I have been in the business of valuing and selling dental practices since 2007. Over that time a lot has changed.
In 2007, I joined well-established dental practice valuation and transition company. We worked exclusively with dentists to help them establish a value for their business for the purposes of either a 100% sale or for a buy-in from the associate or future partner. Our valuation process was always the same. We would request a stack of documents, including tax returns, P&Ls, historical production and collections reports, and payer by source reports. In return our client would mail us 7-11 inches of paper to wade through. We would pour all of this data into a financial model and turn it into information. Next, we would work with the doctor to establish the net income from the business then perform 7 intricate valuations methodologies and weigh each one based on various qualitative aspects of the business. It was a thorough and rigorous process that took days to complete.
After the value was established, we would then author a 50+ page book detailing the methodologies and academic theories we relied on to get to “the answer.” After all that work, the value – without fail – ended up somewhere around 75-80% of collections. Every single time.
Why was that? There are two primary reasons:
- Ability to Pay – we ran a 10-year future cash flow to show that the buying doctor would earn (on a pre-tax, after-debt basis) somewhere around $125,000 (in 2007) in the first year and show an increase each year thereafter.
- Bank’s Lending Ceiling – banks simply were not willing to lend to a dentist for more than 80-90% of value to one year’s revenue. Period. This set the artificial ceiling on dental practice valuations.
These were the two driving forces that kept values at or around 75-80% of collections. It did not matter that these businesses were selling sometimes at 2x EBITDA and other times 16x EBITDA, all that mattered is that the bank would fund it and that a buyer could live off the cash flow.
Let’s make sure we all understand EBITDA. It stands for Earnings Before Interest, Taxes, Depreciation and Amortization. It is a proxy for Operating Cash Flow, meaning it is the cash that the business provides the owner, irrespective of:
• Capital structure (debt and the accompanying interest payments)
• Taxes on sales (so we distill different tax strategies)
• The amount of fixed assets it takes to create the revenue and how quickly you are writing them off (depreciation expense)
• Goodwill from acquisitions (amortization expense - because we don’t care if you built or bought the profit)
EBITDA is the metric on which most businesses in the world are measured..
In the example above, both practices generate $1,000,000 in collections. Many brokers today would still value both of these businesses at 80% of collections, but when you look at each value as a multiple of EBITDA, it becomes readily apparent that Practice A is much more expensive than Practice B. Practice B provides the owner 7.7x ($385,000/$50,000 = 7.7x) more cash flow than practice A. It is a no brainer.
When Private Equity Groups began buying dental practices, it came as no surprise that they might have been interested in revenue but were focused on EBITDA. It was not until Private Equity-backed group practices and Dental Service Organizations (“DSOs”) entered the market when we began to see sale prices above the artificially low values of prior valuations.
Why did it take this event to move practice values up? There are two primary reasons:
1. DSOs backed by Private Equity Groups (PEGs) have access to more capital than the average dentist who is interested in buying a practice. A solo dentist is capitally constrained by what a bank will lend to them (80-90% of collections). A PEG does not have this ceiling. As a result, they can pay much, much more than the average dentist.
2. DSOs are playing a different game than a solo dentist. DSOs themselves are valued on EBITDA. Regularly, DSOs such as Aspen, Heartland, Dental Care Alliance, North American Dental Group sell at 12-14x EBITDA. So, although DSOs do not want to pay any more than they must for dental practices, financially, they can and do pay anything less than those multiples for solo and group practices. They do this because there is a financial arbitrage for their business every time they buy a dental practice for less than their expected trade value. They are not focused on how many locations a group is made of or how much revenue the business collected in the last 12 months. Their primary focus is on EBITDA.
To illustrate the point, I want to share an example of a transaction we completed in the last 12 months. Our client owned a large GP practice in the Southeast. He was the lone dentist and the business generated $2.6MM in revenue with a lean team in a rural area. He was told by a local broker to expect no more than $1.8MM (70% of collections) for his practice because buyers simply could not get a loan larger than $1.8MM due to the fact that the business simply had too much risk and was too rural to warrant a higher price.
We assured him that was not the case and worked with him to position the practice as a partnership opportunity with a DSO. He was excited about the possibility of continuing to work in his practice post-sale while giving up the managerial headaches. We took him through a marketed sales process and within 121 days his business sold for over $4.5MM (170+% of collections).
Why did this happen? Our buyer was not interested in the collections, they were focused on the EBITDA. Our client was an excellent dentist and ran an efficient business, creating a ton of EBITDA (over $800K). From the buyer’s perspective, they paid over 5X EBTIDA, which is within market range (not 170+% of collections). The buyer is likely to go to market in the coming 24 months and sell for 12-14x their collective EBITDA. In short, everyone wins in transactions like this.
So, when you are thinking about the value of your business, do not believe that it is worth some percentage of collections. It is simply NOT TRUE. To those of you who currently own dental practices, congratulations – you own an extremely valuable asset!
If you would like to learn more about Valuing YOUR Practice:
Kevin G. Cumbus is a co-Founder, Partner and President @ TUSK. He has over a decade of experience in the business of dentistry, having valued and sold over 120 dental practices and managed over $100MM of revenue in an Enterprise-level DSO.
About TUSK Partners: We’re passionate about guiding entrepreneurs to build successful businesses and exit strategies. TUSK Partners provides industry-leading resources to group dental practices and DSOs with over 70 years of combined experience. We help our clients START, GROW and ultimately SELL their group dental practice or DSO. For an overview of our services, please click HERE or visit our website, blog or YouTube channel.
**This article originally appeared in Compendium Magazine in November, 2019.