The process of purchasing a dental practice can sometimes feel like a 2nd job. There are so many things to look for when evaluating whether an opportunity is the right fit for you. In this article we will try to break down the major factors to look for and to consider when evaluating a potential dental practice acquisition. To start, let’s define what “doing your Financial Due Diligence” really means. It is like a homeowner getting a home inspection done, when considering the sale or purchase of a home. In terms of a dental practice, it ultimately comes down to looking at multiple factors to determine the opportunities and challenges that practice presents to the prospective Buyer.
“Excess Earnings”
One of the key factors to calculate is “Adjusted Excess Earnings”. Excess earnings are the opportunity to earn more money by owning a practice than you could earn by working as an Associate. The potential to earn more as an owner should exceed the risks and headaches associated with it. This is the real value of ownership. To determine the “Excess Earnings” of a practice, we take the net income per tax returns and add back all discretionary and non-cash expenses, including owner salary, depreciation and amortization, automobile expense, ME&T expense, etc.; this gives us the “Adjusted Net Income”. Based on this amount, subtract the amount of money you are currently making as an Associate to determine the “Excess Earnings”. Generally, calculate the “Adjusted Net Income” for the previous 3 or 4 years to determine if the practice is trending up, down, or remaining stable.
“Basic Economics”
While calculating the “Excess Earnings” of a practice can give a perspective Buyer a good idea if ownership is worth it, that isn’t the only factor to consider when looking to purchase a practice. Supply and demand are major drivers in determining the price of a practice. In the Greater Boston Area, there are approximately 4,000 dental practices, with an estimated average 20-year turnover, which equates to 200 practice for sale per year. The supply of dental practices is relatively fixed; however, demand is generally increasing with more buyers in the market. These buyers include multi-practice owners, DSOs, and traditional solo buyers. We are seeing practices in the Greater Boston area sell for between 80% – 90% of collections, with lenders financing almost the entire purchase price.
“Practice Overhead”
Reviewing and understanding the overhead of a practice is vital in determining if the practice is a good acquisition opportunity. There are two types of overhead costs, fixed and variable. Fixed overhead does not fluctuate, such as facility expense and staff expenses. Variable overhead fluctuates with collections, such as dental supplies, lab fees, and associate expense. Generally, smaller and mid-sized general dental practices have a total overhead of about 60% and profits of 40%, however the better managed practices can be closer to the opposite. Staff expenses are about 22%-28% and facility expenses are about 4%-8% on average based on our database of 200+ dental practices. Ultimately, the buyer will adjust the overhead as they see fit, however facility costs are the toughest costs to reduce in the short-term. It is important to look overhead in the context of the whole practice, high overhead doesn’t always mean the buyer needs to cut overhead. There are other factors that could help explain the difference such as, low fees, poor collection of A/R, capacity to fill, mix and/or quantity of procedures, etc.
“Productivity Metrics”
To put overhead and collections into perspective, we calculate a variety of metrics to provide additional context. The 11 “Productivity Metrics” are as follows:
- Collections per doctor hour
- Number of active patients
- Collections per active patients
- Collections per procedure
- Procedures per active patients
- Non-diagnostic & non-preventive procedures per active patient
- Dentistry production vs diagnostic + preventive ratio
- Percent of Perio procedures vs code 1110
- Re-care efficiency
- Percent of new patients to total active patients
- Adjustments, discounts, and write-offs (percent of collections plus adjustments)
# of Active Patients:
Based on the data collected in 2019, with a high correlation of .88, the number of active patients has a significant impact on a practice’s collections. For Buyers, the lower the practice in consideration is below the trend line the better because that means there is an opportunity to increase collections based on the current patient base. For current practice owners, the higher the practice is above the trend line the better, you are getting the most value out of your patient base, and are very productive. Overall, the number of unique patients treated is a high predictor of revenue. In general, we estimate a full panel for one dentist working 4 days per week is 1,200 to 1,400 patients.
Hygiene vs Dentistry:
Comparing hygiene and dentistry production is a great productivity barometer. For general dentists, most practices produce approximately $2 of dentistry for every $1 of hygiene. For example, if a practice’s total production is $600K then $200K should come from hygiene codes (D0120-D1351) and $400k should come from dentistry. For buyers, the lower this ratio is the better the opportunity. Ideally, you want to buy a practice that has a strong hygiene department with little dentistry. This allows the buyer to increase revenues simply by performing more dentistry on the current patient base. We routinely see Sellers that are nearing retirement slow down their production and reduce their hours. This is good for a buyer because it means there is plenty of work that needs to be done.
Re-care % and Perio %:
Calculating Re-care and Perio percentages are a great indicator of patient engagement. Re-care is the percent of patients who came in for 2 exams or cleanings in that year. We calculate Re-care by taking the higher of exams (codes 0120, 0150, and 0180) or cleanings (1110 and 1120), dividing by total active patients, and then divide by 2. On average for general dental practices Re-care efficiency is around 70%. For example, the value of a 5% increase to Re-care efficiency based on 1,200 active patients is:
- 120 per year
- 10 per month
- More x-rays and diagnostic procedures
- Potential for treatment planning on these patients
Perio percentage is another important factor in determining patient engagement. A higher percentage signifies a more engaged patients base, patient base more willing to accept treatment plans, and a patient base willing to spend more money on dentistry. As a rule of thumb, hygiene makes up 1/3 of practice production and Perio codes make up 1/3 of hygiene production. We calculate Perio percentage by adding up the Perio codes (4341, 4342, 4910) and dividing by the Perio codes plus code 1110. On average for general dental practice Perio percentage is around 14-19%.
The Winning Combination:
High number of active patients + Strong patient engagement + Low dentistry per patient