Everything You Need to Know When Purchasing a Dental Practice

Hey, dental associates and new practice owners. Welcome to the Associates on Fire podcast, powered by Practice cfo. This is the podcast that teaches you what you never learned in dental school, the financial side of dentistry. We cover topics from planning for ownership, buying a practice, to student loans, taxes, and all things financial for the hungry to learn Dental Associate. So let's light it up.

Welcome everybody to to another podcast of our Associates on Fire program. I'm psyched to have you join us. This podcast is going to be a little bit different. It's just me today. It's just me. Wes Reed, founder of Practice cfo, a dental CPA and financial planning firm located in San Diego that services exclusively dentists. And we serve as dentists throughout the country. And I've been doing this for about 13 years and have just, in the nature of my job, accumulated some knowledge on what the life of a dentist is, particularly around all things financial. And so here I am, imparting what I have learned and know and cataloged in my own way and in my own mind and through our own systems, how we help our dentists. And I think I've got a great subject for you today. It's one I've spent an immense amount of time in, and that is the process of buying a dental practice. Now, if you're listening to the Associates on Fire podcasts or videos, you are likely aspiring to become a practice owner. And you know, when I go to dental schools and I ask how many of you like to own a practice, most hands go up in the room. We, we have the interesting phenomenon of DSOs or DPOs or large group practices or group dentistry, however you want to call it, that are emerging, have actually been emerging for a while, but are gaining more and more ground.

And we have a lot of questions about those. We address questions on those almost on a daily basis. I'm going to save that for another podcast, but I'm going to assume that you want to own either as an individual owner or, or perhaps you want to buy into a partnership or a small group practice. If you're looking to be an employee of a corporation and not be an equity holder in any organization, then this podcast ain't for you. You're welcome to listen to all of our other podcasts and things like student loans, but this one is particularly for those who have on the horizon the possibility of stepping into ownership of a dental practice, are actively looking and don't know entirely what that process looks like. And hey, if you haven't been through it, heck, if you haven't been through it like five or ten times. You don't know all the details of what it involves because it can get a bit complicated. So we've done hundreds and hundreds of these things. So I have on our Associates on Fire website a some videos in our fuel cell number two. So if you go to www.associatesonfire.com and fuel cell one is all about the pre ownership days, things like student loans, credit score management, stuff like that. Fuel cell number two is about that sort of bracketed timeline of finding a practice, going through the process of buying it, closing on that practice and, and now stepping officially into ownership. And we have some really good content, a lot of content actually, both podcasts and videos on that specific phase in the life cycle of a, of an early stage dentist. And so I am going to just share some thoughts today and I've tried to organize these thoughts in a way that may be helpful for you for those of you who are looking to buy a dental practice. And here's what I want to talk about. Number one is your team. What does your team look like? What should you consider when you are interviewing team support? Who should be on your team as you approach an acquisition? That's number one. Number two is the analysis. What exactly numerically are you analyzing when you're considering buying a practice? I mean, you've got a lot of student loans, I'm sure you've got your own budget, you've got goals, you've got a lot of things in life with a price tag on it. And as much as I know you love dentistry and you may even be the artist type and love to do that, you gotta admit the finances can't be ignored. And for many of you, the job, the dentistry ultimately is a mean to finances, which then in turn is a mean to achieving your life goals as you define them. And so we have to look at the numbers. And there's nothing greedy about looking at the numbers. I mean, you're going to be taking on a loan, possibly a very sizable loan that the bank is going to basically own your life if you don't pay it back. So you've got to make sure that the numbers on the practice you're about to acquire make sense given all of the obligations that are on your shoulders now and will be on your shoulders once you step into ownership, because it's not easy to unwind out of ownership and debt. So that's number two. Part of this podcast is the is the analysis. Number three is what's called the due diligence and most of you, I'm sure, know what due diligence means. But that's basically you lift up the hood, you look at all the details underlying some stated value or some, some statement, some assumption to validate that it is accurate. And in this second part that I mentioned, the analysis, we're just looking at numbers that are given to us from the seller or the broker. The due diligence is, how do we know that those numbers accurately reflect the reality of the practice that you are about to buy? So you cannot ignore the due diligence. And I, I promise you, you may say, Wes, this is going to be the driest podcast ever. I'm going to try to keep it relevant and understandable for you. I think you need to understand this language at a level adequate to work with your team and to go through that process in an educated manner. And then the fourth part and the final part of the podcast is then planning for ownership, that once you get through the analysis, you get through the due diligence and everything checks out, you are ready to step into ownership. What should you be planning for? What are the immediate needs that you've got to tackle that if you don't tackle right away is really going to set you back after you do step into ownership? So let's, let's jump into this.

So buying a dental practice, your team, I would not advise anybody to go into this without a team. And who's on your team.

Pretty much always. You want a cpa, you need somebody who understands numbers. Number two, you need an attorney. Those are your indispensable team members, the non optional people you want with you through the deal. And then you have some other people. You have a practice management consultant, which I will say is.

Whether it's optional or not really, that's going to be up to you. I see most deals go through without a practice management consultant, but I will advocate for them in certain transitions. And I'll tell you why here in a moment. Also a supplier, maybe somebody you want on your side to help understand the condition of the equipment, whatnot. And then let's talk about the broker and the seller. Are they on your team? Broker is being paid for in the industry the way it is now. The broker is paid for by the seller. So at least on surface, the broker is acting in the best interest of the seller. I mean, they were hired to get the highest price possible on an open market sale. However, keep in mind that the broker is motivated for the sale to actually close because the broker in most arrangements is paid A percentage of the sale price upon close. And if it doesn't close, well, guess what? Broker doesn't get paid anything and dropped a lot of time into it for nothing in return. So brokers are motivated to get the deal done and to help both sides. But I would not look at a standard broker as going to bat for you.

That said, brokers come in many different formats, so some are just really good, genuine people. And some perhaps are just trying to get as much out of you as they can for purposes of the seller and of course their own commission indirectly.

And then the seller is kind of a unique one because I see a lot of deals where the seller really has the buyer's interest at heart. They really care about the buyer, they care about their practice. And I find some sellers are really great to work with and could be sort of relied upon as a source of information for you and guidance as you go through that process. Some sellers just want the highest price and to check out the day after it's done. So you got to measure your relationship with the seller, et cetera. And a lot of times brokers are going to try to keep you, the buyer and the seller somewhat at a distance from each other and, and have intermediaries sort of playing middleman. Attorneys will do the same thing as well. And at times I've seen that take small differences in.

Opinion on some element of the transaction and just amplify it way more than it needs to be. And deals get broken sometimes over that. It can become a very emotional experience for buyer and seller. Seller believes their practice is worth a bazillion dollars because they started it, they've been there for 30 years, it's their baby. And of course, anything associated with them is worth a bazillion dollars. And so they don't want to budge for anything and they don't want to be told that their practice actually might have a few flaws in it. Buyer, on the other hand, is saying, well, I've got to take on a debt, I'm stepping into something that is uncertain and is the goodwill actually going to transfer to me, etc. And therefore there's often a disagreement on what the real value of the practice is. That's where a good broker or a good valuation can help mediate things. Keep in mind, I will say that at the end of the day, one of the biggest drivers of the value of a dental practice is simply what banks are willing to lend on a practice. And I'll tell you in a little bit what banks look at and what they're willing to lend on a practice. But if a, if the seller does want that bazillion dollars but the bank is only willing to lend a million dollars, well that seller ain't going to get a bazillion dollars. At the end of the day it's going to be somewhere close to what a bank is willing to lend. So let's talk about the CPA and the advisor first. What is the role of the cpa? The role of the CPA is to take the numbers and package them up in a way that tells a story for you. The buyer of the financial health of that practice.

And CPAs will typically cost somewhere around either. Lowest point I've seen is zero. The CPA is just trying to do a favor so that they'll win your business and then you hire them as the CPA afterward. I've seen it go up to for a standard single office, single doctor transition, up to ten $12,000 to represent the buyer and practice CFO charges usually somewhere around four to six thousand dollars. What? That's us.

What are the differences you get in a CPA? This is sort of mission critical because some CPAs, let's start off with non dental CPAs. A non dental CPA who only has seen a few dentists doesn't even know really how to evaluate the financial health of that practice. Nor do they know how to appropriately do due diligence on fully on a dental practice. And I have seen some CPAs claim even dental CPAs I do due diligence. And what they do is they take the tax return and they look at the collection numbers, they get a practice management report, they say yeah, the collections tie out and yeah, it seems to be profitable. This looks reasonable relative to industry standards on what labor costs are. And here's what the tax return says is the profit. Yeah, go for it doctor. All checks out. Looks good to me. It's just a glance over that is not what you want to go and pay $4,000 for. You don't want to go pay, I don't know, a thousand dollars for that. What a good CPA or dental CPA really This becomes more of almost like a dental financial advisor will do is they will take those numbers and fully repackage them in a way that will tell you what are you truly going to take home to your personal bank account after paying overhead, debt and taxes. And what does that mean? How do you compare that to other opportunities you have either as an associate or other purchase opportunities? What does it mean and what are the risks associated with that and what have the historical cash flows been like for this. And, and then when they do the due diligence, they know how to look at a practice management software report, they know what labor costs should be in the industry and how to compare what are healthy budgeted overhead costs. And there's a lot more guidance, there's a lot more interaction with the attorney. There's just understanding of all the nuances of a dental purchase. And so it usually takes up just a lot more time, but it's far more thorough for that. And there are some great dental CPA firms out there that do a really good job representing the buyer. As you, as you interview firms, one thing you want to make sure is that a just find somebody who's dental. That just goes without saying to me, find somebody who's dental, has done a lot of dental or is dental specific. Secondly, ask them about their process. Do they, can they explain it? Well, what are the deliverables back to you? What questions are answered during that process of consulting you through the purchase of the practice? So that's the CPA and the advisor. It's also a great opportunity for you to sort of date that CPA or advisor to say do I like working with you or not, Are you reliable, are you responsive to me, etc. And then I know with us at practice CFO, that's also a period where we can date the dentist to say is this a good fit for us? And you say is this a good fit for me? And then if it is a good fit, you close on the practice and that CPA can continue to work with you on an ongoing basis. Let's jump to the attorney. Now the attorney I find typically cost around 5 to $8,000. I hope I'm not speaking entirely out of place, but I've worked with a lot of attorneys on a standard deal, a standard transaction where single seller is selling to a single buyer and it's an asset sale, it's usually around 5,000 to $8,000. If it's a partnership, you got a partnership formation, there's a lot more to it. I will see that sometimes between 8 and $12,000 or so. If it's a big complicated multi doctor organization, I've seen these in oral surgery groups, et cetera. You can see the costs go way up from there. But for a standard attorney, a good attorney, I think you could expect to be paying 5,000 to $8,000 and they're worth every dollar of that, assuming they are good at what they do. And there's a lot of great dental attorneys out there. The practice management consultant, this one is somewhat elective, but I like a practice management consultant to come in and look at what are the.

I'll say the, what's the clinical potential in this practice and to see how well the systems are established or how old and archaic it is, what changes need to be made to modernize it as an operating dental practice. And then also.

What are the effects of Delta Premier. Delta Premier is a problem in most states. If the seller has Delta Premier, they're getting a much higher reimbursement on procedures than you will be and you're going to have the same expenses as the seller. Delta Premier is a huge pain point for doctors, huge pain point for buyers. And sellers often don't want to lower the price of their practice because the sellers, the buyer is not going to get the same reimbursement rates for in contract Delta Premier patients afterward. And so it's really helpful sometimes to have a practice management consultant come in and dig through the practice management reports and find out what does this mean financially. The Practice is doing 1.5 million, but it's 30% Delta Premier. Well then how much of a decrease in revenue are you going to see when you have the same expense structure? And a 30% Delta Premier could end up eroding 50% of your profits just by the nature of the numbers. So I like to have a practice management consultant come in and look at that pretty closely. It's. As a dental CPA firm, it's very difficult for us with all the practice management softwares out there to go in and really isolate that number. Oftentimes we'll just use a ballpark, just as a provision to be safe about it. But if you want to get more detailed, sometimes it's great to have a good practice management consultant come in. Now, as you know, practice management consultants, consultants may come in and want to sell you on a massive plan. And that's going to be totally up to you whether you want something much more strategic, much more sort of owner train, an owner training coaching program. That will really be a personal choice. I like to say oftentimes when you come into a practice, just initially find out what the seller is doing. Great. Because you're paying for a certain amount of cash flows, let's just make sure that that cash flow remains. Therefore, let's at least replicate what the seller is doing, not shake the boat too much. And as your feet get planted, you start to have a much more crystal clear view of what the areas of need are and what the opportunities are. And then you start to roll out a plan for change. But you need to earn the goodwill and the trust of pain patients and the staff at the onset. Suppliers. I think it's a great idea to have a supplier go in, look at the equipment, the health of the equipment, maybe look at the supply costs, help you understand what those are going to be, et cetera. They can be very helpful. A lot of the dental suppliers, they're not just selling a product to you, but they can be really great sort of inside intel into that practice. So that's your team. And get the right team around you, it's going to cost you a little bit. How do you pay for it? Well, as an associate, I always tell associates you need to be setting aside some money, create some liquidity in your financial life so that you can pay for these things. If you go into what is probably the biggest transaction of your life and you don't have proper representation, you run a significant risk of getting too deep into something that you can't get out of or that takes years and years to fix. You cannot be foolish around your pennies when it comes to these big decisions. So get that team around you and then engage them. Let's go on to part two, the analysis. So in dental school, you've been taught everything clinically. If you're lucky, in your undergrad class, you took a couple accounting classes maybe, and you understand a little bit about the numbers. Well, buckle up because you're gonna have a lot of numbers thrown at you as a business owner, and it's important that you become versed in those numbers. So let's talk about the basic P and L of a dental practice. A dental practice standard, GP practice has six categories of overhead. As I define them, they are labor, supplies, labs, facility, marketing and admin. That's labor supplies, facilities, marketing and admin. And in the dental industry, each of those should represent a certain percentage of your collections. Now, I'm going to be a little bit generic here because you may be listening in many different states where the economies of a dental practice may vary, but generally speaking, GP practice, you want your labor costs to be somewhere between 26 and maybe 28%, all in payroll taxes, benefits, etc. And your supplies typically around 5 to 7%. If you have a CAD CAM, it can be lower than that. If you do very high end cosmetics, it's going to be higher than that. Your, your, that supplies, sorry, your, your labs is where they could be a little bit Lower. If you have CAD cam or do a lot more cosmetic work, labs can be all the way up to 13, 15% if you do a lot of that. If you don't your basic block and tackle dentistry and you've got, let's say a CAD cam, you could, I've seen that down to 2% for your labs. And then after labs you have your facility costs, really want to keep Your facility costs sub 9 or 10% for your lease. If it starts to get too high, 15, 20% you are eroding your profits and you are going to struggle financially. So you need to get production out of your operatories and out of your square footage. Then you go on to marketing. Marketing is a unique one because I don't really set a budget necessarily and say I want you to keep it under this. What I say with marketing is find marketing that works, that gets you a return a multiple of five, seven times your dollar and go and pay for it. Some of my biggest, most successful cash flowing practices pay a healthy dollar to marketing. But it's marketing that is working more often than not. If I saw $10 of marketing money, I would say 8 of those dollars are being tossed in the wind and we're getting nothing out of it. Two of those dollars, or maybe one out of five if I distill that down, are being used productively. Marketing is one of those things you just got to explore, find out what works in your area where that's social media, direct marketing, online marketing. Here in San Diego, some of our big practices do commercials or you do sort of these big mailers. There's different things that are going to work for your practice and you got to sort of zig and zag your way to find out what marketing works. But when it does work, be willing to pay some money for marketing. However, I would say most of my practices, even a lot of my big ones, don't necessarily pay huge amounts for marketing. They just do great treatment to their patients, their staff, the culture and environment. It just makes their patients want to refer. And that's the best marketing ever because it's inexpensive. But that said, certain types of practices, particularly when you get into big restorative work or you get into cosmetic cases, will have or need some good marketing for that. And a marketing budget could be anywhere from 0% up to 8, 9% depending on how aggressive you're wanting to go with your, with your marketing. But again, whoever you hire for marketing, keep them accountable. You have to meet with them. You have to think, what have you done for me, lately that's just the world of marketing. Otherwise you sign up for a six month program or a year long program and money's deducted out of your account. Whoever signed you up on a big sales pitch of how many leads they would get or impressions online or whatever, end up just being nothing. And you got this money going out the door and you don't see any change. The other part of marketing too, and this you cannot blame the market, is some marketers will do a great job getting patients in the door. But then if you don't do a good job once the patients are in the door to then convert them in the chair, or they call on the phone to then convert them and get them in the chair and then from there convert them to say yes to treatment they need and then from there to collect on it. That whole funnel is really the marketing program. To me, that's everything. If you can't do all of that, well then be careful paying a bunch of money to marketing, getting people to call you when your team is not able to do the conversion into the chair and the chair into dollars in your bank account. So that is, that's marketing. Then you get into administrative costs. And administrative costs are effectively everything else besides those first five categories of labor, supplies, lab facility and marketing. And things like your accounting costs, things like your phone bill, things like your travel and lodging and office supplies. All that stuff goes under the, under the category of administrative expenses. So whether you're doing your own books after you buy or you get a cpa, that's how I recommend you format your financial statements and the number that comes out of that your collections less those six categories equals your operating income. And your operating income is the punchline of the financial statements. It tells you what is my income after all of my overhead, what's my profit? And then you can compare that with the industry and it should be somewhere around 40% plus or minus 5% depending on your location. For a GP. If you're an oral surgeon, I like to see closer to 50% plus or minus orthodontists. Different than pediatric dentists. They're all a little bit different, but somewhere around 40% is what should be left over of your collections after paying those six categories of overhead. Then below that you still have stuff to pay. What do you have to pay? You got to pay yourself because you got bills. And if you're an S corporation, as you should be, then you got to pay yourself something through payroll as a W2 to yourself. You can also take draws out of your corporation. We talk about all that in our Associates on Fire videos in our curriculum. But you got to pay yourself, you got to pay your debt. Debt isn't an expense. Remember, debt is just you paying somebody back, paying the bank back. And you don't get a tax deduction for that. You do for the interest, but not the principal portion of your debt. So with that operating income, you got to pay your debt. So you got to pay, you, you got to pay your debt and then you got to pay the taxes. And there's FICA taxes and there's income taxes. There are other layers of taxes which we won't get into now, but there's layers of taxes that you got to pay. And that's why you need a good dental tax person to help guide you through that and try to limit. What is the biggest friction you've got to your financial life is taxes. And then here's one more thing, think about it, one more thing that you got to pay for your overhead, your debt, yourself, your taxes, what's left? It's your future self. You've got to be setting aside money for your future self through savings. So that is the, that, that, that's the basic financial.

Format of a profit and loss statement of dental practice. So when you go to buy a practice and we're in this initial analysis, the first thing we're doing is saying, what am I going to take home after overhead, debt and taxes. And earlier in the podcast when I said you want a good dental CPA and should be willing to pay for that person because this takes work. To get the profit and loss statement and to repackage it in a way that tells that story is one of the most important things you can do as you approach ownership. You gotta know what you're getting into. And unless you do that, you don't know what you're getting into financially. And this is called, you'll hear this term, normalizing the profit and loss statement. Normalizing the profit and loss statement. And they do, the CPA and the banks as well will do these things called add backs. And what an add back is is this. You go to Dr. Let's call him Dr. Brown. Dr. Brown is selling his practice. Dr. Brown, will you send me your P and L and your balance sheet, some of your tax returns. So Dr. Brown sends you three years of profit and loss statements. Here you go, buyer. And you take that and you look at it and it has collections at the top for the year and it's got all the expenses listed in Alphabetical order. And then it has profit at the very bottom. There is no story there because baked in there are going to be things like this. The doctor took a trip to Hawaii that cost $10,000 and was 99.9% personal, but ran it through the business because they were being a bit aggressive on their taxes. Is that a true expense to the corporation? No, the doctor is funding their personal retirement plan called a defined benefit plan or a profit sharing plan or some other type of plan. And it's $80,000 per year. Are you going to be. Is that an expense for you? No, that's the doctor funding his or her own retirement. So the Hawaii cost, that cost are going to be added back to the profit. So let's say there was $10,000 to Hawaii. There was $80,000 of a defined benefit contribution to the doctor and the doctor spouse. It's $90,000. If the profit before was $100,000, well now the profit is $190,000. So the true profit is $190,000. Some other things you got to add back are what's called depreciation. And depreciation is when the doctor is taking a deduction for buying equipment over time. And depreciation is a non cash deduction. It's just a paper deduction. They might buy the equipment, pay something. Let's say they pay $50,000 for a scanner and they will deduct that over five years through what's called depreciation. Now I won't get into the details here on depreciation, but I do have on the Associates on Fire webpage, I think this is fuel cell 3 in our accounting education. What is depreciation? You should know what depreciation is and how it works because your dental suppliers are going to be knocking on your door every year telling you to buy equipment so that you get to go depreciate that equipment. And you should understand that language. But that's another thing that could add it back to the profit and loss statement. And there's a number of things. Kids on payroll for purposes of funding their college would be added back. What add backs are personal expenses to the doctor, usually that are not business expenses and therefore should be added back to the profit. So you know what are the true profits to you? The doctor's own salary is an add back because some doctors will pay themselves very little. Other doctors will extract as much as they can out of the practice for themselves. And that should not affect the value of the practice. The value of the practice is how much Profit there is that a doctor could take out of the practice if they chose to. So you go through all these add backs, you normalize the profit and loss statement and alas, you get this view of what your income is going to be after overhead, true overhead, debt and taxes. Then you can make an educated decision. Is this a good decision? Is the amount of money I'm going to take home appropriate for my specialty, for my skills, for my needs as well? So that is in the analysis. That is the first part of the analysis. There's three parts. The first one is should I buy the practice and if so, how much am I going to take home after overhead, debt and taxes? The the second part of the analysis is if I buy the practice for that much or the second part of the analysis really is do I need to make any changes based on the due diligence? And the third part is am I ready for ownership? And so we're going to be going into those other areas. Let me talk a little bit more about.

The debt structure now. And by the way, on our Associates on Fire website we have an activity for a who we call Dr. Devlin and it walks you through this process of normalizing the profit and loss statement with add backs. It's I think a two or three page PDF of a P and L that you print out. It shows you what normally you might get from a seller. Sort of a crappy P and L doesn't tell a story. And then we walk you through. I have a video explanation that walks you through how to actually find the add backs and ultimately answer that question. What do you take home after overhead, dent, taxes? It's a fantastic exercise. I recommend every dentist going to buy a dental practice. You go through that exercise to understand that. Okay, let's talk about debt structures really quickly. Typically loans on a dental practice are 10 years fixed at the going market interest rates. Right now those are plus or minus 4%. And this is 2021, June 2021. They've been a bit lower in the past. They've been coming up just a little bit recently and I've seen them higher in the past as well. What the banks are going to look at is this one thing called your global debt coverage ratio. Now they may term that differently at different banks, but that's what they're looking for, the global debt coverage ratio. And what that means is they look at all of your debt, both the debt that they would be giving to you to buy the practice, any student loan debt, any car debt, any home debt, any debt that you have, they'll pull your credit report and they say, how many times over can the profits of this practice pay all your debt? So if your full debt payment is, let's say, per month, $10,000, I'm gonna use a nice easy number here, $10,000. They wanna see that the profits of this practice are going to produce 1.25 times that. So $12,500, 1.25 is this golden number that virtually all the banks follow with some variations to it. And within that $10,000 is your own budget, too. They sort of budget something for your living expenses. And they say, we want to make sure that there's this extra 0.25, this extra 25% of profit as a cushion so that our. So that the cash flow of this practice not only will pay 100% of the doctor's global obligations, but that there's an extra 25% left just in case. It's sort of their buffer against the risk of lending you money. So this global debt coverage ratio is 1.25. And when you're getting lending on this, most likely you're gonna find a bank that does dental lending. If you find a bank that doesn't do dental lending, they're gonna give you some funky loan with crazy terms like 5% fixed and then variable with a balloon at some point. And they want this much down. And they don't get it. They don't get it. Dentists are a very low risk to banks. And the banks who do get it have a healthcare division that specializes in this. Bank of America.

Wells Fargo, First Citizens Lendevor, now known as Provider Provide. I don't want to miss anybody out because they'll get mad at me, but there's just a lot of great dental lending. Banks out there that just do a great job at this, and they all follow a fairly similar process. So that's the debt structure. When you're doing the analysis and you're thinking about the debt, it's really important that you understand what the banks are going to be looking at. Credit scores. They're usually wanting to see somewhere north of, I think, 680, some banks will be a little bit higher, which to me is a fairly low bar. And of course, the higher credit score you have, the more it may help you in your negotiations on the rate of that loan. I prefer to see north of 750 on your credit score. Have a great video in our Associates on Fire page on fuel cell number one about managing your credit score. Check that out. All right. Now, taxes, when you're doing your cash flow analysis, you're going to say, well, Wes, what am I going to pay in taxes? Well, that's not an easy answer because there's a lot of things that go into determining what your ultimate tax liability is going to be as a practice owner. But when you're doing the analysis, just keep it simple. I would say federally plan on an effective tax rate of maybe 20 to 25%.

Of your profit. And if you're in a state like California, you got to go tack on another 8, 9% on top of that. So you could use an average of say, 30, 35 and call it a day. Yeah, you do have FICA taxes, which are about 15.3% of your pay up to a certain level on top of that. But usually I'll say, let's throw in about 30% to 35% effective tax rate. Now, you may say, Wes, I hear the tax rates are up at 37 and a half percent. Then you add on your state, you add in your FICA. How am I only paying 30%? Well, keep in mind that the initial tax bracket is zero, and then the next tax bracket is 10%. And you have all these low stairs in the progressive tax system that your early dollars of income in a given year are going to be taxed at those levels. So the effective tax rate is just your average tax rate. Eventually, if you get north of 3, $400,000 of taxable income. Yeah, now you're getting into the 28, 30, 35, 37% tax bracket. And. But it will average out to be somewhere lower than your highest bracket that you land in because not all of your income is taxed in that highest bracket. Okay, so that's taxes. Your CPA should be able to do a good job with that. The last thing I want to mention here in this first step is the price assessment. And the price assessment is important. Important. But I also believe that too often doctors will allow a belief that they are overpaying for a practice to. It will cause them to walk away from an Otherwise great opportunity. $50,000 should never, ever make or break a deal. If a dental practice is operating well, it's in the location you like. You've done your analysis on this. This thing looks good. It's got the equipment or you like it, or it's got the doctor's philosophy matches yours. There's a lot of great things about it. $50, $50,000 should never make or break a deal. That said, you should be negotiated for if you're with us, we'll negotiate on your behalf, don't get me wrong, but we're also going to try to create perspective on what should break a deal and what shouldn't break a deal. The price assessment gives you a range more than it does give you a precise, exact, perfect dollar amount of what you should pay for a practice. And the price assessment basically works like this. So practice sales are largely driven by multiples. And the multiples are what are practices down the street selling for or in your city, in your area. And they will look at a good price assessment, will say what is the, the multiple of a, of a dental practice in this area? And base the price on that. For example, let's say a practice is doing a million dollars in collections per year. A practice will typically sell for between 70% on the low end for a GP practice and on the high end up to 100%. Now, I don't see 100% very often, it's usually somewhere around 75 to 85%. And banks will lend up to 85% generally as a cap. It doesn't mean they will always lend 85% of annual collections for a practice, but they'll lend up to that as a limit. But the thing that I like to look at, and banks will also look at this, are what is the profit of the practice? Because at the end of the day, it's the profit that's going to pay back the loan, it's the profit that's going to pay you as the owner and not the collections. The collections is just a means to an end. The collections is how you get to profit. And I've seen some very large practices as defined by collections that actually have a very low take home to the doctor. And I've actually seen some practices that have a relatively low collections and have a fairly strong take home to the doctor because the overhead is so low. And the two multiples they look at are price to collections and price to revenue. Same thing. That's the one that we just discussed, looking at the annual collections and multiplying it by say 80%. So a million dollar practice might sell for 800,000. The other multiple, which is viewed less but I believe is even more important, is price to earnings. And that is the price relative to the actual earnings of the practice. And that's usually a multiple of somewhere around 2 to 2.5. So in my example of a million dollar practice, let's say it has a 60% overhead and a 40% profit margin. So the profit is $400,000 on that million dollar practice. If the price to earnings multiple is two, then that practice would sell for $800,000. Very similar to 80% of collections, the first multiple. However, if that million dollar practice has $800,000 of overhead expenses and a profit of 200,000, well then multiple of two price to earnings is 200,000 times two, that's 400,000. I would not go pay $800,000 for a million dollar practice that is only generating $200,000 net to the doctor. 20% profit margin. That's a practice that has a bloated overhead and ain't for me. It's probably got a high fixed leased cost, staff are probably paid too much, probably paying excessive perhaps on our labs and supplies, probably throw money into the marketing wind and some of that you can change and some of that you're just going to be locked into or getting out of. It is going to take time and it's going to take pain and you don't want to go pay 80% of collections for a practice with a 20% profit margin. So typically speaking, a practice that has a healthy ratio profit margin of 40% is going to be somewhere around 2 to 2.3% multiple on the price to earnings and they'll end up at the same place. But the reason why I like the price to earnings is because it takes into consideration all the other stuff on the profit and loss statement known as your expenses and a practice in. Let's look at our example million dollar practice. $500,000 of overhead, $500,000 of practice profit. A price to earnings of 2 is going to be a million dollars. In that case, I personally would be willing to buy a million dollar practice in collections per year for a million dollars. If it's truly going to generate to me $500,000 per year in profit, that's worth it. Even if the bank won't lend, the bank may cap out at 85% or 850,000. Then I got to go come up with $150,000 somewhere else or, or I need to go ask the seller to carry back the difference of 150,000 and effectively act as a bank for a second loan of that amount and I pay the seller back over time. And there's a lot we could go into on the details of a seller carryback for another podcast for another day. So now we have done the initial analysis, we understand the cash flows, we're going to buy this practice, we know what we're going to take home. We've done Our analysis on the taxes and the debt and the price seems reasonable. It's within range, within striking zone. Now we move on to the due diligence. And usually the event that transfers us into the due diligence phase is the letter of intent. The letter of intent is a legal document that you've, that you sign saying I'm going to offer this price. And here are the terms of the offer. Generally a broker will have a template. You can have an attorney draft one up for you, which is my preferred, or you can, we have on our Associates on Fire program we have a template that can be used. But my, my strong recommendation is that you have an attorney draft that up for you, which sort of begs the question, when do I start paying for an attorney? Because do I want to and maybe even a cpa? Do I want to pay for the attorney and the CPA before I've even submitted the letter of intent? Because I don't know, I'm just checking it out. I'm taking it for a test drive, but I don't want to go drop a bunch of money if I'm just taking it for a test drive. Well, that's a good question. It's a very practical question for the accounting side. You just have to, you just have to go in your relationship. You do a good interview with the cpa. I know for us, if it's a million dollar plus practice, we'll do that initial analysis at no cost because we understand the plight that you're in as an associate. Probably don't have a whole lot of money. So we'll do that initial analysis for you. And then if the numbers look strong and you put in a letter of intent, then you can formally engage us at practice. Cfo, you'll have to talk to any other CPA of how they want to do that with the attorney. You'll just have to talk to the attorney. Some attorneys may sort of give you some free help on the letter of intent just to sort of build some goodwill with you. Or it's possible that they'll just charge you hourly or a flat rate to prepare a letter of intent for you. That's really at this point the only reason why you would need the attorney. It's when you submit the letter of intent and move into legal documents and due diligence, that's when it's go time for the attorney. So perhaps you can pay them just a flat fee or something to help prepare a good letter of intent. Or practically speaking, what a lot of people do is they Just sign their, put their price on a line and sign at the bottom of a template that the broker gives to them, which obviously I'm not a fan of. But that is what happens in the industry often. So now we've crossed over into due diligence. And due diligence is made up of three categories. Due diligence number one, I call financial due diligence. Due diligence number two, I call clinical due diligence and due diligence number three, I call legal due diligence and financial. Due diligence is getting all of the financial documents that validate the financial statements we relied on in part one of the initial analysis, validating that those accurately represent the economic realities of that practice. And a CPA who does this right is going to go get bank statements for the past couple years of the business, is going to go look at the lease, is going to go look at payroll reports and is going to validate those items on the profit and loss statement back to those underlying third party documents. That is due diligence. Back in the day I worked at Ernst and Young, It's a big accounting firm. And that's what I would do every day, all day, is I'd get underlying documents and I trace them back or I trace them to the report the reported financial numbers to validate that they're accurate. So that eventually can go out to shareholders and you know, shareholders can rely on those numbers with audited financial statements. Now, the financial statements of a dental practices are never, ever, ever audited. I don't know if I've ever seen audited financial statements of a dental practice. They're too small. They're not going to go pay an auditing company a bunch of money to audit their financial statements. But that's effectively what needs to be done when you're buying a practice. Somebody needs to audit those numbers. And that's what a good due diligence is going to do, is they're going to go get those reports and validate them back. That's called financial due diligence. Then there's clinical due diligence. Generally, the CPA does not do this. This is going to be you or a practice management consultant or with you. And this is where you are going in and you're understanding the patient demographics, the amount of work remaining or unaccepted treatment. If there's, as I hear often in the industry, if there's meat left on the bone, some doctors will just take off all the meat left on the bone leading into the sale to Pump the numbers up and then you buy the practice and suddenly you got nothing to work on. And look at true active patient count, will.

Look at the equipment and the health of the equipment. They'll look at the schedule and how full the schedule is, possibly looking at just the intake system and how well trained the staff are, how well the practice operates. And then importantly, look at Delta Premier, how much of the practice is Delta Premier as opposed to Delta PPO or Fee for Service or other payers. And then help determine what is going to be the reduction in collections due to the fact that you as the buyer are not getting Delta Premier and will get instead the Delta PPO rates, which for a crown you're talking if the UCR is $1400 crown, you're going to get $600 and you're going to pay the same $400 in overhead to produce that. So it's a massive, massive reduction in the profit on that particular procedure. So the more Delta Premier, the more you may need to reduce the valuation on the practice to account for what are the cash flows that you are actually buying. Doesn't matter what the cash flows the seller had. Those are only relevant to the extent that those will be repeated when you buy the practice. Remember you're buying a subsequent cash flow, not historical cash flow. And the last due diligence is the legal due diligence. And the two primary documents that the attorney will be drafting and working through are the purchase and sale agreement, colloquially known as the psa, the purchase and sale agreement. Typically the seller's attorney will draft that and your attorney, as the buyer will what they call redline. It will go through and make adjustments and negotiate different points on it. And then the other document is the lease and the lease assignment. And if there's one thing that can really hold up a sale, it's a stubborn landlord who doesn't want to allow the seller out of the lease or allow a new buyer to come in. Now, most lease agreements will allow for an assignment, which simply means the seller can sell a business and the lease will be assigned by a buyer. But usually I still see the seller is on the hook with a personal guarantee until the end of the current lease. And keep in mind that you need a lease that usually is as long as the loan term. So the loan term is 10 years. You almost always need a lease that has at least 10 years on it because the bank wants to know that you're not going to be booted out after three years and have to go find another location when you still got seven years and most of the principal left to pay back on that loan.

So some banks will allow five years, some. And so it's important that the lease has a remaining term equal at least to the length of the term of the loan or that has an option to renew. I love a lease. Here's my favorite lease, a five year term with three five year renewals. Now that's me asking Santa Claus for the best lease. But the more, the shorter the terms and the more options to renew, the better. It just gives you more points where you can decide you want out of the lease or perhaps to renegotiate the lease. Oftentimes what I'll see though is a 10 year with a single 5 year option to renew or two 5 year options to renew. Also not a bad deal as well. Okay, that's the due diligence. And when you're doing the due diligence, you're really asking this all important question, should I adjust the price based on what I am uncovering in the due diligence process? What, what I'm unearthing here, does it make me need to change the price or do I move forward? Is everything good? Let's assume everything is good and you move forward or you adjust the price. Everybody agrees on it. Now you're getting close to ownership. The PSA purchase sell agreement just about done, you're going to sign it, seller's going to sign that the loan has gone through underwriting and you have what's called a commitment letter. Different than a proposal letter. Proposal is easy to get, you'll get that in a couple days. Commitment letter is it's been through underwriting and now it's locked. It's locked for usually 60 days or so where the bank cannot back out of that loan. It's they're committed. So you got the commitment letter, you've got the lease assignment, you've got the purchase and sale agreement. Everything's looking good, close date comes, you sign. Now what day one, you're in ownership. Well, I'm going to leave for another podcast, what I call your first month of ownership. And I have on our Associates on Fire webpage a video called your first month. What are the mission critical things financially that you need to have addressed going into that first month or during that first month. But here are a few. Number one, you need to have your corporation set up. You want to be an S corporation and your S corporation, depending on the state, can file, can be set up as an llc. It can be set up as A professional association or a pa. It can be set up as a pllc, a professional limited liability corporation. But all of those will file the same thing with the irs. It's called an S Corp tax return. All of that. So an LLC will file as an S Corp. I know that might sound a little bit confusing, but talk to your attorney. LLCs do not exist to the IRS for tax filing purposes. That's just a state legal structure. But it needs to file as an S Corp. You want an S Corp, you don't want a C Corp. Check out our videos, you'll see why S Corp. Next thing is have a good business plan. And on our Associates on Fire Resources page we have a template dental business plan. One for the associate years and a separate one for the ownership years where you address things like what am I going to do for marketing, what equipment do I need.

What kind of culture do I want to create, how am I going to get patients to say yes? Or sort of a communication program in the office. What am I going to do financially? There's all this great stuff that will guide will lead you through that thought process to make a plan for your practice. Also make sure you have before you close. And you'll need this because the banks will require require it a checking and credit card account. I am not a fan. Sorry banks. I love you guys. I'm not a fan of setting up a bunch of checking accounts. One for payroll, one for your collections, one for your savings. You don't need all that stuff. At most one checking account and maybe one business savings account. Keep it simple. You come to us with eight different accounts. We one of the first things we're going to do is we're going to close a bunch of them. We're going to simplify your structure. Believe me, as life goes on and you buy a house and you buy your practice, maybe you buy your building, you get some investment accounts, you set up IRAs, you got kids funding account for education. It starts to add up like crazy. You want to keep the number of accounts to the minimum. You need to operate as effectively as you can. Credit cards, same thing. Don't go get 10 credit cards. Get one, get one maybe, maybe two. Maybe if you have an Amex and you really need a non amex card because some vendors don't take Amex. Maybe. But keep it simple. Credentialing. Hopefully you got this started well before closing on the practice. Ideally you would have got this started a month or two before closing on the practice. Bit of a catch 22 because you don't even know that you're closing on the practice yet. So you know, play that one as it seems best for you based on the, the likelihood of you closing on this. But, but that becomes a real problem with your cash flows in the first three to six months when you buy the practice. You got to get credentialed with the insurance companies and you don't see anything coming in during that period of time. So how do you mitigate that? Well, the bank will give you a working capital amount on top of the loan. So in my example of a million dollar sale, they may give you $1.1 million and a million dollars goes to the seller and 100,000 plops right in your business checking account. And that helps you weather the dry periods. Number two is you buy the AR of the seller and the accounts receivable. Three out of four times is not bought. There's pros and cons to buying the accounts receivable. The accounts receivable is money that the seller is going to receive for treatment already performed on patients. The patient just hasn't paid yet or we haven't got the money from the insurance company. That's called accounts receivable. And you'll usually see one to two months of collections sitting in accounts receivable. And some of it's really old and you don't want to pay for that or pay a very, very minimal amount and some of it's only due from the past 30 days and you're going to pay 90% of that portion of and we have a module on the accounts receivable, how to value it, why it's discounted, et cetera. I won't go into that now. But if you buy the ar, then as the money comes in, the doctor can endorse that. You can get an endorsement stamp at the front desk and they stamp the back of it and you can go deposit that in your account and that is some money that will get you through the dry period as well. And ideally you got patients paying cash. Make sure you're front office is collecting the cash portion up front. That's really important as well. And if you're Wes's favorite practice, you're just going to buy a fee for service practice. Beautiful, beautiful thing. Rare. But you got to be bold and brave and a lot of times doctors will evolve into that over time. If I were a dentist, that would be my North Star. I would try to get out of the PPOs who make you work long and hard and you don't get Paid nearly as much, but takes a certain type of leadership, a style, a culture, marketing, etc in order to get that type of practice. Also another subject for another day. So you got your, your credentialing, your credit card, you've dealt with the, the ar, your merchant processing. You're going to be approached by every merchant processor in the world, the banks included. They all want you to, to use their merchant processing and they're going to give you some rate that's really low and they're going to try to pitch you on that. What merchant processing is is that it's that scanner, credit card scanner that patients will swipe their card into when they're paying for treatment. And the merchant processor will therefore collect from Visa, mastercard, Discover, Amex, and they'll put that money in your bank account. You'll end up paying them somewhere between 2 to 3% typically. And so you want to find one that is going to be lowered around 2%. We talk about this in our Associates on Fire program that ideally you want to find.

A cost plus plan, which is more a fixed plan than what's called a tiered plan. And I won't go into that now, but you could save some good money, particularly if you're doing a lot of credit card processing in your practice. And then lastly, just making sure that your practice management software is set up, operating right, especially if you're switching. Probably not a good idea to switch that at the time of sale. You could switch that later if you need to, or you stick with the one that they have. So that is the life cycle, that's the, that's the process of organizing your team, doing the analysis, going through the due diligence and then planning for ownership. Let me just conclude by saying in my experience working with dentists who are beloved people to me, they're a huge part of my life because I talk to them probably more than I talk to my own wife and kids every day. With dentists is there's a tendency to be consummate do it yourselfers. And I believe it's because dentists are very intelligent, they've accomplished a lot, they're great at study and research and they also have a lot of student debt and financial obligation and therefore don't have or don't want to pay for other people to do things on their behalf so that all results in them being consummate DIYers. And there are some areas where good you should be a do it yourselfer. But the thing that you have to come to understand is the value of your skill set and the value of your time is increasingly high as you come out of dental school and you start to become very proficient at what you do. And spending time, for example, categorizing transactions in a QuickBooks file or spending time trying to do the due diligence on a practice you're looking to buy is not going to be the most optimal use of that time. You don't in other words, don't underestimate how effective your skill set is and don't dilute out your ability to use that skill set by spending your or devoting your attention to other areas where you'll have to do that study and that research to become more versed in that. You could learn everything I know, everything I west read, know you could learn. I have no doubt about that. And you would learn it faster than me, probably because you're smarter than me. But that's not going to be a good use of your time to try to learn all of that when you could be out producing and leading and hiring great people and getting patients in your office and having an excellent culture. That's the stuff that turns practices into great money making machines for their for their future. Be a leader of people, manage people and you will be a great success story. Thank you for listening to this episode of the Associates on Fire podcast. A lot of good content here as always. Please refer back to associatesonfire.com I would love for you to go through the program, watch our videos, listen to our podcast. We have a short certification exam where you can become Associates on Fire certified. And if you're in certain states like California, we have CE that we grant for that as well. Thanks for tuning in.

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