Dentistry as a profession has experienced much change in the past five years. The economy has also changed immensely in that period. Following suit, the value and sale price of dental practices in the Canadian marketplace has also seen the pendulum swing in both directions. A rise in values as interest rates fell in 2020 were observed, and later a decline in values as the cost of borrowing increased from March of 2022 onward. As the saying goes, it seems “the only constant is change.”
Practice values are influenced by several variables that can be grouped into four categories. These categories include lending availability and terms, the buyer-seller marketplace, profit/earnings of the practice, and the potential risk versus reward of the investment. Economic changes have impacted the cost of carrying debt through interest rate hikes. These rate increases have imposed an increased element of risk for lenders and with increased risk comes increased scrutiny. That scrutiny often includes a reduction in the tolerable ratio of debt service-to-income for a lender to approve a loan and using historical production of a practice to guide decision making more so than forward looking projections when it comes to practice value.
The Emotional Brain
It is the experience of the author that general dental practices in the Canadian marketplace most frequently receive letters of intent to purchase quickly after being listed or take months to sell. It seems there is a dichotomy between practices that are swept up in short order by the marketplace, often in competition versus others that experience a much slower trajectory to finding a buyer.
Research has demonstrated that an individual’s decision making is dominated by their emotions and not analysis. According to behavioural economist Dr. Don Barden, “People make decisions based on the sum of facts and emotions. Those emotions make up 85% of the decision, and they are justified with 15% of the facts. Yet within 10 minutes after the decision or presentation, a person can recall only 6% of the facts, but they recall 100% of how they felt when they experienced the facts.”1
Furthermore and according to a psychological theory called Prospect Theory, humans will avert losses with more intent than they seek gains.2 This bias, referred to as “loss aversion” was theorized by Tversky and Kahneman in 1979 and asserts that individuals are more motivated through a fear of loss than the prospect of attaining an equivalent gain.3 Put another way, an individual would most often rather keep the $5 they already have than risk investing this to earn an additional $5 if the alternative could mean walking away with nothing. Sullivan and Hardy summarize the impact of loss aversion articulately in their book, “10x is easier than 2x”: “Loss aversion primarily manifests itself in three specific forms: 1) Continuing to invest in something unprofitable simply because you’ve already invested in it (i.e., sunk cost bias); 2) Overvaluing something you own, believe, or have created simply because it’s yours (i.e., endowment effect) and; 3) Continuing to do something you’ve previously done in order to be viewed by yourself and others as consistent (i.e., consistency principle).”4
As dentists we are highly analytical thinkers. Our work requires analysis and our education develops these skills. Examination, evaluation, diagnosis, and treatment planning is a linear, analytical process. But dentistry, like all primary care involves relationships. It involves navigating humanity, behaviour and emotions. As a practice owner, this extends beyond patient care to the clinical and administrative team. And in practice values, the relationships and patient behaviour is often where the vast majority of value lies, which is referred to as “goodwill.”
The sale of a practice has a major emotional component. Transitioning out of the role of practice owner for many dentists is major life event. Years of managing and working with a team, caring for patients, and serving a community while earning an income for a lifestyle and often to support a family has a very human element. For a buyer, there is much analysis in the determination of suitability of a given practice but there can also be emotion, especially when there exists competition of buyers.
Fear of loss
Working with dentists selling their practices, it is common to observe a fear of “selling too low” or “not getting what my life’s work is worth.” It is also normal to have a fear of the wrong fit whether that be with a buyer that has a different approach to patient care or management. And in the case where a selling dentist intends on committing to a transitional period, there can be fear and concern about the working relationship, expectations during the transition, and required production among others.
In the dental practice marketplace, buyer behaviour dictates practice values. That behaviour is influenced by the four categories mentioned earlier and includes the ability of a purchaser to attain financing. As a practice appraiser, it is common to hear a seller state, “I want the price to be high enough that there is room for negotiation so I can achieve my price goal.” And although the rationale for this is clear, human emotion and loss aversion tend to suggest this approach is not in seller’s best interest.
With increasing interest rates since March of 2022 in an attempt to curb inflation, the economy remains in a state that is challenging to predict. It is also an economy that is impacting buyer behaviour. Although dentistry is fairly recession-proof, insurance, employment, and the type of treatment elected all affect patient attendance and behaviour in the dental practice. That uncertainty has the banks doing their best to ensure any default is mitigated. Higher interest stress tests and higher scrutiny to approve financing requests have been observed in the recent economy. This uncertainty affects buyer behaviour. Uncertainty is related to fear of loss. As such, it is the experience of the author that when a practice is priced too aggressively in an uncertain economy, the fear of variable rates increasing or practice performance being negatively impacted overrides the buyer’s vision of potential. The fear of “overpaying” and experiencing financial loss can prevent a prospective buyer from engaging with a practice listed for sale. Observationally the opposite seems to be true if the practice is priced “sharp” or on point with the market at the time of listing. Buyers that see a practice with opportunity that reflects affordability and a strong take home income after financing costs are more likely to engage with the listing. Further, a fear of losing the opportunity to another buyer can contribute to a stronger desire to own the practice. This can be reflected by the price paid. And when there is competition for a practice, price paid can often be at or above appraised value.
Fear is an emotion. Loss aversion is an emotional reaction to a scenario. When a buyer evaluates a product, service, or dental practice, analysis and emotion exist. Loss aversion is a well studied bias that affects buyer behaviour. When a product, service, or dental practice is valued higher than the marketplace supports, the aversion to loss is associated with the purchase. When the product, service, or dental practice is valued at a price point that accurately reflects the marketplace value or better, the aversion to loss can be associated with a missed opportunity. In the experience of the author who has valued hundreds of millions of dollars of dental practices, when a seller asks for more than market value for a practice, it often leads to less buyer interest and more disappointing results than when a practice is accurately priced. And with practice purchases being dependant on financing approval, an offer to purchase that meets lender agreement is a must to close the deal.
References
- Barden, D. (2017). The Perfect Plan: The secret formula behind what the world’s top performers do differently. Donald W. Barden.
- Edwards, K.D. (1996). Prospect theory: A literature review. International Review of Financial Analysis, 5(1), 19-38.
- Kahneman, D. & Tversky, A. (1979). Prospect Theory: An Analysis of Decision Under Risk. Econometrica 47(2), 263-291.
- Sullivan, D. & Hardy, B.(2023). 10x Is Easier Than 2x. Hay House Inc.
About the Author:
Dr. Sean Robertson BHSc, DDS, is the founder of Practice Advocate, a dental consultancy firm that supports dentists with business education, practice valuations, practice sale and acquisition. He teaches practice management for the Faculty of Dentistry at McGill University and the University of Toronto. He can be reached at Sean@practiceadvocate.ca
