Update: Dental Practice Sales in a Post-COVID Environment

Like most dentists, we were holding our breath in April of 2020, anxiously waiting to see what the dental industry and practice transition marketplace would look like when we emerged from the COVID-19 shutdown. How long would the shutdown last? Would patients feel comfortable returning to dental offices when they re-opened? Would there continue to be demand from buyers looking to purchase practices? Will banks still be willing to fund dental practice acquisitions?

With nine months of doing business in a post-COVID world behind us and the end of the pandemic in sight, we are thankful and pleasantly surprised with how our clients and the dental industry have weathered this unprecedented event. While adjusting to the “new normal” has been uncomfortable and inconvenient, most practices have fully or partially recovered from the shutdown, and the activity level in the dental practice sales marketplace has been robust. McLerran & Associates has closed on the sale of more than 35 practices since June 2020, with most of our clients receiving the full pre-COVID value for their offices. These results are the product of the perseverance of our amazing clients in combination with the experience and expertise of our team, which has allowed us to successfully navigate these uncharted waters. This article is designed to provide you with insight into how market conditions have changed over the past nine months and what lies ahead.

Practice Valuations 
It goes without saying that dental practice valuations were impacted to some extent by the COVID-19 pandemic. However, not all practices were affected in the same manner or to a similar degree. In our experience, the primary factor influencing practice value post-COVID was not a product of an adjustment in the overall marketplace but more so how the revenue and profitability of each individual practice rebounded from the shutdown.

We are happy to report that practice values have returned to their pre-COVID levels for those offices that have fully recovered from the shutdown. For offices that have been slower to recover, we continue to be proactive in controlling the narrative surrounding pre- and post-COVID revenue trends and creative in utilizing deal structures designed to give the seller the opportunity to receive the pre-COVID value of their practice assuming revenue rebounds within a reasonable timeframe following the sale. By employing these strategies, our team is proud to say the vast majority of our clients have received the full pre-COVID value for their offices over the past nine months.

It is important to note that now, more than ever, buyers, their advisors, and lenders are paying close attention to month-to-month revenue trends, often comparing practice performance over the past six to nine months to the same period in the prior year. Moving forward, our valuations will be heavily weighted on the performance of the practice from June 2020 (or whenever the practice fully re-opened from the shutdown) to the most recent month end, and we are expecting buyers, their advisors, and lenders to follow suit. That said, it is essential that you “keep your foot on the gas” as you approach a practice sale, and update your practice financials on a monthly basis.

As has always been the case, supply and demand continue to play a major role in influencing practice value. As we will detail below, there has been a surge in demand for quality practices among private and DSO buyers over the past few months.

In combination with the low inventory of practices on the market, strong buyer demand has helped stabilize practice values following the shutdown.

Private Buyer Demand
One of the most surprising impacts of the pandemic has been the surge in demand for quality practice acquisition opportunities from private buyers. This increase in demand is a product of several factors converging simultaneously:

• 100% practice financing is readily available at historically low interest rates.
• Many “corporate” dental practices have seen a decline in productivity post-COVID-19 as patients re-evaluate their priorities (place a higher value on safety/reputation rather than convenience/cost) and seek care at established, private practices. This decline in productivity has resulted in a loss of personal income for some associate doctors, thus encouraging them to pursue practice ownership.
• The immediate cash flow and lower risk associated with acquiring an established practice has caused buyers to lean heavily toward buying a practice versus starting a practice from scratch.
• The overall performance of the dental industry during the pandemic (in combination with how quickly the industry recovered from the 2008 financial crisis) has proven that demand for dental services is relatively inelastic, meaning that consumer spending on dental services does not significantly fluctuate in the face of economic adversity. This provides further evidence that dental practice ownership is a sound long-term investment.
• The expectation that the economy will thrive in the second half of 2021 as we emerge from the pandemic and life returns to some sense of “normal”.

As a result of the increase in buyer demand and low inventory of solid practices on the market, our team has been able to procure multiple offers in record time (less than two weeks) for many of the practices we have sold over the past nine months.

As we saw prior to the pandemic, private buyer demand is the highest for dental offices with 4+ operatories, annual revenue of $600,000+, solid net cash flow, and an attractive facility with updated technology. Conversely, the demand for smaller, antiquated offices has declined substantially post-COVID, as many of the more risk averse buyers who have historically gravitated toward these types of opportunities are currently on the sidelines. Securing financing for practices with limited cash flow has also become increasingly difficult.

Practice Financing 
One of our key areas of concern during the COVID-19 shutdown was how lenders would react to this unprecedented crisis. When our team noticed that several large dental lenders were being ultra-conservative following the shutdown, we leveraged our relationships with other nationwide lenders and local/regional banks to fill the void and ensure that our doctors were able to reach a successful closing. As previously mentioned, the availability of 100% financing at historically low-interest rates has helped fuel a recent surge in buyer demand. However, the pandemic has also caused lenders to scrutinize month-to-month revenue trends and compare practice performance over the past six to nine months to the same period in the previous year. Therefore, it is critical for sellers to do everything possible to maintain productivity as they approach a sale and have updated practice financials readily available. Some lenders have also heightened their requirements in evaluating the financial health of buyers, particularly in the areas of credit score and liquidity. With lenders tightening their underwriting guidelines, it is imperative for sellers to work with an experienced and reputable practice broker who has strong banking relationships, the ability to control the narrative surrounding practice performance, and the capability to attract the level of buyer activity necessary to find a doctor who is not only a good fit for their office but also financially qualified to secure a loan.

DSO Transactions 
While McLerran & Associates is one of the largest dental practice brokers in the country from a doctor-to-doctor transaction perspective, we are also experts in DSO transactions. In fact, we have facilitated the sale of over $200 million in dental practices to DSO/Private Equity buyers over the past three years. Prior to COVID-19, the dental industry was experiencing rapid consolidation via DSO/PE buyers aggressively pursuing practice acquisitions at record high valuations. When the pandemic caused the financial backers of these organizations to tighten the reins, most DSO’s paused their growth efforts from March to September of 2020, albeit a few large, well-capitalized players took advantage of the lack of competition (among buyers) by continuing to pursue acquisitions during the final quarter of 2020. We are happy to report that most DSO buyers have resumed their business development efforts, and valuations have returned to their pre-COVID levels. In fact, the dental industry’s resilience in navigating COVID-19 and rebounding from the shutdown has led to several new DSO/ PE buyers entering the marketplace over the past few months.

When it comes to practice valuation, controlling the post-COVID narrative regarding revenue trends and EBITDA is a key factor in maximizing practice value. We have found that the professionalism in which your practice information is organized/presented and how well the financials are represented/explained to buyers is as important as the numbers themselves. DSO/PE buyers have historically based their valuations on the performance of the practice during the trailing 12-month timeframe prior to closing. If the practice has fully rebounded from the shutdown, we have been able to persuade buyers to treat the shutdown as an anomaly and remove the underperforming months from the trailing 12-month analysis (thus increasing practice value). In situations where revenue has not fully recovered from the shutdown, our team has been successful in negotiating valuations based upon 2019 operating results, with a portion of the price being assigned to some sort of COVID recovery holdback (thus providing the seller with the opportunity to recoup any value temporarily lost due to the lingering impact of COVID-19).

With so much shakeup in the financial health and pecking order of DSO buyers over the past year, new players entering the marketplace, and a resounding need to govern the narrative surrounding revenue/EBITDA, it is now more important than ever for sellers to have proper representation when navigating the process of partnering with or selling to a DSO/PE buyer. Ultimately, by having a greater understanding of the process, exploring all options available in the marketplace, controlling the dialogue regarding practice value, and creating a highly competitive environment for their practices, McLerran & Associates’ clients have realized an average increase of 20% in their practice value along with obtaining far better deal terms than if they attempted to sell their practices on their own.

Opportunities 
For the most part, COVID-19 has presented dental practice owners with many challenges and hardships that they would have preferred to avoid. However, if we were forced to find a “silver lining”, the pandemic has provided our clients with several opportunities:

• The shutdown gave practice owners some much-needed time to work on their business (rather than working in it). Many of our clients used this downtime to button up their systems/protocols and knock out some long overdue office projects (cleaning, organization, renovation, etc.).
• For our clients who have not taken more than a week off in 20+ years of practice, COVID-19 offered them the opportunity to rest, which re-invigorated their passion for dentistry and practice ownership. As a result, they are re-energized and have emerged from the shutdown more positive and productive than ever.
• For many doctors, COVID was a catalyst for reflection and re-evaluating their priorities in life. Ultimately, some of our clients decided to retire sooner than expected to enjoy life while they have their health.
• The pandemic has provided practice owners with a reason to maintain regular communication with their patients, further enhancing the doctor/patient relationship by building upon the trust and confidence that patients have in their office.
• The pandemic has caused many patients to re-evaluate the quality of their dental care (place a higher value on safety/reputation rather than cost/convenience) and seek treatment at established, privately owned practices rather than returning to a corporate office that has high doctor/staff turnover and may not be taking the proper safety precautions.
• As previously mentioned, the dental industry has successfully weathered several storms over the past 20 years (i.e. 9/11, 2008 financial crisis, and COVID-19 pandemic), thus proving that practice ownership is a sound long-term investment.
• Quite a few dentists who own smaller, antiquated offices that were declining pre-COVID have already made or will soon make the decision to sell their practices and retire (rather than adapt to the “new normal”). These sellers provide opportunistic practice owners who are not operating at 100% capacity an avenue to significantly grow their practices overnight by acquiring/merging the seller’s patient base into their existing facility. Mergers can be rewarding for both parties, as the buyer benefits from the outstanding economies of scale associated with a merger (increase in revenue with minimal increase in overhead) and provide the seller with a viable transition option (versus the formidable challenge of trying to sell their practice location as an ongoing concern).

Potential Headwinds 
At McLerran & Associates, we have an optimistic outlook on the environment for dental practice sales from both a short-term and long-term perspective. That said, there are several potential headwinds that could negatively impact the performance and value of dental practices:

1. Increase in Capital Gains Tax – The Biden Administration is expected to significantly increase the capital gains tax rate within the next two years. Given that most of your practice sales will be allocated to goodwill and taxed as a capital gain (currently a favorable rate of 15-20%), a substantial increase in the capital gains tax rate could result in a profound reduction in your net from the sale. If selling your practice is on the horizon, this issue is a compelling reason to consider closing on the sale in 2021.
2. Economic Concerns – The lingering impact of COVID-19 and the unprecedented level of monetary stimulus could cause major volatility in the health of the US economy over the next few years. Many economists agree that utilizing quantitative easing for a prolonged period to delay a recession could result in a more severe economic downturn when such an event inevitably occurs.
3. Increase in Interest Rates – Increasing interest rates will be one of the only tools available to combat future inflation that may occur as a consequence of the enormous amount of monetary stimulus enacted to soften the economic blow of the pandemic. As previously discussed, historically low-interest rates are a major factor that has fueled buyer demand over the past few years. A substantial increase in interest rates will negatively impact cash flow and likely put downward pressure on practice valuations.
4. Increase in Available Practices – With the Baby Boomer generation having reached retirement age a few years ago, we are expecting a large number of dental practices to go to market over the next five years. At that point, supply and demand will come back into equilibrium, thus resulting in a potential decline in practice values (especially for smaller practices with limited net cash flow).
5. Dental Industry Consolidation – As the industry continues to consolidate, DSO’s will continue to leverage their size to negotiate higher reimbursement rates from PPO insurers and lower pricing from vendors. In turn, PPOs and vendors will be forced to accept lower profit margins OR pass on these concessions to private practice owners in the form of lower reimbursement rates and higher prices, thus resulting in a reduction in net cash flow and practice value.

While we remain hopeful that the above headwinds will occur in isolation (or not at all), practice values could be substantially impacted should several of these factors occur in quick succession of one another. Practice owners who are considering selling within the next few years should keep a close eye on these factors and do everything possible to position their practices for success regardless of market conditions. Many of McLerran & Associates’ most successful practice sales were the product of our clients establishing a relationship with our team and beginning the planning process well in advance of the sale.

In Conclusion 
The COVID-19 pandemic has negatively impacted all our lives in some form or fashion, but the light at the end of the tunnel is finally within sight. The dental industry has proven itself to be a formidable opponent to adversity once again and will continue to thrive as COVID fades away into the rear-view mirror. We are thankful to say that the marketplace for dental practice sales is as healthy as ever, and we look forward to continuing to serve as a resource for dentists who are contemplating a transition. If you are within a few years of a practice sale, we encourage you to reach out to our team at McLerran & Associates to begin the conversation. We look forward to working with you!