I’m not breaking any news by telling you that goodwill values in independent dentistry are overheated.
Yesterday I was asked to give an opinion on the proposed purchase of a small private practice less than 5 years old, moderately profitable for the last 3 years and offered at over 7.25 times adjusted earnings.
That may be the kind of risk that can be taken by a private equity firm with a 1:6 success ratio on investments, or a health insurer looking to cross-sell services to the patients.
For the independent buyer, it spells at least 3-5 years of extremely hard work to see any realistic return on investment – long hours of dealing with the initial transition of ownership, establishing oneself with the existing team/patients, often building a new management team and significant investment of time and money in finding new patients.
I seem to spend most of my time, when reviewing these proposed purchases, issuing all sorts of health warnings that can be summarised as:
“Are you really sure that you understand what you are taking on here?”
Most often, I listen to over-optimistic expectations of what it will take to make the new purchase worthwhile.
New buyers make the following mistakes:
- Under-estimating the hours, the support team and the additional cash (over and above the purchase price) that they will need;
- Over-estimating how quickly they will see a profit;
- Rule of thumb – work out your plan and add 40% to every estimate of cost and time.
In recent weeks I’ve spotted a trend that can be best summed up by a telephone call I took at home yesterday evening from a dentist who connected with me in June/July this year to look at proposed purchase details.
I analysed audited accounts for 2014-2016 and advised him to walk away from the asking price and the location.
Last night’s call began with “after looking at a number of practices for sale, I’ve decided that it may be best to consider a private squat – could you talk me through the basics please?”
That’s a small question with a big answer – much bigger than a Wednesday evening phone call – but I highlighted the following:
- Decide what type of dentistry you are going to be happiest to deliver for the next 5-15 years;
- Decide on the demographics who are most likely to want that type of dentistry;
- Look at post codes in your chosen general location to identify where your chosen demographics are concentrated;
- Look at locations within those post codes that are going to be easily visible and accessible;
- Investigate the likelihood of planning permission;
- Start the serious hunt for premises.
Then – as a parallel activity:
- Create a 3-year cash flow forecast to identify
- Initial capital outlay to open the doors;
- Number of chairs initially and eventually (I suggest 2 to begin with capacity for 4 – common mistake – only room for 2 chairs);
- Running costs month 1 to month 36;
- Sales targets realistically achievable month 1 to month 36;
- Additional capital requirement to fund the 36-month J-Curve in addition to initial establishment costs;
- Plan a marketing budget large enough to get you off the runway (suggestion £50,000 per annum for the first 3 years).
Often, I hear dentists tell me that they can open a private squat for less than £200,000.
That may well be to cut the ribbon on day 1 but they forget/don’t know that they have to revise to £400,000 over the first 3 years and run the numbers.
It’s hard to decide what’s worse:
- The Principal who has paid too much for a (sometimes poor) practice and has no money left to transition and expand or
- The Principal who hasn’t spent enough on a private squat and has no money left to grow.
I’m sure we are going to see a trend away from over-priced purchases and towards the squat – and it indicates a clear need for some kind of “Private Squat School” to teach dentists and managers what they will have to know before they embark on this dangerous journey and how to make sure they arrive safely at their destination.
That’s in addition to the “Just Bought a Practice School”.
Perhaps this trend will be the quiet beginning of a readjustment in goodwill values?
If we can get them back to around 4 times adjusted earnings, the next cohort of buyers will emerge, micro-corporates leading the charge.