Thinking about Buying a Dental Practice in 2013?

In case you haven’t heard, there were some significant income tax law changes effective January 1, 2013 and for the most part, income taxes went up. Why is this important for buyers?

You see, some folks who place prices on practices will use the profit and loss reports from the most recent year. Now sometimes this isn't an issue if the practice has been fairly consistent with revenue and expenses, however, sometimes it is an issue and this year, 2013, I’m betting you might see some over-priced practices if the person generating the price is ONLY using 2012 financials.

As Certified Public Accountants (CPA) specializing in dental accounting, which means we work with a lot of dentists and their practices for CPA services like bookkeeping, accounting, tax planning, tax preparation, business management advice, etc... and 2012 was a pretty unique year.

As part of the planning process for our ongoing CPA service clients, we have to consider what the income tax rules are in the current year, the following year and sometimes even a couple years ahead as best we can. So in 2012 we had to consider that some of our clients might have the ability to pay tax on their income on tax rates that would be lower than the tax rates they might be in for 2013. In addition, some of our clients have certain types of income that might be subject to additional taxes in 2013 compared to 2012. Why should this impact a practice?

Well consider that the main source of taxable income for most of our dental clients is their practices and with some, the real estate where their practices are located. Also consider that most actually have the ability to “control” what their taxable income will be for a particular year by deferring income and accelerating expenses OR accelerating income and deferring expenses. The most common income tax strategy is to defer income and accelerate expenses, putting off the tax hit as long as possible. However, as I noted above, 2013 was one of those unique years where many were actually doing the opposite, accelerating income and deferring expenses, or,  said an easier way, taking as much income as possible in 2012 at potentially lower income tax rates compared to allowing the income to get taxed at higher rates in 2013.

So why should buyers care? If the person generating the asking price is ONLY using 2012 as their basis for practice performance, the practice income for 2012 could be substantially inflated and therefore, the practice purchase price could be substantially inflated.

Therefore, if you’re in the market to buy a dental practice in 2013 make sure you do your homework on the purchase price so you’re not paying an inflated price based on inflated practice profits.

For more information, please contact info@dentalcpas.com

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Real Life Dental Practice Purchase Case Studies

These are my top five examples of how proper due diligence can avoid the overpayment for a practice, or worse, a buyer having to claim bankruptcy!

1. Missing dental supplies – Normalization, good intentions, bad results

I gathered the information from the seller’s advisors and prepared my analysis worksheets. I noticed there wasn’t a specific category called dental supplies. That may not be an issue as they may have been thrown in with office supplies and expenses which were around 7-8% or revenue - right ? However, since office supplies and expenses run around 1-1.5% the person who did the valuation eliminated around 6% of the office supplies and expenses, adding profit of approximately $50,000 to the bottom line. So I ask two questions: the first: “why did you reduce office supplies and expenses from 7-8% down to 1-1.5%?” The reply was “because office supplies and expense are usually in that range and when we asked the seller why they were that high they said that’s the category that they run their perks through”. Fair enough, however, my next question was “so where are the dental supplies? Don’t they typically run 4-7%?” ….silence… so then I ask “isn’t it likely that the dental supplies were included in the office supplies and expenses and that’s why they’re 7-8%?” I was right and the price dropped by over $150,000 because of this one oversight!
2. Income, now you see it, now you don’t  – Poof post settlement

After gathering all the information to prepare my assessment I was comparing the annual practice management reports of production, adjustments, collections by provider and everything looked normal. Then, I compared the practice management collections to the collections reported on the tax returns and the tax return collections for the past three years were higher by at least $85,000 and $110,000 at the most. Generally the collections between the practice management reports, tax returns and profit and loss reports are different, however, they should be close and most of the times the practice management report collections are HIGHER than the tax returns, so this was strange. After asking the question to the broker, who had to ask the seller, we learn that the seller was working a day a week in another office about an hour away from his office to earn extra money. The seller did nothing wrong as they were reporting the income for income tax purposes as they should. However, the broker only used the income tax returns for their valuation (apparently) and failed to compare them to the practice management reports. Therefore, the practice price was inflated by more than $75,000 because that income would have disappeared right after settlement…at least for the buyer!

3. Prostho practice in sheep's clothing – Do the referrals even know you?


I was hired by a doctor to assess a GP practice that was doing just over $1 million per year in revenue, with overhead lower than 50% at a price of $765,000. On the surface nothing seems out of place so far. So we ask for the information necessary to assess the price and the practice performance and I begin my analysis. Right away I notice staff wages are hovering around 15-18%, strange, but great if that’s what the seller has been able to achieve in a GP practice. Then, as I’m going through the production\adjustments\collections by provider I notice hygiene production is only $90,000 on average. I then compare the staff wages and sure enough, hygiene wages are only around $35,000 annually. So I do some quick math and determine the dentistry should be around $270,000 for a GP practice of maybe $400,000 at best…so where’s the $1 million in revenue coming from? The seller does a ton of full mouth restoration work and we ask where these cases come from. The reply is through seminars and referrals from other professionals. Apparently this doctor had made a name for himself doing these full mouth cases and was getting referrals from other local GPs, plastic surgeons and ER docs that saw broken teeth accidents. Unfortunately the broker had valued the practice as though it was a GP practice without doing any analysis on the make-up of the revenue. My client really wanted this practice and against my advice they agreed to a $600k offer with $50k contingent on future revenue. I had suggested a base offer of $350k (the premium price for a GP practice doing $400k) plus $150k contingent on future revenue because I suspected the buyer would NOT see much, if any referrals from these other professionals. I was right, revenue in the first 12 months dropped to just over $750k only because part of the deal was that the seller would remain for two years to finish up some cases and help with the goodwill transfer. Revenues in the next 12 months barely topped $700k. On the upside my client didn’t get sucked into paying $765k, the downside is they overpaid at $600k and they are feeling it now.
4. Invisible perks – No double-dipping allowed!

I had gathered much of the information needed to assess the asking price for a practice before getting the valuation that was performed by the broker. After receiving their valuation report I saw that their asking price was more than $300,000 higher than the top end of my price range…which is quite unusual. So as I review their valuation report I noticed that the broker had added back to profit exactly $100,000 each year and labeled it “owner perks”. This was in addition to the correct add backs of pension, automobile, travel, ce, meals & entertainment, and other expense category normalizations. So we asked for a breakdown of the $100,000 of additional “perks” and the reply was “we asked the owner how much in perks they run thru the office and he replied well over $100,000, so we just stopped at $100,000”. Then I asked “did you ask the seller what made up the figure he gave to you? We need to see the details”. They hadn’t, however, they did after we brought it to their attention and the owner was including many of the adjustments they broker had already correctly made so in essence, they were adding back many of these expenses twice. They took the practice off the market shortly after that, we suspect because the seller realized he wasn’t going to get 95% of revenue for his practice!

5. Created profits – The tale of two offices

A buyer wanted us to evaluate an opportunity where he was offered to purchase the satellite office from a doctor who had a primary office about 30 minutes away. Our first question was if the seller kept these locations in two separate entities and the answer was yes. Great, that’s usually good news since having two locations in ONE entity can be a very complicated assessment as you have to try to separate the two locations just to evaluate one of them. initially we only got the tax returns and we saw a practice doing about $600k in revenue with expenses of $300,000, 50% overhead… that’s pretty good. They had established a price of $475,000 for this practice which seemed reasonable based on everything we saw, especially the low overhead. So as the asset purchase agreement was being drafted and negotiated we continued to ask for the practices production reports and w-2s for the staff. We finally get the information just about when the asset purchase agreement was getting finalized (coincidence you think?) so we compared the w-2’s with the wages deductions on the tax returns and the w-2 totals were higher… that’s not right. We then compared the PM collection reports with the collections per tax returns and the tax returns were higher… that’s not right. Here’s what we determined even though the seller would not admit it: 1. They were reporting some collections from the primary location into the satellite location to inflate the income. And 2. They were paying\reporting some of the satellite expenses from the primary location to deflate expenses. the result was the appearance of a highly profitable practice worth nearly 80% of revenue when it was a practice probably doing between $500k-$550k in revenue with expenses closer to $350k, 67% overhead worth maybe $300k, a price difference of $175k.

Buyers Beware! You really need to make sure you perform a thorough due diligence and if you don’t know how to do that or what to look for you could be setting yourself up for failure at worse, a very difficult road for the term of your loan at best.

For more information, please contact info@dentalcpas.com

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The Profession of Retirement from Dentistry

This is a guest post from one our earliest dental clients.

It seems to me there are a lot of things about retiring from dentistry that need to be addressed.  Having been in retirement for 2 years following 50 years of active practice in the specialty of Oral and Maxillofacial Surgery, the lesson to be learned is that one must study, prepare, and understand the "profession of retirement."  Just as we studied hard and long for our dental career, so should we prepare for this phase so that our natural desire to be helpful, caring, loving, meticulous, generous, exacting, tolerant and all things that combine to make us good practitioners, should be evident when we no longer take that journey to the office every day.

The first obvious preparation for retirement is financial.  Those of us who were fortunate enough or wise enough to have good advisers probably feel quite smug about our situation at the end of our career.  However, this is not an end, but the beginning of a new journey and in most cases, it is an unknown journey.  The use of time, the discipline of daily planning, the desire to contribute are but a few of the areas of preparation that need to be addressed and to be learned.  The financial issue is so important.  To that end, I would advise every student, young practitioner and even the mature doctor to make it mandatory to contribute to their retirement fund. It is essential that they have the best advisers that are available and willingly compensate them for their time and talent just as we were compensated for ours.  This begins with an attitude first.  Then the accountant can bring together the people necessary to reach the goals, needs, and wants that you are seeking. It is never too late to begin this phase of the journey.  What are the financial goals, what are the needs (health, insurance, family obligations) etc. that are required to give you financial stability in retirement.   If this sounds like a team effort, you are correct.  Just as we had a team in place (front desk, treatment coordinator, chair side assistant, RN, etc.) so do you need the team for retirement.  That might just be a coined phrase - The Team For Retirement. 

This begins with the accountant and extends to the banker, insurance broker, investment adviser along with other specialists as necessary in a given situation.  Then a goal is made, an end-point established and success for financial security become a reality.  It only happens with a plan and the plan must start with mandatory investment while earning power is there.  It can even start with the senior practitioner if he was not wise enough to begin in "embryo."  The first step is always the hardest, but it is the beginning to that new journey called retirement.

More mistakes made and lessons learned next time.

Dr. Donald B. Lurie, DDS

donald.lurie@att.net

phone:  717-235-0764

cell:      410-218-2228

For more information, please contact info@dentalcpas.com

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