Selling to the financiers

June 1, 1998
Dentistry is a demanding profession. Dentists typically see 15-30 patients during a regularly scheduled day, and often are on-call to handle emergency situations. In addition to clinical responsibilities, dentists must wear other "hats" as well, including business person and leader-manager. The many roles that a dentist must play require that he/she make dozens of decisions as they relate to the operation of the dental practice.

What are the key considerations in a sale to a management-service organization?

W. David Griggs, DDS

Dentistry is a demanding profession. Dentists typically see 15-30 patients during a regularly scheduled day, and often are on-call to handle emergency situations. In addition to clinical responsibilities, dentists must wear other "hats" as well, including business person and leader-manager. The many roles that a dentist must play require that he/she make dozens of decisions as they relate to the operation of the dental practice.

When the time comes to plan for retirement, however, many dentists struggle with choosing an appropriate exit strategy. "When and how should I sell?" "Will selling the practice prior to actual retirement be the best financial strategy?" "Should I sell the practice outright and retire immediately?" "What about hiring and transferring ownership to an associate?"

In addition to traditional selling options, dental-management companies (also known as management-service organizations - MSOs) have entered the practice-transition arena, offering dentists an opportunity to cash in the value of their practices. Though this has provided another option for dentists to consider, it also has created a great deal of confusion.

The MSO typically purchases the hard assets of the practice; current employees of the practice generally become employees of the management company.

MSOs offer, as part of their program, a number of services, including practice marketing, inventory maintenance, office systems such as appointment-scheduling and recall, and billing and collection functions. Most MSOs we have interviewed administer these services through an on-site manager.

Upon signing with a management-services company, the doctor`s role generally is limited to providing clinical services. For the many dentists frustrated with the evolving administrative and regulatory challenges of the modern health-care environment, however, such a "limitation" may be perceived as anything but restrictive; i.e., some dentists will enjoy being freed from management hassles. Herein lies one of the benefits being touted by MSOs.

Although some MSOs limit their operations to specialty practices, many deal only with general practices. In comparing practice sales involving "generalists vs. specialists" and "MSOs vs. traditional buyers," some trends are apparent. For example, orthodontists who sell to an MSO often receive a higher selling price for their practices than do general practitioners. In addition, the seller`s exit from the practice often can be sooner than a general practitioner due to the apparent ability of some MSOs to more easily recruit orthodontists to provide clinical services.

Most dentists who are entertaining offers from dental-management companies are looking at specific benefits in exchange for the transfer of equity (as well as control) of their practice. Some of those benefits are as follows:

- Cash in practice value before retirement

- Management "relief"

- Enhanced practice profitability

- Continued compensation for clinical services

On the traditional side of the equation, many selling dentists desire a professional relationship with a successor-dentist as part of the process - someone they can mentor as they transfer the goodwill of their practice. This part of the process seems less clear to those dentists selling to dental-management companies. Depend-ing on the transition scenario implemented (i.e., expansion-transition options such as associateship buy-ins leading to practice co-ownership vs. straight-transition scenarios such as retirement, preretirement and deferred sales scenarios), the professional relationship can last from 30 days to decades, depending upon the ages, desires and the career positions of the individuals involved.

We have interviewed and consulted with hundreds of dentists considering the MSO approach. Here are some of the things we have heard them say ...

- Some dentists selling to dental-management companies hope to profit from any stock that might have been offered as part of the selling price. However, but most dentists we interviewed were not "betting" on this (which is probably a good thing, as no one can predict the future value of known stocks, much less the value of stock in new companies).

- The benefit most dentists focus on is the ability to cash in practice equity. Practice equity for most dentists lies in a dormant state until shortly before or upon retirement. Many dentists want the chance to invest these "captive" dollars in a profitable investment vehicle. Some also feel that now is an ideal time to sell. A common question we hear is: "What if I wait five years to sell, only to find that the practice-sale market - which looks good now - has dried up?"

- Sellers across the board believe that they will receive a higher profit margin for their continued clinical services from traditional buyers than with MSOs. This could be offset, however, by the higher profit margins that many MSOs promise as part of management support. The idea is that, at some point, the profits taken by the MSO for its management services can be negated by the higher overall profits generated by what will be a better-managed practice.

Some of the dentists we interviewed felt that they could hire a management consultant to achieve the same results without giving up any equity or control. They also felt that the long-term cost to them would be substantially less, even if they were paying 35,000 to 40,000 per year for management-consulting services.

The Transition Group, a consulting group that provides transition-planning and implementation services for dentists nationwide, receives dozens of calls each month from dentists who have been approached by an MSO. The Group helps dentists compare sales to an MSO with other traditional sales strategies, such as the retirement, preretirement and deferred sale. By reviewing both MSO contract, and financial projections contrasting various sales options, dentists can make intelligent choices about transition options.

In contemplating any offer from an MSO, dentists should consider the following:

Company Profile: For an understanding of clinical needs at a management level, look for an MSO with one or more dentists in principal positions within the company.

Dentists Who Have Sold: Speak with dentist-colleagues who have been with the MSO for more than a year to see if they are content with their decision to sell. How are they fairing emotionally and economically?

Management Services: Ascer-tain that the company is staffed with an adequate management-support team. Promises of future profit expansion by the MSO are only as good as the support team.

Purchase Price: Is the proposed price fair and based on an appraisal? Consider how much of the practice purchase is being paid in cash vs. stock and in promissory notes from the MSO.

Terms: Assess the downpayment. How will the invested after-tax proceeds impact you financially?

It`s useful at this point to discuss the recent history of practice sales. In the not-too-distant past, a $50,000 to $75,000 downpayment was common in a traditional practice sale. The seller then generally financed the balance for five to 10 years, typically fixed at 1 to 2 percent above prime. Today, however, specialized financing firms like The Matsco Companies offer 100 percent financing, representing a far cry from the majority of sale transactions that transpired just two or more years ago. This availability of cash provides the seller with a ready-to-invest income source and eliminates the risk that, traditionally, has been involved in seller-financing. These terms can be quite desirable, particularly when there may be no personal guarantees on the financing. This new availability of cash has lessened one of the benefits of selling to an MSO.

Compensation for Clinical Services: To determine how future income from clinical services from the MSO compares to the dentist`s compensation prior to selling, first ascertain what the true net income from the practice has been. This should include all compensation and "perks," such as travel and entertainment, insurance benefits and automobile expense. (In many practices, perks can account for 5-20 percent of the total gross income of the practice. In such a situation, the pretax net income from a practice might appear to be only 30 percent; with these added perks, however, the true net of the practice could be as high as 35 to 50 percent.) This "true net" figure is important to calculate prior to selling to an MSO and should be part of any comprehensive practice valuation.

Next, decide the percentage the dental-management company is going to pay for the continued delivery of clinical services (or the portion of the practice gross or net the company is retaining for management) and over what period of time. Calculate the difference in compensation received as the owner vs. that after selling to an MSO. This figure, in essence, represents an ongoing "contribution" from the dentist-owner`s earnings to the MSO, offering a clearer rendering of the actual net price received by the seller for the practice.

Lastly, a word of advice: Due to the current frenzy in the marketplace created by MSOs, overzealous brokers, consultants and vendors have emerged and, in some instances, are overselling the concept to some of their clients who might not be good candidates for this type of situation. Keep in mind that it can be a quick commission for some, especially since the completion time of a transaction with an MSO can be one-half the time required to close a traditional sale. Also, many MSOs are offering referral fees to brokers, consulting companies and vendors as an added incentive for them to refer clients. Bottom line: Don`t rush into anything. Talk with qualified individuals, do your homework and run the numbers.

The decision to sell a dental practice, however, isn`t only a matter of dollars and cents. For dentists looking for a lighter work load free of day-to-day management concerns, an MSO may have some of the answers. Remember, though, that for many dentists, the same benefits can be achieved through a traditional sale.

As with most decisions in work and in life, there are advantages and disadvantages. Ultimately, it is up to the individual to find an acceptable trade-off. It is advisable, however, to compare offers made by MSOs to those from traditional purchasers. Some dentist-sellers prefer working with the doctors who purchase their practices over that of the "absentee owner" scenario utilized by MSOs.

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