Never has the statement that we live in unprecedented times been truer. As of the writing of this article, none of us fully understands how this pandemic will play out. But even in times of unprecedented crisis, experience and basic principles can often help us draw reasonable conclusions about how businesses will likely be affected.
What is going to happen to dental practices in the short run?
In March, regulators and health authorities recommended that dental offices immediately stop seeing patients, except for emergency treatment. The resulting office closures led to unprecedented revenue declines across the sector. The key thing to keep in mind, is that unlike many other businesses, much of this is a deferral of revenue, not the loss of revenue.
This is very different than many businesses. The revenue for the Uber ride someone did not take, or the meal they did not buy at a restaurant is lost forever. But COVID-19 does not reverse tooth decay or make impacted wisdom teeth go away. That restoration will still need to be done, and those wisdom teeth will still need to be extracted. There will be lost hygiene revenue, and depending upon how the eventual recovery goes, revenue for some elective procedures may be lost. But unlike many businesses, that deferred revenue is building up a back log that will help the recovery in the dental industry far more than many others.
In addition, dentists have been able to shed most, but not all, costs. The four costs which generally account for the vast majority of dental practice expenses are wages (25%-30%), rent (6%-9%), supplies (6%-10%) and lab (3% to 8%). Most offices immediately laid off staff. Supplies and lab costs are not incurred until patients are back. So, with the exception of rent, most offices pared costs to the point that their economic survival is not threatened. In addition, unlike many small businesses, most practice owners have sufficient assets to withstand business interruptions for longer periods, especially with the government support programs that have been implemented.
What about practices with high levels of outstanding debt?
For the most part, banks are working closely with the dental offices that have significant debt. Of the many types of small businesses that banks have loaned money to, dental practices will remain among the most secure loans the banks have. As noted above, in almost all cases, the survival of a dental practice is not in question. This has been a timing issue, not an existential one. And banks are smart enough to know this.
In most cases, banks have been prepared to defer principal repayment and make other arrangements to keep practices going. The banks have a very strong economic incentive to help a dental practice weather the storm. Only those practices that get through this crisis will be able to eventually repay the loan. So, the banks have an entirely rational, economic imperative to help practices get through this.
Just look at the facts. In most cases, 75% or more of the value of a dental practice is goodwill. That goodwill becomes virtually worthless if the dentist and dental team aren’t there to treat patients. And even the 25% that may be tangible assets can’t be sold at close to that value, in the absence of ongoing practice operations. So, in almost all cases, the best way for a bank to protect itself is to ensure continued operation of the dental practice – and that won’t happen if they push the practice into bankruptcy.
What will dental practice recovery look like, following the shut downs?
As previously discussed, much of what has happened in the dental industry is a deferral of revenue, not a loss of it. So, when the advisories are lifted and practices return to normal patient treatment, there could be a surge in business at many practices. We do not yet know if that surge in business will build slowly or quickly. Much will depend on the decisions that public health authorities and dental regulators will make on the manner in which dental offices can return to work. But we do know that those restorations will still need to be done, and those wisdom teeth will still need to be extracted.
In some recovery scenarios, we think the only limitation on the magnitude of the revenue increases will be the availability of staff. Certainly, most staff that were laid off in a practice will be more than eager to make up for lost time and wages. But before the pandemic hit us, the number one issue we were hearing from practice owners was the challenge of getting enough, good staff. Prudent practice owners have been making advance preparations to ensure they will have adequate staffing to deal with the substantial backlog. You should too.
We are now in a recession. How will this impact dental practices?
History has a lot to teach us in this regard. Readers will remember the major recession we went through as recently as 2008/2009. By many measures, it was the worst economic decline since the Great Depression. How did it impact dental practices?
For most practices, it had only modest, if any, negative impact on revenue and earnings. There were individual exceptions, but for the most part, dentistry is remarkably resilient in the face of economic declines. Indeed, that is often cited by the large institutional and private equity investors, who are backing the companies consolidating dental offices across Canada, as a primary motivator in investing in dental practices. That isn’t going to change.
History teaches us that a recession will have far less impact on the average dental office than the vast majority of other businesses, small and large. While the exact impact will be determined by the magnitude and duration of the recession plus regional factors, we and, more importantly, many buyers remain confident that recessionary impacts on dental practices are likely to be moderate, and an eventual return to normal levels of revenue and profitability will ultimately be where things end up. The only question ishow long will it take?
What will be the impact on dental practice selling prices?
Once again, history provides us some great guidance, for when we emerge from practice closures.
First, a key thing to keep in mind is that prior to the COVID-19 pandemic, existing supply and demand forces had already driven practice values to unprecedented heights. We were in a strong “sellers’ market” in most places across Canada. The key drivers of this – a significant oversupply of dentists making patients the scarcest resource in dentistry, the excellent economics of most dental practices, banks offering great financing terms on practice loans, and an unlimited supply of investment capital funding practice consolidators, have not changed.
Second, history teaches that those intractable forces of supply and demand are likely to get stronger. During and after the 2008/2009 recession, what happened to dental practice selling prices? They went up! Often considerably. That may sound counter intuitive to some, but not if you look at the factors driving supply and demand – the ultimate determinate of the price of everything.
The devastating drops in stock markets in 2008 meant that many practice owners, who had been planning on retiring, could no longer afford to. That resulted in a reduction in the supply of practices for sale. Then, like now, government responded to the recession by cutting interest rates to stimulate economic growth. Lower borrowing costs drove demand up then, and will again. With a reduction in supply, and an increase in demand, prices responded the way they always do when those forces are at work. They went up and laid the foundation of the sellers’ market that ran non-stop throughout the past decade.
And, what of the corporate practice consolidators? They all rely to some degree on institutional investors and private equity. In tough economic times, professional money managers look for safe harbours. Dental practices are high cash return businesses, that have shown better ability to withstand recessions than most industries. That makes them far safer harbours than most alternatives for investment capital.
While the corporate consolidators are not usually the “high bidder” on individual practices, they will continue to provide a solid floor to practice values.
With inevitable declines in revenue and earnings in 2020, won’t that result in a lower appraised value for my practice?
A basic principle in valuing a business is to remove the impact of one-time events that purchasers are not going to factor into their assessment of future earnings potential. The revenue declines that practices experienced due to office closures in March, April and May 2020 are just that kind of “one time” event.
It is straightforward to adjust for this in a practice valuation. The most common approach will be to substitute monthly revenue from 2019 for the months in 2020 that are affected by COVID-19 related declines, with appropriate consideration being given to whether monthly revenue trends prior to the arrival of the pandemic were positive or negative.
The longer-term unknown is whether earnings will be impacted once everyone can return to work. Past recessions indicated little to no lasting impact. If that is the case this time around, valuations need not come down.
Are there any other risks to worry about?
Sadly, there will always be those that will try to take advantage of the fear, uncertainty and doubt that we all experience in a crisis. Just a week into this crisis, we had already begun to hear stories of buyers who were trying to panic practice owners into selling now, at prices below fair market rates, or with unreasonable conditions that hugely favoured the buyer.
Practice owners need to take comfort in the fact that, despite everything going on, the fundamental laws of economics, led by supply and demand, have not been repealed, or even deferred. The one thing we know about all crises, is that they end. And that the prospects for practice values remain strong. The key is to seek out experienced advisors you can count on, not yielding to buyers whose real interest is their own gain.
In conclusion, no one can deny the incredible challenges dental practice owners have faced over the past months, and the sacrifices they have made. As we work through the impact of the COVID-19 pandemic, patients’ needs should remain your focus. As you focus on that, you can do so knowing that history and the basic laws of economics, suggest that your practice value remains strong, and when the time comes for you to sell, a strong market awaits.
About the Authors
Bill Henderson (left) is President of Tier Three Brokerage Ltd, one of Canada’s leading dental practice brokerages. He has an extensive business background including senior executive positions at Procter & Gamble, AIM Trimark and was a board member for the Investment Funds Institute of Canada.
Dr. Bernard Dolansky (right) is a Past President of the Ottawa Dental Society, ODA, CDA, and the Dentistry Canada Fund. He is currently the Senior National Partner at Tier Three where he continues to assist dentists with transition planning; evaluations: practice purchases and sales; Bill and Bernie write and lecture about practice valuations and transitions across Canada.