This message is for dental practice buyers. Be on the lookout for Covid related income disguised as patient income or reduced overhead.
We’ve been seeing this since early to mid-2021 and we continue to see it. As we’re doing our due diligence for our buyers, we’re uncovering issues of how Covid income was reported on practice financials which should have been removed or adjusted out for cash flow analysis.
So what is Covid income? Covid income is simply income or benefits that the practice received due to the various Covid relief funds that were made available to dental practices to help them recover from shutdowns and\or payment of employee wages during Covid.
Buyers need to look for this income and ask the right questions to make sure this income is accounted for in the analysis of the practice price and performance. If it goes unnoticed and unaccounted for, the result could be a couple of years of higher practice income and\or reduced overhead that makes the practice look much more profitable than it really is. This leads to an overpriced practice!
For the most part, this income and\or benefits have been properly reported by the practices and have been properly accounted for within a seller’s financials that they (or sellers’ advisors) present to prospective buyers. However, we have found situations where proper reporting wasn’t adhered to and properly reported benefits haven’t been disclosed or even known by sellers and their selling advisors. I’ll go through some examples of situations we have seen and uncovered for some of our buyers.
- The first area is usually the easiest to identify and as noted above, generally gets reported properly by sellers and their selling advisors because it was tax free income. I’m talking about the PPP loans. Practices could have had PPP “income” in 2020 and 2021 and if it wasn’t reported properly by the seller and their advisors it could make those two years look incredibly profitable. In some cases we have discovered that this “income” was simply added to practice collections, along with all other patient collections and an unsuspecting buyer may not know to ask about this
- The next area is with the HHS funds, that’s how we identify it anyway. Some practices applied for and received Covid related HHS monies to help cover covid related expenses. These reimbursements could have ranged anywhere from $10k to $100k+ and this “income” IS taxable. Therefore, it didn’t necessarily need special reporting on an income tax return and therefore, if this income was added to patient collections, an unsuspecting buyer might not realize that the collections used to determine price are inflated. It could have also been reported as a reduction in the various expense categories like repairs & maintenance, office supplies or dental supplies. Buyers need to ask about this income if they don’t see it separately reported
- The next two areas are related to wage tax credits. By now, most people have heard the term ERC, or Employee Retention Tax Credit. The other wage tax credit was available under the FFCRA “act”. These were wage-based tax credits that employers could apply for and receive based on certain criteria that had to meet. Unfortunately, the “income” from these tax credits is somewhat hidden even though it’s been reported properly. Let me explain. The ERC tax credit is reported as a REDUCTION to wage expense in the year the credit was taken. So you could have a practice with $100,000 in actual wages paid with an ERC benefit of $25,000. When you look at the tax return and\or financials for this practice, wages will show as $75,000. This is proper reporting for the ERC tax credit. Unless the buyer knows to ask about this, practice wage expense and total overhead expense could be unusually low for 2020 and 2021 which makes the practice look more profitable. In fact, we’ve seen very few seller financials and corresponding analysis to determine price account for this Covid income. The FFCRA tax credit could have been handled in a similar way. Its also possible that this benefit was incorrectly reported when it was received in 2022 or 2023
- Finally, many states provided their own Covid relief to businesses in the form of grants, expense reimbursements, and loans that were “forgiven”. Unless they were reported separately within the seller’s financial statements and\or tax returns, we wonder how many seller advisors are really asking about this income and trying to separate it out from the patient revenue when doing their asking price analysis
Now, I’m not suggesting that sellers and their selling advisors are doing anything intentional. I just believe many selling advisors don’t know to ask the questions themselves or have asked the questions and the sellers are replying that they didn’t receive any other Covid income without knowing what it really means.
It is up to the buyer to do their own due diligence and ask these questions and ensure they get satisfactory answers. This will continue to be something buyers will need to ask about as long as they are getting seller financials for 2020 and 2021. You might think that once we get past 2021, we should be in the clear, not so! I suspect there will be CPAs and accountants of sellers reporting ERC refunds in the year the refunds were received, in 2022 or even 2023. Again, I don’t think it’s intentional, just not proper reporting. Therefore, buyers will need to ask these questions well into 2025 and even 2026 if they are including 2022 and 2023 financials in their analysis.
Buyer Beware!