I admit that I am a closet dummy when it comes to accounting and their Generally Accepted Accounting Principles (GAAP), the fascination of dentists with DSOs, and valuations of dental practices from individuals that don’t know the first thing about what makes a dental practice profitable in the real world. I am confounded by the “logic” of dental practice buyers as well as sellers when it comes to understanding the challenges in a transaction that will affect the rest of their careers.
I want to delve into one of the opportunities ripe for picking during this pandemic and financial recession that will follow. This window of opportunity will be with us for about 24-36 months. Just like in 2009 at the end of the Great Recession, there was money to be made and opportunities for the few wise doctors who ran their practices like a business with consistent growth and at or below a 60% overhead. They understood and followed the important numbers that create success in dentistry. As a run up to buying or selling a practice, we need to take a couple of items and be sure that you understand the significance and impact of certain accounting practices used by appraisers, banks, and equity money lenders partnered with large corporations and DSOs.
Revenue vs. Earnings
Revenue refers to the most inclusive measurement of money coming into a company. Essentially, it’s the total sum of all money paid to the company for goods and services that it provides. Revenue in not and has never been Earnings or Net Profit.
Earnings or income usually refers to some kind of measurement of net profit or loss. Net earnings of a company will be the sales or revenue minus all expenses incurred during the period. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) adds back to the earnings expense items that are not directly related to the function of the company. The term and the origin of EBITDA goes back to the mid-eighties and was invented by billionaire investor John Malone. He used this to look at distressed companies that needed financial restructuring in a leveraged buyout. Even then, it was criticized as an imperfect measure of earnings to use broadly in comparing the profitability of companies across industries. It is not used or acknowledged as GAAP (the Generally Accepted Accounting Principles).
There has been an upsurge by DSOs and brokers referring to EBITDA in multiples to value a dental practice. The equity partners that supplied the funding for these entities drove this. This misuse of the term by “dental” experts further clouds the appropriateness of using EBITDA in establishing the actual value in the dental market place. What we are looking for is Operating Income, which tells the profit after taking out all of the operating expenses. In every business except dentistry, “Expenses” would include all of the workers and actual real overhead costs of producing a product. In dentistry, EBITDA assumes that the money earned by the owner dentists is not an expense. How far off could this be? Most doctors, if I asked them “how much profit they made last year” would answer by telling me the dollar amount or the percentage of total collections they took home. The problem is that most practices make no profit. If the doctor took home 20-30% of the collections that would not be profit. It is merely the income earned by that owner doctor. Well paid, yes, but with an overhead of 70% or higher, there is no profit. That income they took home represents what you would have to pay an employee to do the same work the owner did. Profit occurs after that point. That means that you get your 25%-30% (for patient care) and there is still money (profit) left over that you also get to keep. Bingo. In most dental practices there is no E in EBITDA. Most doctors look at their Profit and Loss Statement and decide that what they took in salary, benefits, and anything left over is “PROFIT”. Let’s not forget that a Profit and Loss Statement does not include payment of debt, so, we must subtract that from what is left over to get your actual take home. Bottom line: Companies that assume “Earnings” without subtracting the cost of the owner doctor’s salary totally miss the mark. There likely is no E in EBITDA for 80% of all dental practices.
Why is this so important? It’s important because now is the time to buy, sell, and tune up your practices. We need a consistently profitable way of looking at the performance in our own practices to judge if we are going in the right direction, the performance of other practices if we are considering buying one, and the price you might shoot for if you were selling your practice. EBITDA is not that tool in understanding success and value. Acquisitions in challenging times have the greatest possibility of the highest return. While there is never perfect timing in life, expanding your existing practice and adding another practice can give you huge returns on your investment of time and money.
One of the most profitable investments you can make is in your practice. This could even extend from buying your first practice to expanding into multiple practices. One of the most consistent results of a broad economic downturn from financial or, in this case, a pandemic, is that there are always incredible opportunities that don’t even exist in the best of times. The challenge is that you have to be poised for growth, have a great consistent growth track record, be flush with your money and have the testicular fortitude to act when others are sheltering in place. In others words you need to have your house in order: Overhead of less than 63%, hygiene doing 33% of your collections, stable long- term staff, 50% of your new patients are referred by existing patients, and a consistent growth of at least 15% a year. By anyone’s definition, a really good practice. I will assume you know, but I will remind you over the next few weeks of the specific benchmarks you need to reach in order to successfully take on this strategy. The pandemic is not over, and a deep financial recession is on the way, the only certainty is that this will happen again. A word to the wise: Position yourself to take advantage when the herd mentality of most dental practices will cripple most dentists.
In a way, buying your first practice or starting one, and even adding a practice is a solid investment that can give you over a 300% return on your money. If done correctly, you can double your money in the first year. It is my belief that we will see about 10% of the dental offices change hands over the next 12 months. I believe there will be a hefty number of older doctors who just call it quits and move on to something else. Another group of owners will sell and move to being an associate in another practice. Finally, there will be those who will not make the cut, and regardless of age will lose their practices in bankruptcy.
No matter how you look at it, there are going to be deals that pop up and they are going to make some of us rich. 2009, at the end of the Great Recession, was just a preview and warm up for the Great COVID RESET. Over the next few weeks, I will try to touch on these what, when, where, and how strategies of assimilating a new office into your future plans. We will delve into the “why” of doing this as well as jumping into some of the how.
Michael Abernathy, DDS
PS. We are saddened to report the recent death of Dave Rutty after a long and difficult struggle with several health issues. Many of you knew Dave from his work with Summit as our primary consultant for many years. Always professional and well liked, Dave was truly an asset both to Summit and to the many practices he consulted with through the years. He will be greatly missed.