Practice Sales: The Role of the CPA

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Everybody. Welcome to another edition of the Dental Boardroom podcast. We are continuing on our series on the on Dental Practice Transitions. And this is our, I think our fifth episode on the subject. And again on the show, I've got my good friend Matt Odgers, dent attorney. Welcome back to the Dental Boardroom, Matt.

Yeah, as always, thanks so much for having me, Wes.

And just a reminder that this podcast series on dental practice transitions is being posted both on my Dental Boardroom podcast, which is associated with my dental CPA and financial advisory firm called Practice cfo, but also on a separate podcast called the Dental Practice Sale podcast, which is related to a technology company called the Practice Orbit, which is centralizing dental practice sales in one location and providing technology tools and a digital ecosystem to manage very, very smoothly the sale. Okay, so on the subject today, this is, this is selfishly in my domain, which is what does a CPA do in a dental practice sale? And to do this, I'm going to turn the tables and I'm going to, I'm to hand over the host responsibility to Matt to interview me to make this a little bit more dynamic. So perhaps I'm not talking the entire time. So, Matt, lead on.

I'm looking forward to this and kind of learning a little bit more myself about the intricacies of the CPA side. I know that you guys are incredibly invaluable. And I've almost gotten to the point now where I won't take on clients that don't have a dental cpa because getting the deal done from start to finish, there's just so much on the tax and accounting side that are outside the realm of what attorneys do that we lean heavily on the CPA to come in and make sense of all that. So to begin with, Wes, I'd like to hear kind of a summary. In our last podcast, we did this on the legal side, but I'd like to hear a kind of a summary of what a dental CPA does during a transaction.

I've seen all formats or levels of involvement, maybe better said, of what a dental CPA will do when they are representing a buyer or a seller. And I'll talk a little bit from both those angles. I would say on the less involved side, and this is very common, a CPA representing a buyer will look at the seller's tax return and maybe their financial statements, eyeball it and say, yep, that looks good, doc. Go ahead and move forward with the purchase price. And they label that as due diligence. Now, I don't mean to throw Any negative comment on my peers out there who I think do a great job, But a lot of times you have somebody, especially somebody who's not don't specific, they don't really know how to assess the true economic profitability of, of a dental practice. And I have seen some dental CPAs also not really lift up the hood much. And the eyeball approach is not my favorite approach because you're going to miss a lot there. So a good dental CPA will do the following and I'll just summarize it right now and we'll go in a little bit more detail. But ideally, prior to the loi, the dental CPA is going to do an analysis on the cash flows of the seller's practice. And when I say cash flows, that's kind of an accounting or finance lingo, which means essentially how much money is coming in, how much money is going to pay overhead, how much money is going to have to pay taxes and debt? And after the transaction costs of buying this business, what are you going to take home after all of that as a buyer? And at the end of the day, the question is that it's very simple. If you buy a practice at a given price, what are you going to take home after overhead, debt and taxes? Then you can ask yourself, okay, does this make sense? Because now you've got the X ray to make this clinical decision, financially speaking, of whether or not you want to move forward. And too often I see buyers move forward in a dental practice sale without having done that analysis. And, and so really, to me, that's like taking a step in the dark. You don't know if you're going to make more or less money than you're making now as an associate with a lot more responsibility, and you're going to have the debt and therefore you're taking on a lot more risk. And your employer, you're an employer of employees, it all gets a lot more complicated. So that's the first thing that a good dental CPA will do, is that initial analysis.

Now let me jump in real quick, Wes. Is there a rule of thumb for what the cash flow should be or is it a case by case basis question?

The cash flow is going to be a function of the collections and overhead. And then the debt, if I had to say, the cash flow and the debt should have a relationship between each other. In other words, if you buy a bigger practice with better cash flow, you should expect to pay more debt. So the question becomes, after the debt payment, how much are you taking home now? Eventually after generally 10 years, that debt is paid off and you get a significant salary increase at that point or take home increase at that point. But there's not a rule of thumb. I guess I would say it depends how willing are you to take on bigger debt for a bigger practice?

Yeah, absolutely.

And if you do that successfully, your cash flow will be better. So I think that's going to be unique to the, to the goals and practice profile that a buyer is looking for. But yes, there should be a relationship between the cash flows of the practice operationally and the debt that they take on. And I would also say and their associate income, if they're an associate making $400,000 a year and then this practice after the debt is going to make them $150,000 a year. Well, I'm going to say don't buy the practice.

Yeah, absolutely.

Yeah, good question. So that's the first thing. Second thing is they do the due diligence. That's once the letter of intent is signed and once the due diligence is complete and everything checks out, then you move into practice ownership and really stepping into your first day operating a business. So let's dive into these a little bit more if I can. Matt, let's go back to the beginning on that initial analysis. The initial analysis ideally is done before the letter of intent goes in. A lot of times the letter of intent is signed just to get the practice off market and we can do it after the fact. Now we, as CPAs will do for a practice doing north of a million in collections, we will do a free initial analysis for a prospective buyer. Why? Because we want to work with you after closing as your dental CP and advisor. So it's kind of a lost leader of time for us. And in that analysis, what the CPA should be doing is getting three years of P and ls. The P and L is the profit and loss statement which shows the income from collections, the labor, labs, supplies, facility, marketing and admin costs. Those are your six categories. And then what's left. And what's left is called your operating income. And then the operating income is used to pay the doctor. It's used to pay taxes, it's used to pay debt, and it's used to fund any savings accounts for say, a house or retirement or kid's education. That should all be dissected and condensed into a very simple report for the CPA to review with the buyer to say here's what the cash flow is going to look like. So when I say cash flow, that's what it's going to look like. And then you can compare that. Let's say you're looking at three practices. You get P and LS for all three of them. You should be able to sift through the financials, format them so they're all in the same format that way compare across them. So you have an apples to apples analysis and then you can make some really good educated decisions on what's going to be the best option and what that means for you. And we call that the initial analysis. And in doing that, we're also doing incidentally a price assessment. And I will say most CPAs won't do a formal valuation. And for our listeners out there, there are valuation experts. They have the credential generally of accredited business valuation abv. And that's like a CPA or an attorney. There are formal credentials around valuation experts. Most of the CPAs that I work with are not a formally valuation certified or licensed, but they will, as we do an analysis of the price assessment and a good dental CPA should be able to right size the P and L and say, yeah, I think the purchase price is within this range. And so if the asking price is way above that range, well, you got to ask yourself as a buyer, am I willing to pay 20% more than the market value? It's no different than buying a house. Are you willing to pay a lot more than what Zillow says for neighboring houses? But that initial analysis, really vital, should be done beforehand and then if it all checks out, you move to the letter of intent. Any questions on on that first analysis, Matt?

Yeah. So when you talk about doing the cash flow analysis and you're running the numbers, are you doing that from the numbers that the seller is giving to you or are you providing any advice on changes which the buyer could make that might be advisable to get a better cash flow analysis? So say, for example, I know I've sat in on some of your meetings and I see where you have these KPI metrics where you'll say this is probably way off but you know, 5% of your revenue should go to employees or something. During your cash flow analysis, are you talking with your clients about what your recommendations are to get them more profitable or is it strictly an analyzing what the seller has operated under or is it a mix?

It is both. And I'm glad you brought that up because what you're paying for is you're actually not paying for historical profitability. You're paying for the profitability that you're going to get on day one. That's what you're paying for. Now, sometimes the profitability will change from one day to the next when you take over. For example, historically Delta Premier was an issue because the seller had Delta Premier and got paid, you know, 1300 for a crown. And now the buyer for the same patient is only going to get $600 for a crown. Well, you're paying for the $600 revenue stream, not the $1,200 revenue stream. Now, most of Delta Premier has been sort of flushed out at this, but that's a clear example. You as a buyer have to get credentialed with the insurance companies separately from the seller. So hopefully the seller's contracts will be able to be conveyed over to you at the same terms. That's not always guaranteed. Now, that's a little bit outside my scope, but point is that when we do the analysis to determine the price, we will project what is going to be the cash flow to the buyer. We use the seller's historical P and L information to start, but we do a forecast of what it's going to be and then we determine the purchase price off of that. You following me on that, Matt?

Yeah, yeah, absolutely.

And in doing that, what you're all automatically doing is you're staging the mindset to be thinking about the future. So to answer that question, we do in the forecast, we'll run scenarios, I like to call them best case, worst case scenarios. What happen, doc, if you get in there, new blood, new energy, new hunger, and you grow this practice 10% over the next five years, what's that going to look like to you? Well, certain costs will go up, like labs and supplies. Certain costs will stay the same, your debt will stay the same, your taxes will go up. And you do that analysis to say, what is that going to mean to you as a buyer? Well, what happens if you get in there and just chaos ensues and you have staff that go AWOL and you lose your hygienists? Maybe there was a key associate who leaves, whatever. And so you see a 20% decline year over year for the first two or three years. What does that look like to you? And so we have a tool where you basically plug in the scenario assumptions and it will forecast out the cash flow and factor in taxes in that cash flow. So we have a really keen understanding of what the range of profitability could be to the buyer. And always in those conversations, we start talking about some marketing, we start talking about the labor costs, we start talking about debt? What equipment is going to be needed? Are we going to buy a CAD Cam? In the practice, all those things invariably do come up. So it's an interesting combination of both analysis for the purchase price, reasonability, but also for how do we just step into this thing, hitting the ground running as a business owner. Yeah, I love that question, Matt.

Yeah, absolutely. Do you consider that as part of the due diligence or is due diligence something that's completely separate on CPA's side?

Yeah, I like that question because I want to emphasize this term due diligence. In the industry, banks require that the buyer has financial due diligence done. And what is due diligence? Let me just define that. Financial due diligence is validating that the collections and overhead is true based on the P and L that's presented to you. Most people have heard of the term cook in the books. You know, back in the day when I was in college, you had Enron and you had WorldCom and you had these big frauds that took place. And let me tell you, it's extremely easy to go into QuickBooks or any accounting software and just make up some fake transactions. Yeah, I had an extra collections of $50,000 in June and $80,000 in August. Sure. You know, you can book that really easily and then present a financial statement that's looking amazing, but it's not accurately reflecting the economic reality of that practice. So due diligence is getting supporting documents to validate the accuracy of the P and L. What do we get? So let's talk about due diligence. Then. I'm going to answer your question. We get the bank statements usually for a year or two. And on the bank statements you can literally look at the first page and see what were the total deposits. Now, generally speaking, the only deposits going in a dentist business bank account are collections from insurance companies and the patients. Every once in a while they might put in some money from their personal account or there's some other deposit in there. And usually you can find those and sift them out. But you want to validate. Once you add all of those deposits up per the bank statements. Because the bank statements is real. That's real money hitting the bank account. You add it all up for the year. It should approximate what the P and L states. And in every bank statement, we'll look to see if there's a big even dollar contribution of like 30 grand. Because I'm going to say, okay, seller, what's that $30 contribution that happens to Be a perfectly even big number. And the explanation either is going to be, well, that was a large deposit from a big case I did. Okay, great. Maybe I'll even ask for some patient records or. Yeah, that was me putting in some money for xyz. Well, if that's money they put in, it's not collections. We sift that out, that's not collections. And we don't want to pay for that as a buyer. So that's. That's collections. The two other, we really only validate two items on the expense items on the P and L. We validate labor, which is by far the biggest expense. And we do that by looking at payroll reports and W2s. And we can tie this thing called the W3, which shows your total W2 summed up. We can take the W3 and compare it to the profit and loss statement labor expenses to determine whether the labor is accurately reported. Then the facility cost is another big one. We can just look at the lease agreement to see if the facility costs are accurately reported. Supplies and labs, I don't worry about, because we know that supplies and labs are generally going to be in a certain range and the buyer can just pay whatever they want to to their own supply and lab company. So we don't really do any due diligence on supplies and lab. Same thing with marketing. That's going to be what the buyer wants to do. Same thing with things like phone bills and paying their CPA and maybe their own travel or education cost. We don't validate those things because the buyer has total control over what they want to do with those types of expenses. So that's called due diligence. Banks require it. And generally speaking in the industry, CPAs provide one purpose and that's it. And I would say that's your baseline. Now, I rarely see a CPA actually get all those documents, put them in Excel, tie them out, provide a report, a PDF that shows the tie out and says, yep, this buys off, the due diligence is done. Go ahead and sign off. I don't see that very often. I usually see just people eyeballing it and calling it a day. So I would say if you hire a cpa, ask them to give you a due diligence report showing the work that they did. But more broadly speaking, a good CPA is going to go beyond that and start doing business consulting for the buyer.

Now, real quick, before we go into the business consulting, Wes, how do tax returns play into the. What you just finished talking about? Is there a. Because I know as a seller you want to be paying as little in taxes as possible. So it's not always a clear snapshot. Do you take that into consideration or do you just. Is it just one last thing to check to make sure there's nothing out of line?

The tax return. I do get the tax return, and here's why. A seller is motivated to have a very high profitability on the profit and loss statement. Because guess who doesn't get the profit and loss statement? The irs. What does the IRS get? They get a tax return and the profit and loss data does transfer into and make up the tax return. But it is very possible that a doctor will beef up the P and L and then beef down, that's even a word, the tax return, in order to have the best of both worlds. Oftentimes the tax return is more reflective of what's really happening economically in there. So I will use the tax return as another angle to validate the data on the P and L. If they're showing dramatically different collection or expenses than the P and L, I'm going to start asking some questions as to what. Why? That's the primary reason. Sometimes I will look at, if I'm representing a buyer, the seller's, what's called Schedule L, which shows their assets and their depreciation on those assets. This gets a little technical. I'll keep it light. But one of the important aspects of the CPA's role is to guide the seller and the buyer on what is an allocation of the purchase price to the assets that are being bought and sold. And a seller wants to have as much of the purchase price allocated to goodwill. Now, I'm generalizing a little bit here. Every case needs to be looked at by the CPA, but sellers want everything allocated, ideally 100% to goodwill. Why? Because goodwill is taxed at the lower rate, called capital gains rate. At the federal level, at the state, it's usually the same. And so if the seller is in a 37% high tax bracket for income taxes, the capital gain tax rate for that seller is going to be 20%. So you're saving 17% on whatever is allocated in the purchase price to goodwill. Now, the buyer, it's the opposite. The buyer doesn't want goodwill because goodwill is deducted as a tax deduction over a longer period of time, 15 years. If 100% of the purchase price was for the purchase of equipment, meaning it was all allocated to equipment, this tangible asset like chairs and X ray machines and furniture and all that stuff, then the Buyer gets to deduct that over five years. And again, in all of this, I'm making a few generalizations here. There are nuances to this. And tax dollar saved today is worth more than that same tax dollar saved in 15 years because of inflation. So buyers want to get more tax deduction earlier and not have to wait so long. And so one of the things that we'll do as a cpa, if I'm representing the seller, is I try to allocate the price to what I call the ideal, which is what is the allocation that keeps the most money out of the IRS hand and the most money in the buyer and seller's pockets. I call that the ideal. And then I work from there one direction or the other. But usually the ideal is pretty close to where we want it to be. It would get way too technical if I talked how you arrive at that ideal. There's things called depreciation recapture from the seller side and some other nuances in there. So I'll stay away from that. But that's one of the key features that we do. And the tax return, going back to your question, gives us some insight into what might be the ideal allocation of the purchase price for the seller.

Okay, that kind of sounds like the bare minimum of what needs to be done from a cpa. And earlier you started talking before I interrupted you. But it's the side that I'm really excited about, which is learning about what the kind of the business decisions that need to be made and how you as a CPA can step in and kind of help on that front and what you guys do.

Yeah, I would say the bigger mission actually isn't the due diligence and the price allocation. That's the baseline.

Yeah, yeah.

But the bigger value proposition, I'll say for a CPA to. I'll start off with the buyer is coaching them, educating them, giving clarity to what all of this means. Coordinating with the bank, coordinating with the attorney, and even coordinating with the broker if there's a broker involved, such that the buyer feels like they have an advocate walking them through this relatively complicated transaction, number one. Number two is now that we're approaching closing and you're about to be a business owner, how do you do that feeling confident. So we make sure we have the right checking a credit card account set up, the right payroll company and payroll process set up. We start talking about getting the accounting in place because you want good reporting to understand your numbers every month. We start talking about what's the goal? Start setting collection goal for the year. Now, we're not practice management consultants, so we don't go. CPAs aren't going to go into the practice and talk about scripting or marketing and that kind of thing. But as a CFO for that's the way I view it, we sort of act as this, you know, part time CFO to help the doctor make these strategic financial decisions that I think is the most valuable now to a seller. Sometimes it's a little bit more. It's simply how do we reduce your taxes on the sale of your practice and what other financial implications do you have moving out of ownership? And if some CPAs might get a little bit more involved in the financial planning aspect, which we do at practice, cfo, we will say, how much are you going to net after taxes and overhead, I'm sorry, taxes and debt on the sale and is that enough for you to pivot into retirement or that next step? Ideally that should be done before they list their practice so they know whether or not they're ready. But that's also what a good CPA I think will do for the seller. Generally, though, for sellers, they don't recruit their CPA very much other than they just sort of buy off on the price allocation. That's generally what I, what I see. But for the buyer, the CPA becomes much more important because of the due diligence and the general coaching that I think is needed.

Yeah, oh, absolutely. Now what do you do in a situation where a seller's books might not be in order or where their taxes haven't been completed yet and they reach out to you for the first time when they have a buyer in mind?

Great question. You cannot sell your practice.

Unless you have a set of numbers that allows other people to rely on to make decisions around buying your practice. For example, a bank, this is probably the biggest example. A bank is never going to lend to a buyer unless they can see the story behind your financials as a seller. And so if the books aren't done, I'm going to tell a seller, hey, we got to get some clean books here. And depending on how clean their books are, and I've seen some.

Really poor books or even books that haven't even been done for nine months. At the end of the day, they got to be done because they have to file the tax return every year. So you need something there, but you're going to clean up the books, have something to present first. Yep.

Yep. Good question. But.

On the seller side, I think a seller should start anticipating their sell. Ideally three years plus before they sell. Because you really want to hit a high note when you list your practice. And so engage a good cpa, not just at the time of sell. I mean, everyone's got their accountant. But have a CPA start to window, dress your practice, give you some consulting on how to get your numbers looking great and format it great so that when you list your practice, you've got something really appealing out to the marketplace.

So earlier, Wes, you mentioned that you guys provide a free purchase price analysis, not a valuation, I took that away. But a general idea of what a fair price would be based on the cash flows. But what should a buyer expect when it comes to the fees for the due diligence side of it during the transition? And then do you stay on and help them in their practice? I know the answer to that is yes or that's the goal. And what does that look like as far as costs? Or what should dentists be? What questions should they be asking whoever they're interviewing?

Yeah, you got it. I have seen a range and the range usually is no cost by the cpa. And all the way up to, I think the highest I've seen is around $10,000 to represent a buyer through the purchase of a practice. The CPA who charges zero, you're probably not going to get a whole lot of involvement from that cpa. That's the CPA who's going to eyeball the seller's documents and then just give you a general comment about whether or not it looks reasonable. We charge a practice CFO, to give you an example, we charge $5,000 to represent the buyer. We charge zero to do the initial analysis, assuming the practice is more than a million dollars. And the reason why I say that is practice CFO is not a good fit for a practice doing under a million dollars. Generally speaking, because we're a more involved service as a cfo, we go beyond bookkeeping, beyond accounting and beyond tax to really provide proactive CFO style advice. And so since we, this is really, it's an engagement period for us with a buyer to see if a do we really enjoy working with this particular doctor and does this doctor enjoy working with us? So the rings are on in a way. So we do charge because we put a lot of work into it. We generally don't make much of a profit off of it. It's a way for us to start connecting in relationships and having longer term CPA CFO relationships. After closing, we charge $5,000 and half of that is due at the LOI and half of that is due upon closing. If the doctor ends up not moving forward with that practice, the second practice, we help them with the first $2,500 is credited against that second practice. So it's only $2,500 on that second practice and any subsequent practice after that. The initial analysis, like I said, will be free. So the doctor knows whether or not they should even invest any money in an accountant and an attorney, CPA and an attorney to move forward.

Yeah. And then so after the closing, what does your relationship look like with the buying dentist? What services do you guys do and how does that look?

What I would answer that is generally. And then us at practice cfo, generally speaking, the CPA will continue to do the accounting and to do the tax work for the buyer and for us. We do the accounting, we do the tax work. But additionally. And the most important thing we provide are regular CFO meetings with our clients. And so we usually meet three to four times during the year. Each meeting is usually two to three hours. And we're covering a review of the P and L. We're forecasting taxes, we're forecasting cash flow, and overall, just giving guidance around all of the doctor's financial ecosystem as their business and personal cfo. So that's really why we exist. We love to help doctors do personal and business financial planning and the accounting of the tax and the payroll. That's just an X ray. That just gives us the X ray to then sit down and have these really great rich clinical meetings around their money which result in a set of action items that we all work on until the next meeting. So Here at practice CFO, we do have an accounting department with about 20 people. We have a tax department with about 7 people, a 401k department with about 5 people. And then we have 10 advisors who are the ones doing the client facing meetings throughout the year as an outsourced cfo, who then coordinate or liaison between the dentist as our client and those other groups within our company to make sure that the overall game plan is rolling forward in a very cohesive manner.

Okay, excellent.

So that's a little bit of a sales pitch right there for practice cfo. Thanks for teaming me up on that one.

No, no, I think it's all good information because, you know, I think it's also important to note that even after you first buy, there's an idea that you should have your exit strategy. Not necessarily a strategy, but you should go from the very beginning and kind of managing your practice for when the Time to sell comes or in the event that something unfortunate happens and you're required to sell before you're ready to retire. You know, I know that in the past when we worked with practice CFO clients, they're really buttoned up. There's none of the issues or delays that can come with somebody who kind of took it easy on their accounting and financials and all of that stuff, as well as the performance metrics that you guys track and the growth that I see your practices have. So I've been impressed. And there's definitely other good, great CPAs out there. But that's what the expectation should be for a buying dentist, is to find a CPA that offers that kind of value, not just filing your tax returns.

It's a mindset as a business owner, and how you approach your finances, your financial reporting and the financial advice that you seek is indicative of whether or not you view yourself as a clinician or as a business owner. And if the decision is, I'm running a $1.5 million practice and I want to pay 250 bucks a month to a bookkeeper, that's a mindset of a clinician. Let me only pay money where I have to pay money, and let me produce and be a doctor, Great, okay, maybe you're going to do very well. And there are some that do very well in that model.

Yeah.

But if you want to have a strategy around your finances, once you start to get north of a million, a million two in collections, you start to need better guidance as a business owner. And those doctors that view themselves as a business owner first, those are the ones who start to make decisions around allocating their money, who they recruit, what advice they seek, what education. They get to grow an enterprise, to grow, to grow a mini enterprise. Those are the ones who really hit it out of the park, financially speaking. And not everybody wants to do that, which is totally fine. But a lot of the young doctors coming out of school with $800,000 in student loans, they sort of have to start thinking like a savvy business owner. Otherwise, go, you know, go work for a DSO and make 200 grand a year, and you'll get inflation adjustments every year. Great. You can live a fairly stable life that way, but you're never going to hit it out of the park unless you go be a business owner and you go be a really effective business owner, not just surrounding yourself with employees to support you as a clinician. Two different mindsets. So the doctors that come to us are the doctors who. And really want us are the doctors who have the mindset to be really successful.

Absolutely. Well, I appreciate your time, Wes, and I feel like I've got a much better understanding and I'm sure everybody listening as well on how the CPA works on the transaction and then also after the transaction, which is just as important.

So, Matt, it's been fun. It's been an honor to let you take over the reins as the host of the Dental Boardroom podcast today. So thank you and thank you everyone for listening in. Tune in as we have more on the series of practice transitions. We're going to have more deal points on that. And even if you're not looking to sell or buy your practice, guess what? You're going to be pitched to possibly by DSOs out there. You might want to bring on a partner at some point. You should kind of know what is the value of your practice. There's a language that comes in there that just overall helps you be a more educated business owner. So tune into these episodes. Hopefully they're content rich and we'll be back for another one soon. Matt, thanks for joining SA.