Prevent Premature Evacuation! by Jason Wood, Esq.

Prevent Premature Evacuation! 

When is the right time to sell your dental practice, and which buyer should you sell to?


by Jason Wood, Esq.


Do you feel burned out? Are you tired of dealing with staff? Do you feel like the weight of the world rests on your shoulders when you pull up to your office? As Cher would say: “Snap out of it!”

These negative thought patterns are what fuel doctors who make irrational career choices in the prime of their moneymaking years. I handle far too many calls on a weekly basis from practice owners ages 38–50 who are seeking my counsel in selling their practices; almost universally, I tell them, “You should not be doing this.”

Why would an attorney, who only stands to make money if someone becomes a client, spend hours per week telling doctors not to use him yet? Very simple: It would be the wrong thing for them to do from an economic standpoint, and there are unfortunately too few voices in this profession that will say this. So, when is the right time to sell? It’s a complicated question that is unique to each and every dentist—a combination of economic and lifestyle concerns, all of which need to be taken into account before you make this monumental decision. Some of the reasons people are looking to sell:
  • They don’t want to manage people.
  • Running a business is difficult.
  • They feel chained to the practice.
  • They don’t know what the future holds and want to sell when they know practice values are high.
All of the above reasons (and many more) come at a price that very few doctors actually contemplate, and can significantly harm your future if they’re not properly thought out and evaluated.

For the sake of this article, let’s assume you have a practice that collects $2 million, of which $1.5 million is doctor revenue and $500,000 is hygiene revenue. Let’s also assume you have overhead under control and your profit is 40%. Therefore, on a yearly basis your profit is roughly $800,000. (Profit is all direct and indirect consideration you receive from the practice.)

If you were to sell to a private buyer, there’s a good likelihood that in the majority of the country, you’d be able to receive $1.5 million to $1.75 million for this practice. If you were to sell to a DSO or private equity buyer, your total purchase price could be anywhere from $2 million to $3 million, based upon many variables. Seems pretty simple which party you should sell to, right? That’s your first mistake.


Practical Tip #1

Your purchase price is much less important than you think it is.
When evaluating practice sales, the purchase price you “see” on the paper is much less important than what you put into your pocket after the government, advisors and future obligations dictate what you receive.

In selling to a private buyer, you will most likely receive the entire purchase price in cash, with an allocation between 80% and 85% goodwill. That means most of your sale will be taxed at the capital gains rate, which currently is much less than the ordinary income tax rate. In selling to a DSO/private equity buyer, you will receive between 60% and 70% of the total purchase price in upfront cash, with the remainder being set aside in the form of:
  • Equity in a parent company.
  • Holdback based upon future revenues.
  • Or continued ownership in a portion of your practice.

(Every DSO/private equity group is different and these issues vary wildly, so consult advisors on the actual structure of your transition.) Usually, the upfront cash is slightly below what you would have received from the private buyer (tax allocations are usually 85%–90% capital gains); however, the equity portion allows you to participate in future growth of the company “as a whole,” which causes the purchase price you eventually receive to be higher than what a private buyer can offer.

However, this is far from a guarantee. Every single DSO/private equity buyer requires you to sign paperwork wherein you acknowledge your equity interest is “highly speculative” and “is not a marketable security.” In layman’s terms: This is a risky venture. Unlike the private buyer, this is not money in your pocket but an additional investment that you’re betting is going to make you additional money.

In addition, when selling to a DSO/private equity buyer, you also need to provide three to five years of continued employment at a compensation rate somewhere between 30% and 35% of your individual collections.

When evaluating between the two options, it appears the choice is simple. Using the higher end value referenced before:
  1. Sell to a private buyer and receive $1.75 million, minus taxes and advisor fees.
  2. Sell to a DSO/private equity buyer and receive $1.8 million in cash and $1.2 million in equity/future earnouts, plus $450,000 for five years for associate salary (30% of $1.5 million), minus taxes and advisor fees.
The problem with this analysis is that it isn’t stepping back and properly evaluating the economic model we have. The way the choice should be reviewed is:
  1. Sell to a private buyer in five years and receive $1.75 million, plus $800,000 as an owner for an additional five years before the sale. As an owner, you continue to receive preferential tax treatment in connection with your clinical production, and thus keep more money in your pocket for every dollar you make.
  2. Sell to a DSO/private equity buyer now and receive $1.8 million in cash and $1.2 million in equity/future earnouts, plus $450,000 for five years for associate salary. Your associate wages will be as an employee, which means you will make less per dollar earned because of your income being all W-2 income.
When seen through this lens—and please understand there are still many additional economic layers we haven’t discussed—the difference between the two potential buyers actually becomes significantly closer in value for the seller. If the equity portion never crystallizes into a recapitalization event wherein the equity becomes something you can sell, a doctor who sells to a DSO is significantly worse off than a doctor who sold to a private buyer.

For this reason, among others, we tell our clients it doesn’t make much economic sense to sell to a DSO/private equity buyer if their revenues are below $2 million. There is not a great enough “upside” in comparison to the risk of owning a nonmarketable security you can’t sell to anyone. There are definitely exceptions to this “rule,” but you probably aren’t the exception.


Practical Tip #2
It’s a marathon, not a sprint:
Selling too early costs you millions. If you own your practice and you still see yourself practicing dentistry for more than three to five years, you should not sell your practice, regardless of how big it is. Despite what others may tell you, the economic equations never equal out.

We all hear phrases like “12 times EBITDA” (earnings before interest, taxes, depreciation and amortization) and other outlandish figures perpetuated by people who make a lot of money off you if you sell too early. First, the reality is you very rarely if ever receive 12x EBITDA. Second, and more importantly, even if you hit such a high valuation, if you plan on working another decade as a clinical dentist, you still come up short based upon the current tax code, a concept called “time value of money,” the ability to use your excess cash flow to invest in additional income streams, compound interest, etc.

If we take the same example given above and extrapolate over a 10-year time period, the seller would have continued to make $800,000 for an additional five years. This is juxtaposed against the seller’s income of $450,000 in W-2 income the seller would have received if the seller had previously sold to a third party. That’s a difference of $1.75 million, which doesn’t take into account the large differences in taxes associated with owner vs. associate, which would cause the difference to be in excess of $2 million. This is exactly why you have so many companies reaching out incessantly to get you to sell your practice. They entice you with what appear to be gigantic numbers, but when stretched out over time against what you currently make, you end up on the wrong side of the equation.

Please understand: This does not mean you shouldn’t sell to a DSO/private equity buyer when the time is right and if your practice is big enough. However, if you don’t plan and speak to people who are going to “tell it to you straight,” it will significantly alter your earning potential over your career.


Practical Tip #3
Whom you sell to is extremely important.
Finally, the DSO/private equity buyer you choose to sell to is extremely important, and so is when you choose to sell. I cannot stress this enough! Many companies enticing you to sell have never had a recapitalization event—something these companies and many brokers trying to sell your practice to them don’t want you to know. This is a huge issue that can leave you being an employee for a large entity without ever being able to participate in those large recapitalization events you were promised.

On a parallel line to this is knowing when one of the few companies that has actually gone through a recapitalization event last executed this event. If you have two identical offers and one company just went through a recapitalization event and another one is going to go through an event in the next six months, which offer should you take? The one that’s about to go through an event will allow you to receive a return on your investment over a shorter period of time, which means your rate of return is significantly increased.


Conclusion
All of these issues and many more are extremely important when making a decision to sell or not. Knowing when to sell and whom to sell to can be some of the most important decisions of your career. The right time is clearly dependent on your individual circumstances, but the economics involved are applicable to all.

Before making this decision, speak to people you trust to help guide you in the process. Remember, talking to someone who will tell you “now is not the right time” might be the most important business conversation you have.

Author Bio
Jason Wood Jason Wood is a partner in the law firm of Wood & Morgan, and has been with the firm since 2004. He is a graduate of San Diego State University and the University of San Diego School of Law. Wood’s primary emphasis is on business transactions for dentists and doctors: leases, purchase agreements, partnership agreements, shareholders agreements, corporations, associate agreements and other business-related legal needs.

Wood is a member of Dentaltown’s editorial advisory board and a frequent contributor to Dentaltown’s online message board forums. Before joining Wood & Morgan, he worked in Washington, D.C., in connection with presidential and U.S. Congressional campaigns and for the U.S. House of Representatives, drafting legislation for various House committees.

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