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.
