Over the course of 2018, we were fortunate to host over 50 different businesses in our office. Some of these were private equity groups and search funds; others were established, founder-led group practices; and some were solo doctors with only one or two locations under their belt. That’s quite a variety, but they all shared two things in common…
All of them came into our office with an aggressive growth strategy in hand and each one had a large exit number in mind.
Drivers of Expectation
Let’s face it, there are a number of factors leading to the overall consolidation of the practice of dentistry, but one of the frequent catalysts to many wanting to form a group practice is what we call “the pot of gold at the end of the rainbow” scenario. Yes, there are many entrepreneurial dentists who have built successful businesses and have reaped a healthy financial reward for their success.
Notice I said, “reward for their success,” which is significantly different than saying “reward for their efforts.” Your financial reward comes from building a successful business– not just putting in a lot of time and effort.
Of the many clients who spend a day with us in our office to learn the fundamentals of group practices, most have unrealistic expectations about the business they desire to build. These unrealistic expectations can take on the form of:
- Transaction value and actual structure of the sale
- Requirements post-sale
- Strategy necessary to achieve their intended outcome
Let’s unpack these one at a time in an effort to help you create realistic expectations around what is possible and what isn’t.
Valuation and Structure
Everyone gets focused on two numbers: the total transaction amount and the multiple of EBITDA. “I want to get $20,000,000 for my business." Is that number pre-tax or post-tax? Is that number after paying off your bank loans? Is that your number – or do you have partners and it’s the number for all of you combined? The total dollar number on the transaction is “the ego number.” The more important number is the one you want to net after taxes and after debt service.
“I want to get a 10X multiple for the sale of my business.” The multiple is another “ego number.” A typical transaction can be broken down into three primary components: cash-at-close; earn-out; and equity roll. Any established DSO or Private Equity Group would be willing to pay you 10X for your business, but if it were structured in a 10-year earn-out, would that be what you really wanted? “Cash-at-Close” is the amount of money in your bank account. The more cash-at-close you receive in a deal usually means the lower the multiple the buyer is willing to pay.
From the context of the buy-side, they evaluate deals based on two things: cash flow and risk. Ask for more cash up front, then you get a lower multiple because there is more risk on the side of the buyer. On the other hand, ask for less cash up front (more deferred compensation or deferred equity), then you typically get a higher multiple because some of the risk is shifted from the buyer to you (as you are tasked with continuing to operate and grow the business you just sold). Which brings us to the next dose of reality: that very rarely, if ever, will someone buy the successful business that you built and allow you just to ride off into the sunset.
If you and your team mates built a successful business, then chances are you were instrumental in creating that success. No buyer is going to let you leave and take the chance that they can’t continue to replicate that success without you being part of the process. Again, it shifts too much risk to the buyer immediately after they just paid a premium for your business. If you want to leave immediately after the sale closes, then plan to see that reflected in a lower purchase offer.
It’s important for you to have realistic expectations about the necessity to stay on board with the new company post-sale. That being said, your role in the new company is often negotiable. Do you want to return to the chair and practice clinical dentistry? Do you want to be part of the business development team and recruit more dentist colleagues to potentially sell their business to your new owner the same way you just did? Do you want to be the person in charge of the entire business and take on the formal role of CEO?
The point here is that very rarely would any buyer pay a premium for your business, then allow you to wander off into the sunset and buy an island in the Caribbean, so don’t have that expectation as part of any liquidity event.
The third unrealistic expectation many clients have centers around the strategy to achieve their desired outcome, specifically related to time frame and growth rate. If you tell me you currently have a business that generates $2,500,000 in revenue and a 20% EBITDA margin, and your desire is to sell it for a net $10,000,000 walkaway number (after debt service and after taxes) in a matter of four years, then my reply would be: is that a realistic time frame to execute a strategy to yield the outcome you want?
Any exit number and any time frame sounds great in a vacuum, but you get paid when you execute on your strategy. The numbers don’t usually lie, so let’s reverse engineer the outcome.
If you want to “net” $10,000,000, then you probably need a transaction value of around $20,000,000 to account for taxes (~25% blended average) and debt service (~$5,000,000 for a business of that size).
If you need a $20,000,000 transaction, then it would probably be a multiple of around 7X, which means the business you’d need to build would end up generating EBITDA of around $3,000,000. At your current EBITDA margin of 20%, that’s a revenue number around $15,000,000.
Now the question for you to answer is: “How am I going to go from a business that currently generates $2,500,000 in revenue to one that is generating roughly six times that amount in only four years?” Put another way: that’s roughly an 80% compounded annual growth rate (“CAGR”).
Is it realistic for you to grow the business 80% per year for four years in a row?
If it is, then let’s get started. If it isn’t, then do you need to lower your exit number? Or do you need to extend your time frame?
The overarching sentiment here is not to get hung up on the total value of the transaction or the multiple of the sale, but to define what matters most to you and your partners in terms of three things: cash-at-close; what you want your role(s) to be post-sale with the new company; and whether or not you want an equity stake in the “new business” going forward. And when you’ve clarified those aspects, then ask yourself if the time frame you’ve set out is truly realistic to build the business that will yield the outcome you desire.
For those of us who have been involved in the dental industry for a while, I think we’d all agree that we’re experiencing some pretty remarkable times. We now live in a world of seemingly endless opportunities, but those opportunities typically require a lot of hard work to realize an intended level of success. It’s important to make sure that you define your level of success realistically or you may find yourself reaching for an unattainable goal.
When in doubt, fall back on a SMART goal: Specific, Measurable, Attainable, Realistic, and Time-bound.
If you’re interested in building a more quantifiable and realistic growth strategy or discussing your exit strategy, feel free to connect with me directly.
And if you’re still committed to that island in the Caribbean idea, then here’s a place to START...
If you’d like to learn more about our Strategic Consulting program or to discuss any other topics related to trends in our industry, please feel free to contact me at Perrin@TUSK-Partners.com. TUSK provides industry-leading resources for Group Dental Practices and DSOs. We help our clients START, GROW and SELL their Group Dental Practice or DSO. For more details, visit our website or feel free to download our Overview of Services.