Don’t Be So Quick to Turn Your Head on High Overhead

So you’re in the market looking to buy a dental practice, and you’ve seen information from brokers with summary practice information.

As you’re looking at the overhead information, you think that some of the OH stats look really low and that must be great, and some look really high, and that must be terrible, so you quickly disregard the high OH practices and move on.  Well, I’m here to tell you that sometimes the opposite is true.

The ones that appear to have low overhead may not have low overhead at all, or there’s a not so good reason the overhead is low….that’s going to have to wait for another blog. This blog is about the practice with what appears to be high overhead, which you think is bad.

Like ANY practice purchase transaction, a buyer MUST do their due diligence, and I’m here to tell you that sometimes high overhead can be a good thing.

First, higher overhead while generally not a good thing will usually generate a lower asking price. Higher overhead means lower profits; lower profits usually mean lower values. So from a buyer’s perspective, a lower price can be a good thing in terms of price.

Second, once you dive into the overhead and find out WHY it’s so high, you might learn a little more about the practice and how the owner is actually running the practice. Maybe they’re being lazy and not shopping around for the lowest cost of supplies or worse; maybe they’re letting a staff member handle all the supply ordering without any controls. Maybe they’re using the most expensive labs out there. Maybe they’ve cut back to working three days a week which can make some of the fixed expenses seem high like rent, utilities, insurances, etc. and maybe they’re still paying staff for four days per week.

Third, maybe they’re a fairly aggressive taxpayer and like to try and deduct as much as they can thru the various expense categories. Sometimes this is the hardest area to verify and confirm, other times this can be detected and verified. This is when we get to advise the buyer that the overhead will be lower under their watch.

Fourth, one common aspect of high total overhead is high labor costs. As noted above, maybe it’s because the staff is getting paid for more hours than they’re working. That can be an easy fix, just add another day of production to match the hours they’re getting paid for…assuming the patients are there to allow this. Maybe the owner has been very generous and the staff is paid at the top of the market or even above the market for the area, or the owner is paying 100% of their health insurance premium and some pension contributions. This is a little more difficult to address and will usually require a buyer to “ease” into proper compensation and benefits. Sometimes it fixes itself when the employees leave, and the buyer can replace with market rate pay.

Lastly, and the main reason for this blog, is maybe it’s because the hygienist comp is running 15% of revenue when it usually runs around 8-10%. Unfortunately, some buyers and their advisors won’t even look this deep to know exactly where the issue is. This is one reason we want to see the W-2s for each year and break them down into their departments. Many times, if hygiene wages are high it usually means the practice is generating a lot of hygiene production and you’ll be able to see this when you breakdown the production by provider. You may see hygiene production at 40% of total production when it usually runs around 25%. When you see it at 40% or more, you’ll almost always see hygiene wages greater than 10%, and that drives up the overhead percentage. It also usually means many of the other categories will be higher than the normal ranges as a percentage of revenue because there’s not enough dentistry. This isn’t always the case; however, we see it quite a bit with high overhead, high labor practice stats.

The lesson to learn here is DON’T automatically run away from a practice that appears to have high overhead. Look at some of the other stats first like the breakdown of production by provider, the specific department wage percentages to revenue and look at the schedule to see how many hygiene hours they have per week compared to dentistry hours. This information alone may provide the insight you need to pursue the opportunity and do a little more digging to see what the real deal is.

Sometimes these high overhead practices are the goldmines you often read or hear about. Good luck and happy practice hunting!

About Tim Lott

Tim Lott, CPA, CVA has decades of experience working with dentists at all stages of their careers. He is a regular speaker at study clubs, societies, and dental schools. Tim is a frequent participant and a moderator on Dentaltown.com. You can reach Tim at tlott@dentalcpas.com or any of the other dental partners/principals at (800) 772-1065 or info@dentalcpas.com. For more blogs, visit our Dental CPAS blog page.  

What Percentage of the Purchase Price should be Allocated to Goodwill?

I see this question frequently, and occasionally I get asked this question from potential buyers. I see claims made by sellers’ advisors that goodwill should be at least 80% of the total purchase price or worse, they suggest that anything lower than 80% will draw the attention of the IRS. This is just plain FALSE!

I hate to break the news to all the folks who believe that there are “standard” percentages that should be used, there aren’t! In fact, I often define goodwill for my buyers as “the difference”. That’s right; goodwill = the difference. Here’s what I mean by that.

Let’s assume you have two practices, each 4 Ops with nearly identical equipment and it’s valued at $150,000. Let’s also assume they’ll have the same allocation to the covenants of $5,000 and the only other remaining assets that need to be allocated are dental supplies and goodwill. Practice A has revenue of $1.5 mil and is selling for $1mil while practice B has revenue of $750k and is selling for $500k. Here’s the proper way to go about allocating the purchase price:

                                                            Practice A                      Practice B

Furniture and equipment                  $150,000 (15%)                  $150,000 (30%)

Dental Supplies                                     20,000                                  10,000

Covenants                                                5,000                                   5,000

Goodwill (the difference)                 825,000 (82.5%)                   335,000 (67%)

You’ll note that goodwill is listed last as it should be the last item that is assigned a value. That’s because every other asset above it should be relatively easy to value and after you’ve agreed upon the values of them, the difference goes to goodwill. Furniture and equipment can be appraised, and dental supplies can be estimated based on practice revenues. You might even see allocations for other items like net contract receivables, consulting agreements, leasehold improvements, patient charts, etc. in every case, a value should be assigned to those assets FIRST then the remainder of the purchase price is allocated to goodwill, LAST!

Technically you’ll see the definition of goodwill, an intangible asset, as the excess amount paid for a business over & above its tangible and other asset values. In my world that’s the same as saying “the difference,” it’s that simple. Statistically speaking I would agree that with the “typical” dental practice sale, 75-80% of the allocated purchase price is usually goodwill, but it’s just a statistic, that’s it.

So don’t get sucked into someone else’s world when they tell you “goodwill should be at least 80% of the purchase price of a dental practice” and any other allocation will draw the attention of the IRS. If you hear a seller’s advisor say that then you know they’re NOT being truthful with you and you have to begin to wonder what other statements they’ve made that aren’t truthful.

Written by Tim Lott, CPA, CVA. For more information on our services, please feel free to contact Tim or one of the members of the Dental CPA team by calling 844-DENT CPA or emailing info@dentalcpas.com.

There’s More to Selling Your Dental Practice Than the Price

Here is a post from Tim Lott, CPA, CVA and Ellen Dorner of NL Transitions, a Dental Brokerage firm.

Far too many times when dentists are preparing to sell their dental practice, they are focused mainly on the price and may wind up overlooking many other issues surrounding the practice sale that are just as important, some even more important than the price. That is not to say the price is NOT important, because it is; however, there are so many other aspects of the transaction.  Sometimes you need to know when to give on one issue so you can profit or benefit from another issue.

The following are some examples of different components of the dental practice sale where the seller can benefit.

• How are you handling the assets that you are including in the sale? How is the price going to be allocated among those assets?

o As a seller, do you know how the allocation is going to impact the income tax picture in the year of the sale?  It is important to have an income tax projection done to determine how one allocation may differ from another in terms of the income taxes you will pay.  If there’s an allocation that works better for you, compromising on the price may be necessary for you to benefit from that allocation.

• If you plan to stay and work for the buyer as an associate, how will you be compensated?

o Would you prefer to be treated as an employee or an independent contractor? What professional expenses do you want the new owner to cover?  These are all negotiable points and if you’re planning on staying on for at least a year, the compensation you receive might actually be more valuable to you then standing firm on a higher price.

• Will you be selling the accounts receivables to the buyer in addition to other dental practice assets?

o If so, how will they be valued?  If you’ve compromised on the price of the other assets, you might be in a better position to use that as your negotiating chip for a more favorable price on the accounts receivables.

• Do you currently own the real estate where your dental practice is located and if so, will you be selling it or renting to the new owner?

o Again, if you’ve compromised in other areas of the transaction, you’ll want to remind the buyer of the compromises you’ve made in those areas so the price of the real estate or monthly rent works more in your favor. The annual increases and/or expenses can be passed through to the buyer within the lease agreement.

So as you can see, there so many other areas that get negotiated during a practice sale.  If you are solely focused on the price of the practice, you may wind up losing a good buyer when, in actuality, the difference in the price may be made up in other areas of the transaction.  It is important to look at the ENTIRE picture and plan accordingly.

Have a range in mind for the price you’ll accept for the practice.  Also have a range that you’ll accept as compensation, a range for the value of the receivables and if you own the real estate, a range for the sales price or annual rent.  When you approach the transaction with a global view instead of just concentrating on the price, you’ll have a much better chance of success in not only selling the practice, but getting what you want from the ENTIRE package.

For more information about your situation, email Ellen Dorner or call her at (800) 772-1065. Visit our website at www.NLTransitions.com .