March 23, 2017
by Timothy A. Brown
Our firm was recently asked by a bank to measure the return on investment of an Investor Dentist™ acquisition. Specifically, they wanted to know the annualized Return on Investment (ROI) for the absentee owner (hands-off) dental practice investment model. This request was due to a failure of an unrelated i-Dentist™ who was unable to meet his/her income targets and subsequently defaulted on the loan. Bankruptcy and liquidation of the dental practice was the unfortunate result.
While this is a rare case, some of the details of this bankruptcy will trickle through the marketplace and it may impact how all banks now look at their credit scoring systems for any dentist who owns or aspires to own more than one practice in Canada. Banks and the tightening of their policies towards lending are a leading indicator of the “bubble” that is talked about much more frequently of late. When banks retract and credit policy tightens, values stop rising. It is an inevitable phenomenon when a market has risen steadily for over a decade and dental practice values may now be at their peak. Let’s consider the view of the various invested parties; when looking at debt service ratios (as most accountants do) practice values have peaked. From the buy-side (high demand), values are well beyond their comfort levels. From the sell-side (owners), there is little objection to the present high sale prices. From my perspective as one who assesses the value of Canadian dental practice values daily—yes, we are now at the peak.
With those views in mind, and considering the recent statement made by the chief executive officer of Canada’s largest bank that Toronto’s housing values are unsustainable and require financial restrictions, it’s likely this sentiment will permeate through all the banks’ credit and risk departments. This will certainly have the largest impact on the health care practice sales marketplace.
For those who already have multiple locations I caution you that your loan portfolio is likely to be examined and reviewed more frequently and the rights and privileges contained in the banks’ loan documents will be acted upon more often and without extension. Items such as interim financial statements (which your accountant may have to prepare on short notice at your cost), properly written associate agreements, premise lease renewals and other important business documents will be demanded within the bank credit terms that were first extended to you when taking out the debt instrument(s).
By coincidence, we appraised such a practice for a client in March, 2014 and because he regularly updates all his information, including his dental practice appraisal, we completed another appraisal for him of the same practice as of January, 2017—a 34-month investment analysis.
The highlights are as follows:
This investor dentist purchased this practice from a client of our firm in 2012 for $2 million. In March of 2014, roughly two years later, we appraised the practice at approximately $2.2 million, a 10% increase in the first 2 years. Not bad. As of January, 2017 we appraised the practice at approximately $2.8 million. This investor dentist is highly regarded as a sophisticated and savvy i-Dentist™ by our firm and he has proven that he can maximize efficiencies, stimulate new patient flow and treat his associates and staff with respect and reward. He has replicated this process of buy, improve and then remarket numerous times. He jokingly calls himself a ‘flipper’ but in my opinion he does it with class!
Here is the bottom line. During his 3rd, 4th and 5th years of ownership (a 34-month period from 2014 appraisal to 2017 appraisal) the practice increased in market value by $600,000. This represents a 27.3 per cent increase in value over 34 months. That averages out to about 0.8 per cent per month increase in valuation. That also works out to about 9.1 per cent increase in value on a simplified and annualized basis.
Therefore, this is a positive example of an absentee owner, investor dentist purchase proving that a dental practice is indeed an exceptional investment, which is the byline of my book titled, Profitable Practice. When compared to other investments such as common stocks, guaranteed investments (GIC’s or bonds) the return on investment is impressive. Not to mention the practice has reduced the debt (since the original purchase in 2012) in the amount of about $460,000 (principal only) and the i-Dentist™ has also drawn a respectful salary/shareholder draw of over $200,000 each year.
I have seen other instances where the return on investment has been greater; particularly, when the investor dentist™ enters the practice both as an active owner/manager and one who also brings in additional specialty procedures that he/she can perform that were previously referred out. If this occurs, the return on investment or the growth rate can be substantially higher.
In other instances, when the investor dentist™ is not an experienced manager/owner, particularly in respect of the ever-important human resource responsibility, they may have difficulty recruiting and motivating associates or accidentally demoralize the staff and the result is a negative return on the investment. While the investor can usually service the debt load and pay the wages, Associates and operating costs, he/she may be unable to draw a salary/dividend for the first one to three years of ownership. This is largely due to amateur mistakes that most dentists make in the early years of ownership. Certainly, all of us made mistakes in the early years of ownership.
To conclude the investor dentist business model can be profitable subject to the skills of the individual dentist. I would caution those who have acquired, or plan to acquire multiple practices, that business experience in human resource management is one of the most critical skills that allows an i- Dentist™ to succeed.
The greatest failure of an investor dentist when examining human resources is that he/she simply does not consider the legacy, the reputation and the connectivity that the existing staff or the previous owner and/or associates have with the patients. Often, the investor dentist™ mistakenly assumes that he/she can replace long-term existing staff with inexperienced or lower-cost staff to reduce overhead. The most common result; the patients do not respond well and leave for other nearby competitors. The patient experience is a very important contributor to patient retention and new patient referrals. Most of the research indicates that new patients come from existing patients who are satisfied and they refer their friends and family. All the marketing and all the social media in the world cannot compete with a direct patient referral.
Now let’s turn quickly to the corporate dentistry phenomenon. Many people wonder how some of these groups can acquire, 10, 20, 50 or more practices. How do they do it? What is their secret to success? What are their failure rates? Do they have weaknesses in their business model? Obviously, there is a lot of speculation about the corporate model. While delivering a CE seminar on a cruise ship in mid-February of this year (thanks to Kennedy Seminars of Winnipeg) many of the more mature members in the audience had some serious reservations about corporates. Those over 50 in the room remembered the days of Tridont Dental Centres and most had heard some stories—not all good—about the current generation of accumulators. Rumours are rumours and some have been inflated by those who made poor decisions and have regrets that they sold their practices prematurely. Others are bothered with the frustration of no longer owning the practice and having relinquished their ‘control’—not an easy thing for type “A” personalities to do!
This can happen in any type of dental practice transitions—corporate or not—but there is some merit to heeding the concerns that are voiced on an ever-increasing basis. For example, it is difficult to sell your practice and then work for the buyer and watch them make changes. Some will make the same mistakes you did when you started out – and it’s not easy to stay quiet and some have been known to interfere with the new owner with words of advice like “when I was your age” or “we always did it this way” – advice that can be valuable but not always well received nor timed in terms of delivery or tact. No matter how small or insignificant—change comes at a price—and as we age we adapt to change much more slowly and for some, not at all! What sacrifices are we prepared to make to sell our practice, get the cash and then continue working for the buyer? Can you take direction from a non-dentist manager? Can you adapt? Are you sure?
Here are the thoughts of dentists I am hearing.
I dread the thought of selling and working for the corporate but maybe as I age that will change? At this time, I prefer to remain the sole decision maker and the captain of my own ship. Yes, there are numerous owner/operator challenges—human resources come to mind. But I can do it. At 53 years young I am confident I can do this for another 3 to 5 years (standard baby-boomer mantra!) and in the 3 to 5 years I will review and probably decide that I can then do this for another 3 to 5 years! Until then, I suffer the joys of ownership and the profits associated with them.
It is also important to consider the terms of these corporate offers to buy a practice. There are as many formulas, structures and types of transactions as there are corporates—and they often change their business model/buying proposals to suit the individual’s location and logistics. When the market evolves, corporates must adapt. What you heard just 6 months ago about selling to a corporate may not be the present transaction structure. It is evolving quickly and corporates are competing against each other for your attention, and primarily for your practice. The most coveted asset you have is your client list and they want to own it, control it, manage it and benefit from the cash flow your clients generate in your practice. In exchange for that, you get a cash/shares/earn-out offer up front and for most, you also get a job for a specific term. Some see it as a get cake and eat it too scenario but others see it as buying your practice back from yourself or certainly working to help the corporate pay off their debts.
Large corporates are successful because they have access to capital markets and lower cost finance terms than an individual or the smaller investor dentist™ buying groups. The result is what I term, “patient capital” or “investor capital”, meaning they are not required to make immediate principal and interest payments. This frees a substantial amount of cash flow for the large corporate and they are more financially nimble to re-invest cash flow and acquire more practices rapidly.
Large corporates also have professional human resource managers and other management systems to control supply, laboratory and training costs. An investor or corporate that has, say upwards of 100 locations, has buying power and economies of scale that most smaller businesses only dream of.
The weaknesses of the corporate business model are their institutional style and approach. They are corporatized. They are systematized and often this means ignoring the individuality of all the unique practices they are buying and converting to fit their corporate model. To clarify consider the example of a McDonalds restaurant chain. McDonalds does not buy individual burger stands and convert them to McDonalds. McDonalds only starts from scratch, that way, every single system, every single policy, every piece of equipment, everything about the business is done according to the franchise and the proven business system manual.
A corporate or investor when buying multiple practices in multiple locations is acquiring different dental software, different management styles, different philosophies, different equipment configurations and so on. Imagine all the logistical strategies needed to try to convert 50 or 100 dental practices over a 5 or 10-year period into a systematized, organized, marketized system of delivering quality dental care to an efficient, overhead ratio.
In my industry, it would mean I buy a competitors’ brokerage and begin to learn all their software, get to know all their people, all their policies which are likely very different than mine, their fee structures, their collection policies, their marketing systems etc. Frankly, a daunting task I am not about to take on anytime soon.
To conclude, the investor dentist™ business model can be an exceptional and lucrative investment, as evidenced by the sample practice discussed earlier. Secondly, not every dentist should consider this model for him/herself unless he/she has outstanding human resource management skills and access to financing that is not restrictive nor highly leveraged. These are the main prerequisites and necessary skills of the successful corporate or investor dentist.