When NOT to Sell the Accounts Receivable in a Practice Transition
The first article in this two-part series presented the case for selling accounts receivable during a practice sale.
By Edward R. Esposito, MBA, AVA
The first article in this two-part series presented the case for selling accounts receivable during a practice sale. There are many circumstances when it may be inappropriate to sell the accounts receivable in a practice transition. One of the best reasons to transition the accounts receivable is when the parties can agree on value. Conversely, the biggest factor not to sell the A/R would be that the selling dentist and the buying dentist disagree in their perception of what the accounts receivables are worth. The seller may feel his accounts are perfect and worth 98% of total balances due. The buyer may have a low expectation of the value of the accounts. If a buyer perceives that the accounts are poorly managed, it is difficult to convince him or her that the accounts are well managed.
There are other considerations when determining whether or not to sell the A/R in a practice transition:
- The dental lenders may not want to allocate money in the funding agreement to purchase the A/R. Ordinarily banks limit what the buyer may borrow. Lenders will usually lend up to 15% to 20% of the purchase price for working capital or accounts receivable or both. So if the buyer has reached a limit with working capital, it may not be feasible to purchase the A/R as well.
- Many lenders agree that working capital is a known quantity whereas the accounts receivable, relatively speaking, have some unknown characteristics and are slightly riskier. Practices with low annual collection rates may not be a safe bet for collecting A/R after a transition.
- From a software perspective, if the data necessary to properly evaluate the accounts receivable cannot be retrieved, the accuracy of the valuation is hindered.
- In some specialty transitions like orthodontia, the contracts receivable are account balances for work that has not been performed. This type of account is extremely difficult if not impossible to value and sell.
- From the seller’s perspective, it’s easy to believe that the accounts receivable has a certain value because, of course, they are his or her receivables. The buyer, on the other hand, may have an entirely opposite point of view. The buyer may feel that the selling dentist has fiscally irresponsible patients who are never going to pay compared to the patients the buyer is accustomed to dealing with.
- All of the proceeds and payments coming to the practice in the mail are endorsed to the seller and the buyer may have to ask the seller to endorse the checks.
- The buyer may have working capital of his or her own and would not benefit from having immediate cash flow from the accounts receivable.
- In any practice, accounts receivable collection has inherent costs associated with processing A/R. These costs are electronic statements or paper statements, electronic claims (or in rare cases manual insurance claims), postage, labor, phone calls, secondary insurance submission, and communication time with the patients or account holders. Most studies show this internal collection cycle costs anywhere from 5% to 12%. This is a conservative, reasonable range. The buying dentist may have a better system of collection than the selling dentist and therefore may not want to inherit and continue the selling dentist’s accounts receivable processing system.
On balance, each transition is unique, and it is the duty of the practice brokers, consultants, attorneys, and accountants to make sure the transition is competently reviewed and successfully executed, whether or not the receivables are transferred.
Edward R. Esposito, MBA, AVA, is a licensed broker and appraiser, and as an owner of ADS Precise Consultants, he has provided transition consulting since 2003. Call him at 800-307-2537 or email at email@example.com. www.adsprecise.com
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