Looking at the marketplace, it seems as though there are a growing number of practice transitions, as well as a growing number of practice transition specialists. Many doctors have commented to me recently that if they were going to sell, now might be the best time. Currently, many independent dentists are being approached with this same sales tactic. In fact, you might be thinking the same thing. But before you jump into a transition, let’s look at some math that will help you make an informed and wise decision.
Dental practice value
The first question you need to ask is, “What is the current value of my dental practice?” There are three different ways to look at the actual value, and all are extremely important to analyze.
Appraised value—This is the value assigned by a professional who is certified to take into account all the factors that contribute to the value of your practice, i.e., equipment, financial profitability, patient base, and more.
Market value—This is the price that’s most commonly paid for an asset at a given time. For a dental practice, market value typically ends up being between 60% and 85% of collections.
Economic value—This is the most important number to consider as it is the cost to replace a given asset. It has a dramatic impact on your ability to retire and on your future financial prosperity.
Before you sell your dental practice, you will need to calculate its economic value. Let’s look at an example. Assume that a dental practice with $1 million in annual revenue is operating at a 30% profit margin.
$1,000,000 x 30% = $300,000
Based on the math, if you were going to replace this asset (economic value) you would need to yield $300,000 from another investment to replace it. Assuming that a retirement portfolio could safely yield 5%, it would take an astonishing $6 million in that portfolio to achieve the same result.
Do this math to find the economic value of your dental practice. Remember, knowing the facts—the numbers—will give you power to make informed and practical decisions about a practice transition.
Your future income
Now that you know your practice’s economic value, look at what selling it would do to your income. For a practice yielding $1 million annually in collections, selling on the high side of market value, approximately 85%, would yield the following:
$1,000,000 x 85% = $850,000
There are multiple factors that affect the overall taxation of a dental practice, but for this example, assume a 30% tax on the sale.
$850,000 x $ .70 (after taxes) = $595,000
Once the taxes are paid, the practice then needs to pay off debt. But let’s assume optimistically that there is not any debt on the practice and the seller yields the entire $595,000.
Assume now that the seller invests the $595,000 into a stock portfolio yielding 5%.
$595,000 X 5% = $29,750 of annual income, or approximately $2,500 a month.
This example is powerful in so many ways! If this practice was yielding $300,000 a year in profit before the sale, then it’s reasonable to assume the doctor was most likely living off of at least $200,000 of the $300,000 yield.
In this example, the doctor’s annual income goes from $200,000 to an astonishing $29,750. This would create a dramatic change in lifestyle for the doctor, and based on this example, we can see that the economic value of selling the practice is a tremendously poor decision, based on economics.
You may ask, “How can a doctor live off of this income in retirement?” Typically, the doctor won’t live off of this small amount. Instead, he or she will live off of part of the principal every year and hope the principal does not run out before death. That’s a big risk to take, especially for a healthy person who wants to enjoy a long, active retirement.
This is known in the investment world as the “death spiral.” Each year, if you take more of the principal, you have less overall yield. This will require you to take even more from your portfolio. It’s a spiral.
Many advisors intentionally put clients in this situation. Simply look at the projection an advisor may have given you for retirement. If your retirement assets are illustrated in a bell curve, meaning the assets are reduced each year, the death spiral is exactly what will happen to you and your wealth.
A better, wiser option
Armed with this powerful math, you can see that economically speaking, keeping your dental practice long-term will yield the greatest wealth. You can create a bigger asset that increases, year after year. You may think to yourself, “Yes, but I will need to manage the dental practice, and this will create a continued amount of stress.”
While this is true, it is also true that all assets have to be managed. Either you pay someone to manage your assets, or you manage them yourself. Whether you have a stock portfolio, real estate, or a dental practice, someone must manage it.
Also, remember that there are many forces that benefit economically if you sell your dental practice. Do not be surprised if you are inundated with people who want you to sell. If you sell the practice, the financial advisor will make money, the transition company will make money, and often the bank associated in the transaction will make money.
You should focus on making the best economic decision for you, your team, your patients, your wealth, and your legacy. My advice is to take time to truly understand the value, both intrinsically and extrinsically, of holding on to your dental practice as a long-term asset.
A personal example
I’m married to a dentist, and last year she had to have emergency surgery. She was out of the practice for an extended period of time, yet the practice did not lose revenue or profitability during her absence. How was this possible?
The truth is, when you grow your practice effectively by hiring a growth-oriented team, putting systems in place, and bringing on associate doctors who are driven toward your mission and vision, you can maintain the asset and still have a phenomenal quality of life. In fact, this is the model that many dental practices are moving toward, and they are experiencing tremendous success.
Typically, once these systems are built out, you will have the same benefits, i.e., the margin of time and money that you were hoping to have in retirement. You will find your goal will be to hold on to the practice as long as possible.
Many dentists I have worked with have tried this approach. They all tell me that not only do they now love the business side of dentistry, but they have also found a renewed passion for clinical dentistry!
I encourage you to find a firm that can assist you in building out these systems in order to hold on to your dental practice for as long as possible. This approach will allow your practice to reach its full economic potential, which will positively impact your family, team, patients, and community.
Eric J. Morin, MBA, is the founder and CEO of Tower Leadership. He’s a business consultant, author, financial professional, and thought leaders who has been in consulting for more than a decade. Morin founded Tower Leadership with the purpose of keeping dentistry in the hands of dentists by equipping them with the knowledge and tools they need to run a flourishing practice where everyone on the team benefits.