How to avoid nasty surprises when buying a practice
High practice values mean buyers should be extra wary of a purchase that could become a long-term liability, says PFM Dental’s Martyn Bradshaw
There is no doubt that the values of practices are at their highest ever. Because of this, buyers need to undertake extra due diligence when purchasing a dental practice as otherwise they may find themselves committed to a 15 to 20-year liability that doesn’t meet their expectations.
There are a number of ways in which a practice should be valued but always on a multiple of profitability. The beauty of using a profit multiple is that this gives the truest representation of the potential profits going forward. The first option is to consider an “associate-led” position, where all income is met by associates (known as EBITDA). The EBITDA stands for earnings before interest, tax, depreciation and amortisation, and therefore all personal items and tax reducers are removed from the practice expenses, but an associate cost would be added in for the principal’s gross fees.
The second route is a “principal-led” model which would benefit anyone who is looking to work in the practice – a corporate style structure would not benefit from this. This is the same as the above except the principal income is left in (without an associate cost relating to this). One thing that a buyer should consider is whether they can replicate the level of gross fees that a principal is generating.
In my experience, anyone trying to do this alone, rather than getting an expert valuation (generally costing under £1,000), will probably cost themselves tens of thousands in overpayment.
Once you are comfortable that the valuation is correct, this is the most important step of all. You need to consider what profitability the practice will generate for you based on your projected turnover, any proposed changes to the practice, tax and finance costs. This will potentially be a practice that you are going to own for the rest of your career – you do not want any nasty surprises with the profits.
Let us assume that a valuation has been based on a principal-led model and the purchaser is going to replace the principal (it could even be that the buyer is an associate at the practice and they are looking at a role reversal with the principal). However, the principal generates £250,000 in gross fees but the buyer feels that they will only be able to generate £150,000 in gross fees. This would hugely impact on the profitability, bearing in mind that the value has been based on a multiple of this profit.
If, for example, the projections depleted by £50,000 and a three-times income multiple was being used, they would be paying £150,000 more for the practice (with fewer profits to repay the loan) than was estimated on the financial model. This does not necessarily mean the practice is overvalued but that, based on the price, it may not suit this particular buyer’s needs.
Partnerships (buy-ins) are where I probably see the most mistakes with people estimating values. There are a number of different partnership types and each of these would have a different valuation figure put on them. For example, if you are buying into a true profit share, which is quite uncommon, then as the profit is being split, the value of each share of the practice would be equal.
However, on the more common expense sharing routes, the partners would have a different income levels. Should the turnover be £500,000 with one principal generating £300,000 (60 per cent) in turnover and the other £200,000 (40 per cent) in turnover, the values would need to reflect the relevant percentages – as the profits of each would be different.
Once the above has been considered, it is time to put the financing in place. Approaching one bank or a local bank is not the way to go. A number of banks should be approached with a full report of the practice, your personal profile and the projections based on your circumstances. This way you can ensure that you get the most competitive interest rates.
Just a 1 per cent difference in interest rates on a £500,000 loan is an extra £5,000 in cost in the first year alone.
About the author
Martyn Bradshaw is a director of PFM Dental, which offers a number of services including dental practice valuations, accountancy, finance negotiations, finance projections and financial advice. It has offices in Edinburgh and York. Go to pfmdental.co.uk for more information.