Once you have a signed Letter of Intent, it’s time to take a closer look at your potential new practice. Due diligence is one of the most important aspects of preparing for a successful dental practice acquisition.
There are several important indicators that offer insight into practice performance. In this blog post, we will look at the financial side of due diligence.
Your banker is an important member of your transition team and will help with the financial side of due diligence. Because they are looking to avoid risk, they are naturally in your corner. Your success is their primary goal – when you succeed, you make your loan payments.
The first step in evaluating a practice that you think you want to purchase is to look at the finances. You should already have determined that – based on the practice prospectus – this practice could support you and your family after you pay all of the practice expenses and the bank loan. Now it’s time to double check all the figures.
Cash Flow Sufficiency: Monthly practice cash flow must be sufficient to cover practice overhead, practice loan/lease payments, and all of your living expenses. Sometimes with a smaller practice, it is advised to keep working at an associate position until practice cash flow increases. The benefit of buying a larger practice is that it should be able to meet all of your financial obligations.
So, what is sufficient? California Dentists make $164,000 per year according to the Bureau of Labor Statistics (bls.gov). That may sound good to you, or you may be looking for significantly more. The good news with purchasing a practice is that you’ll immediately start to take home a significant income (depending, of course, on the size and profitability of the practice).
Consider asking your Dental CPA to perform a “Review of Books and Records”: While the bank does a good job reviewing the practice books and records (to protect themselves), some buyers prefer to have their own CPA review the tax records, financial statements, and bank statements.
Financial Arrangements and Accounts Receivable (A/R): Review computer or manual reports that document patient payments as well as the accounts receivable percentages. A healthy A/R might be ½ of a typical month’s collections. A high A/R (over one month’s collections) might indicate poor financial arrangements. Even if you are not purchasing the A/R, doing an A/R review gives you insights into the practice.
Purchasing Accounts Receivable: Often the A/R will be included in the sale. Typically, the price for the A/R will be calculated using one or more of several popular formulas such as;
- 100% of current A/R and 50% of everything over 30 days, or
- 90% of current A/R, 80% 31-60 days, 70% of 61-90 days, 50% of over 91 days, or
- 75% of all A/R less than 90 days
Another option is to purchase the “first $____” of the A/R. This number might be 70% of the total A/R, in other words, if the A/R total is $100,000, then the A/R would be sold at “$70,000 for the first $70,000 collected”. In this example, the last $30,000 would be collected for the seller and given to the seller, once collected, for a typical 5% fee that the buyer would charge.
Property Taxes: Review the property tax bills for tangible personal property and also real property, if applicable. Personal property is anything that can be subject to ownership except land. Real property is immovable property, such as land or anything attached to the land. Bottom line: ask your tax advisor about this.
Payment Arrangement Balances: Examine any written patient financial agreements for balances due. Office policies vary drastically in this area, from verbal “agreements” (not recommended) to solid written payment plans that include interest.
Fee Schedule Review: Review the office fee schedule and compare it to typical fees in the area. IPS can help by providing typical area fees. How often does the office increase fees, and when did the last fee increase take place?
You generally don’t want to raise fees as soon as you purchase a practice – it is much better for the seller to have raised fees in the last year. However, as with so many items, this is unique for each practice. Ask your agent and other advisors about the pros and cons of raising the fees and be sure you understand how fees affect profit. I’m not kidding. Realizing that, with a 70% overhead and increasing the fees 10%, you will increase your profit by 33% … or you will make the same if you treated 33% fewer patients. (Google the Kodak Study that was done in the 80’s for more info on this).
These are some of the most important aspects of conducting due diligence on the financial side of a dental practice. If you are currently looking for a practice to purchase, please take 5 minutes to join our Inside Buyer list and be the first to hear about upcoming practices.