Buyers today want to pay less for their practices. They argue collections have dipped, costs for personal protective equipment are up, and overall risk has increased. Sellers disagree. They say that any dip in collections is temporary, that their practices are coming back stronger than ever, and the lack of COVID-19 outbreaks in dental offices shows that overall risk is the same, if not less. Who is right?
No price decreases, but an increase in creative structures
As summer ends, the data show that sellers are winning the argument against price decreases . . . so far. I gathered data from 67 transitions that closed between March and August 2020 (all specialties).1 Some of these transitions were in negotiation prior to the shutdown, but most were negotiated after COVID-19 hit. The median price to collections for those transitions was 68% with an average price to net income of 152%. That compares very closely with 2018 data from 202 transitions at nine brokerages spread around the country where the median price to collections was 67% with an average price to net income of 154%.2 The difference between 2018 and 2020 is statistically insignificant (table 1).
The data indicate that COVID-19 hasn’t changed median prices for practice transitions. While prices haven’t changed, the market is seeing an increase in creative structures to get deals across the finish line. Buy-ins, seller financing, and holdbacks are all tools showing up more often in deals to help provide additional assurances practices will return to 2019 levels.
One way to know where practice values are headed is to watch what the banks do. Two of the largest dental lenders in the US, Bank of America and Lendeavor, have taken totally different approaches.
In 2019, Bank of America had more than 50% of the market share in dental lending. They held loans for over 20,000 practice transitions around the country. When COVID-19 hit, Bank of America (like most dental lenders) offered each of those borrowers a 90-day pause on their loan payments. Several bankers at the company have told me about half of that group took the bank up on their offer.
At the same time, Bank of America stopped lending on all new practice loans. Deals that were already underwritten went through, but no new deals were underwritten starting around March. The obvious question is: Why? Does Bank of America see a fundamental shift in dentistry that others don’t?
One Bank of America banker told me, “This is not a fundamental shift in our view of the dental lending marketplace. We simply have to dedicate all our time to servicing the thousands of borrowers who had their loans on hold and ensure they have all the support they need to succeed after opening back up, including help with PPP [Paycheck Protection Program] loans.”
One big clue as to where practice valuations will go is to watch how Bank of America reenters the marketplace. The company started underwriting new loans again at the end of July. Details on their return are still emerging at the time of this writing. If they come back in with a huge promotion, low rates, and aggressive deals, it might indicate they are seeing strength in the dental market. If, instead, they tiptoe back in with more strict requirements to approve a deal, it might indicate the market has shifted downward and prices will follow.
Lendeavor has taken a different approach. Lendeavor isn’t a traditional bank with branches and deposits. Instead, they focus exclusively on lending solely to dentists across the country, taking (by some measures) the number two spot in dental acquisition lending. Prior to COVID-19, Lendeavor was growing aggressively. When the shutdown occurred, Lendeavor ramped up their operations and increased their lending.
Sean Simon, Lendeavor’s vice president of credit says, “Our outlook on acquisitions, and more broadly, the dental industry, remained bullish even at the height of the shutdown. We expect practices to remain more resilient than nearly every other industry in small business during a post-COVID recession.” When asked why they ramped up lending when other lenders shut it off, Sean says, “The PPP program caused most banks to divert all available personnel to areas that would help support processing PPP applications. We didn’t have that same limitation.”
Valuation models don’t determine price—banks do
Watching what the banks do is the best way to tell where practice valuations will go. If practice valuations are a freeway, banks are the highway patrol setting and enforcing the speed limit. Some dentists incorrectly think they can plug their practice numbers into a formula to get the “correct” value. When it comes to valuations, the definition of “correct” is determined more by banks and their rules than a broker’s formula.
There are generally accepted methods and formulas for valuing dental practices. But every one of those methods includes assumptions and use of subjective judgment. Brokers and those who value practices use judgment deciding which expenses to back out or normalize, the discount rate, comparable practice rates, and other factors to reach a price.
Many dentists assume practice values are determined by a broker or CPA coldly assessing a set of tables and rules and plugging numbers into boxes to get a “correct” price. And some valuations are done this way, but just as many are not.
One broker told me, “In the real world, if I want the listing, I have to promise the client a number they already have in their head and then back into that number by choosing the valuation method and assumptions that get the number the dentist wanted to see in the first place. The client will only be happy if they get that number.”
A better barometer of practice prices than formulas is to watch bank lending rules. Up until about 2017, the maximum most banks were willing to lend was 85% of last year’s collections. From 2017 to 2019, that number started creeping up from 85% to 100% of last year’s collections. And wouldn’t you know it? Most practice valuations started increasing right along with those bank limits.
As the summer of 2020 ends, practice valuations are holding steady. But watch the banks to know whether they’ll go up or down in the future because of COVID-19.
References
1. 14 transitions of the author, plus 53 transitions from seven brokers around the country who shared data and prefer to remain anonymous. 26% rural, 40% suburban, 34% urban.
2. National Association of Practice Brokers. Comparable Sales Database Summary. 2018.
BRIAN HANKS, MBA, CFP, is the author of How to Buy a Dental Practice. He hosts the Practice Purchased podcast and represents buyers in dental transitions nationwide. Hanks can be contacted at brianhanks.com.
