We wrap up our acquisition discussion by hitting on some frequently asked questions about some situations in practice purchases that do not fall neatly within the examples we’ve discussed in the previous musings on this topic.
Of course, every situation is unique and it would be impossible to cover everything here, but here are some outliers that we’ve seen frequently enough that you will probably stumble across a couple of them if you are serious about practice acquisitions.
How do I value a practice that is experiencing a severe decline in the patient base?
This one comes up regularly – especially if you scour the classifieds for potential acquisitions. The situation usually works along the following lines: a retiring doctor decides to put his or her practice up for sale and simultaneously stops seeing new patients. So, the practice begins to wind down. For whatever reason, that practice stays on the market for an extended period. The patient base continues to dwindle with each passing month. Perhaps on top of that, a dental chair goes out of service and instead of getting the repair guy out there, they decide to leave it for the next guy. The practice is going to sell any day now, right?
By the time you come across the practice, you are looking at a practice with a shrinking patient base, no new patients coming in and broken equipment. How do you value this one? If the practice has less than $50,000 of patient contract balances on hand, the value of the existing patients is essentially worthless. You are basically looking at a brand new, or de novo, practice. The value of the practice is the value of the fixed assets (leaseholds, equipment). Your decision becomes this: do I want to build a new office with new equipment or do I want to take this office at a reduced price (with an older facility and older equipment, you should obviously pay less) AND be in production without waiting the 6-9 months to build out a new facility? This is a little different than projecting based on what you can do with the existing practice because you will be starting from scratch.
Location becomes a major consideration here. If you love the location, you may have a steal of a deal on your hands because you buy the facility at a reduced price, new patients come rolling in and within a short period of time, you’ve got the income necessary to make additional improvements or put in your own pocket.
What about the “paid-in-full” practice?
We see this one less frequently, but enough to address here. Whenever the selling practice signs a new patient, the contract is turned over to a finance company. The finance company takes its piece and sends the remaining value of the contract to the doctor. So, the doctor has his or her money up front. All that’s left to do is to treat the patient. Or, the doctor may charge a large down payment, or they may collect the entire fee over the first 6 months of treatment. Whatever the specific situation, the practice now has a bunch of patients that owe nothing, but will incur cost to treat those patients until treatment is complete.
For an acquirer, that creates a serious problem. When you walk in, you may be acquiring 300 patients that owe nothing, but will also cause you to incur cost to treat them. You cannot simply assign them a $0 value because there is a net loss to you for seeing all of these patients.
This needs to be accounted for as an adjustment to your purchase price. You could go through each patient, compute an expected remaining cost (take your normal monthly cost and multiply it by the number of months remaining for each patient) or come up with a general expected number by taking the average number of months remaining and computing the number of days to see those patients and that cost per day. That would be the adjustment to the price.
Here, the key to the valuation becomes the number of new patients coming in each month. If you are going to keep the same payment/financing plan or not, if the practice simply does not have material new volume coming in each month and you are adding cost for the existing paid-in-full patients, you are looking at something even less valuable than a brand new practice. Consider your price accordingly.
A few other questions:
For a normal ongoing practice, why don’t you take into account the newness of the equipment?
The real value of a practice comes from the patients – contracts, doctor relationships, name (potentially), etc. The fixed assets of the practice need to be in working order, but whether not a practice has brand new chairs or chairs that are a bit older doesn’t really have a material impact on the future patient flow or success of the practice. Equipment value certainly does come into account if you feel strongly that something like a new X-ray machine or Suresmile system will attract extra new patients. But normally, as long as it is in working order, equipment value a relative constant.
How do I value existing patient contracts?
Here’s a simple system that we’ve used over the years. Any patient contracts that are more than 120 days past due are valued at $0. The old practice couldn’t collect them and your chances a probably slim as well. 90-120 days are discounted 80%. Again, your chances of collecting funds are slim. Balances 60-90 days past due get discounted 30%.
After that, any balances current to 60 days past due and any unpaid balances can be valued at 100% of their current book value. When you combine all of those, those percentages should match or exceed the selling practice’s historical bad debt rate.
Of course, there’s a lot more ground to be covered on this topic. So, if you have specific questions, please let us know. We’ll be around.
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