‘Scratch’ start-up or purchase?
Last week, I was again asked to give my opinion about the merits of starting a practice from "scratch" as opposed to purchasing an existing practice.
Last week, I was again asked to give my opinion about the merits of starting a practice from “scratch” as opposed to purchasing an existing practice. The answer is an easy one if there is an existing practice for sale in a location that appeals to you.
So, as an example, let’s compare Dr. A, who chooses a start-up practice, with Dr. B, who purchases an established practice.
Dr. A decides to start a practice in a popular growing community. An attractive space is available, and demographics support the need for an additional dentist. Dr. A leases enough space - 1,500 square feet - to accommodate future expansion. He qualifies for a loan, so he can purchase the equipment, supplies, and furniture he needs. Dr. A completes his leasehold improvements conservatively, which cost $100 per square foot, minus $20 per foot provided by the landlord. Including other expenses, Dr. A’s total start-up costs are $340,000. The monthly debt service is approximately $5,200.
Dr. A begins operation with a minimal staff. He promotes the practice in several ways, and has the personal and technical skills necessary to attract patients. Within three or four months, the practice has an astounding new patient flow of 35 patients per month. He is pleased and feels confident that the practice will be successful both professionally and financially.
Dr. B chooses to purchase an existing practice. The practice has a competent staff and annual receipts that have totaled $600,000. The practice has four days of hygiene production per week, with approximately 1,200 active patients. The new patient flow is 15 to 20 patients per month or 210 per year. The practice has four operatories, and most of the equipment is 12 years old. The profit margin is 40 percent, which produces an annual income of $240,000. The agreed-upon price for the practice is $430,000. Dr. B also purchases the accounts receivable for an additional $75,000. Dr. B’s total indebtedness is $530,000. The monthly payment will be approximately $8,100.
At first, some may suggest that Dr. A’s new practice is the better choice. Dr. A has the benefit of new improvements and equipment. The new-patient flow is above expectations and the smaller monthly debt obligation suggests less risk.
Let’s take a closer look. Experienced consultants usually agree that the patient attrition rate of an established practice runs between 7 and 10 percent. However, the attrition rate for patients in a new practice is in the 15 to 20 percent range. If the new patient flow in Dr. A’s practice is 35 per month, then the actual rate of growth may be between 30 and 35. At the end of the first year, Dr. A may be fortunate to have an active patient base of 385 patients. If Dr. B’s attrition rate is 10 percent of the original 1,200 patients, then he loses 120 patients. Combined with the new-patient flow, his active patient base at the end of the first year would be 1,270, or a net gain of 70. It will take Dr. A at least three or four years to reach Dr. B’s patient-volume level.
Now let’s assume Dr. A outperforms the expected or customary performance of a new practice. His receipts for his first year of operation are $300,000. Because he has less hygiene costs, the practice has a 45 percent profit margin. Dr. A has reason to be enthusiastic about his profit of $135,000 in the first year. The debt service for the first year will be $62,400, providing a personal net income of $72,600.
On the other hand, Dr. B continues to operate the purchased practice as it had been functioning under the previous owner. The annual receipts remain at $600,000, and the profit margin is 40 percent. After providing for the annual debt service of $97,200, Dr. B will have a personal income of $142,800.
After a few years, Dr. A’s practice may become similar or even larger than Dr. B’s in terms of net profit. However, Dr. A will never recover the difference in income that Dr. B accumulated during Dr. A’s formative years.
Of course, in addition to increased initial cash flow, there are other benefits that the buyer realizes after purchasing an existing practice. Some examples include improved initial patient acceptance, instant practice organization, and a tenured staff. After considering these benefits, it is obvious that if there is a practice for sale in the area of a doctor’s personal and professional choice, it makes sense to purchase it rather than start from “scratch.”
After practicing dentistry for 30 years, Dr. Rich Seims now specializes in dental practice mergers and acquisitions. Seims & Associates, Inc. provides management-consulting and brokerage services for dental practices in the Pacific Northwest and Alaska. He is recognized as a seasoned facilitator and discreet confidante. Seims & Associates can be reached at (888) 720-7220, or by e-mail at firstname.lastname@example.org. Visit his Web site at www.seims.com.