplies, lab, and advertising as well as any contracts that will be assumed after the sale such as maintenance contracts, equipment leases and warranties, and advertising contracts. In addition to the monthly rental rate for the office space, the assignability and term (including options to renew) of the lease are also important considerations.
Taking a focused, organized approach to the due diligence process will allow the buying dentist to make an informed, confident purchasing decision and set the foundation for a successful transition.
At McLerran & Associates, we take in active role in helping our buyers create a strong foundation for success as a practice owner. Should you have any questions regarding how to prepare for practice ownership and the practice acquisition process or simply need a referral to an experienced dental advisor (attorney, accountant, etc.), we are here to help. We believe that our buyers are the future of our business!