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Examining the impact of COVID-19 on practice values

Aug. 24, 2020
You’re returning to a practice that’s likely different than the one you left when you entered the shutdown. Here's a discussion about the pandemic’s effect on your practice’s value.

You’re returning to a practice that’s likely different than the one you left when you entered the shutdown. Here we will discuss the pandemic’s effect on your practice’s value.

Reopening costs and personnel issues

During the period of mandated office closures, you likely used your time to research, plan, and train for a safe reopening. Unfortunately, clinical guidelines were sparse and sometimes contradictory, and many were left to the “professional judgment of the dentist,” a risky standard should COVID-19 lawsuits ensue from infections.

Due to coronavirus governmental mandates, 97% of practices were forced to shut down except for treatment of emergencies, resulting in more than 500,000 dental jobs lost in April alone.1 Now, practices have reopened and rehired furloughed staff. But this was hard on many, as some staff members at high risk of contracting COVID-19 refused to return due to concern for their health and safety. 

Also, the unprecedented demand for personal protective equipment has far exceeded the supply, resulting in shortages and massive price gouging. 

Impact on productivity

Productivity under the new normal is another barrier in regaining previous levels of profitability, at least for the short term, with new safety and social distancing procedures in place, appointment times expanded, and fewer patients scheduled. We believe these issues will decline over time as the virus threat subsides. Barring a second coronavirus wave, we expect most practices to reach 80% to 90% of their 2019 monthly production by December 31, 2020.

Impact on valuations 

What impact will low profitability in 2020 have on practice values? Very little, in most cases, as the value is based on future profitability, not historical results. Since the impact of COVID-19 is likely temporary, any damaging impact to practice values should also be temporary, assuming a practice rebounds to near normal capacity in the near future.

Normalizing or removing the impact of a one-time event is a commonly accepted valuation method—for example, the temporary closure due to a weather-related disaster—and most banks and buyers are comfortable with this valuation method approach. Sellers should work with a qualified and experienced appraiser to properly implement this normalization—or risk using an appraiser who bases the value on a percentage of historical collections. Then sellers could end up with an unfavorable result.

Are banks and buyers believing it?

While normalizing earnings to eliminate the one-time impact of COVID-19 is theoretically sound, it matters little unless banks and buyers are comfortable with this approach. Currently, banks are accepting applications for new practice loans but are scrutinizing applications more closely, sending deals through underwriting, taking new practice acquisition loans through the approval process, and then hitting the pause button. Banks are primed to close on practice acquisition loans to boost their earnings, but they don’t like the current level of risk and uncertainty.

Therefore, many banks are adopting a hybrid approach, closing and funding a majority of the sales price once monthly production levels reach 75% to 80% of pre-COVID levels. Under this scenario, the seller takes back a note for the remaining portion of the sales price until production returns to an agreed-upon level, when the bank funds the remaining loan balance. Thus, banks’ involvement in transition deals will be more ongoing than pre-COVID as they monitor these numbers. 

Luckily, it’s a great time for buyers because interest rates are near all-time lows, with the prime interest rate at 3.25% at the time of writing. Many banks are offering practice acquisition loans with interest rates in the 4% to 5% range. Also, many lenders are offering a six-month deferral on payments or interest-only for six months.

Supply and demand in the practice sale marketplace

Some doctors have decided not to return to practice, and a few buyers have been scared off by the managerial complexities of dealing with the new normal that’s emerged from the pandemic. However, buyers, both corporate and individual, are still moving forward with due diligence, legal, and financing arrangements for deals in progress. As a practice resumes operations and reaches roughly 80% of same-month production threshold, the bank will proceed and the deal will close. But in response to the production decline, corporate buyers (dental service organizations) are now seeking price discounts or larger holdbacks in order to close.

 Reference

1. Coombs B. Dental practices led record health care job losses in April but are already bouncing back this month. CNBC. May 9, 2020. https://www.cnbc.com/2020/05/09/dental-practices-led-record-health-care-job-losses-in-april-but-are-bouncing-back.html

ROGER K. HILL, MSA, ASA, provides transition planning through Roger K. Hill & Company Inc. JOHN K. McGILL, JD, MBA, CPA, publishes The McGill Advisory newsletter through John K. McGill & Company Inc., a member of The McGill & Hill Group LLC. This is your one-stop resource for tax and business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. Visit mcgillhillgroup.com.

About the Author

John K. McGill, JD, MBA, CPA

JOHN K. McGILL, JD, MBA, CPA, provides tax and business planning for dentists and specialists. The McGill Advisory newsletter is published through John K. McGill & Company Inc., an affiliate of the McGill & Hill Group LLC. It is your one-stop resource for tax and business planning, practice transitions, legal, retirement plan administration, CPA, and investment advisory services. Visit mcgillhillgroup.com or call (877) 306-9780.

About the Author

Roger K. Hill, MSA, ASA | President

Roger is an accredited senior appraiser (ASA) of the American Society of Appraisers, who has also earned the coveted MSA, specifically geared to the business of your practice. With over 30 years of experience serving dentists across the United States, Roger is an active speaker, frequently addressing national and state study clubs and other professional groups. He has published extensively, and recently published a book about practice transitions (published by the American Dental Association). In business since 1979, Roger joined The McGill & Hill Group in 1997.

In his spare time, Roger enjoys a variety of activities ranging from scuba diving to four-wheeling in Colorado to cruising. In addition, when he is not wearing his trademark bowtie, he prefers to be in cowboy boots and jeans (and loves almost anything cowboy). As you might expect he enjoys country music (more about this at our seminar). Roger and his wife live in Charlotte, North Carolina. Currently their twenty-four year old daughter (Taylor) is nearing the end of her bio-chemistry major at Queens University.

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