THINKING BUSINESS
a blog by Chris Barrow

Building the £10m micro-corporate – Step 3 of 7

Valuation, Growth Potential and Property An ideal target would be a £500,000 practice that you can grow to £750,000 using the same number of surgeries (3) and perhaps the ability to add a fourth surgery and take the gross up to £1m. So how much is that £500,000 practice going to cost you? The “vox-pop” on practice valuations will inform you that an NHS contract value can change hands for up to 150% of value (165% of orthodontic contract value) depending on the location, size and appetite of the larger corporates in the area. There is no doubt that prices are, once again, at an historic high in the NHS sector. It would be as dangerous to say that the market is overheated now as it was to say the same in early 2008 (100% of contract value) and 1997 (35% of contract value). Nobody knows where it will end but the nature of cycles is that it will, perhaps after the artist formerly known as IDH floats, after Oasis changes hands (again) or some external event provokes a collapse in market confidence. Certainly the arrival of organisations like BUPA (health insurers), Sainsbury (retailers) and Denplan (existing suppliers) into the ownership landscape provide the fuel for change. Imagine a world in which Zurich (the biggest health insurer in the world), Asda (owned by Walmart – the biggest dental business in the USA) and Henry Schein (they did say “everything dental”) decide that ownership of the patient database is attractive for cross-selling? All of which, by the way, is a darned good reason for building your micro-corporate right now. Meanwhile, back in the leafy suburban cul-de-sac of private dentistry, the volume of transactions has been lower, the feeding less frenzied – until now. An economist would argue that a private dental practice is worth 4 times EBITDA which, for the non-accountants (like me) means: Earnings Before owner’s drawings: Add back Interest on loans and asset finance Add back Taxation Add back Depreciation Add back Amortisation (a fancy word to describe writing your capital loans off over time) The accountants reading this will howl – soz – but for you and me EBITDA represents what the business is really making if we take a look at income less expenses – the real world of money coming in and money going out. A lot of practices in the £500,000 zone tend to make around 25% after all expenses (fixed and variable) are paid – and that is where the 100% of gross comes from – 25% x 4 = 100%. A good economist will look at the actual EBITDA and pay 4 times that as a commonly accepted measure of the number of years the investor should take to get their money back. What we then have to add in is what is called the “opportunity cost” of the deal – an emotional measure of value that has bugger all to do with economics. Emotion can mean: You want to live in the post code and send your kids to school there. You want to flip or float your company and have time-activated targets to meet. You want to block any unwelcome competition. The opportunity cost will inflate or deflate the price, subject to market forces. It can work against the vendor if opportunity cost reduction is the result of ill-health, debt or divorce. So the dental entrepreneur picks his targets carefully, looks at the economic value (multiple of EBITDA) and the opportunity cost (negative or positive) before making an offer. Which means….. 1. taking a good long look at the last audited accounts and the latest management accounts (you must have up to date numbers) 2. taking considerable time to engage the vendor in conversation to assess the impact of any opportunity cost on either side of the deal. To quote Stephen Covey “seek first to understand, then to be understood.” But as the purchaser you also have you eye on the growth potential (upside) of the acquisition. 3. taking an equally good long look at the location, the existing common and clinical equipment, the business systems, the existing team (of which more later in this series) and the demographic and dental health of the existing patients. That’s why, after the initial emotional high of an offer in principle, the vendor often then faces 3-6 months of gruelling due diligence, whilst the purchaser checks to see if the reality is the same as the estimate of value. The tired practice is attractive in this respect. It may well be that the current owner has been losing his/her passion for the business in recent years and that reflects not just in the supervised neglect mentioned earlier but also in the fixtures, fittings and the attitude of the team. A good dental entrepreneur will have a sixth sense around this and, rather like walking into a prospective new home and seeing past the G-Plan furniture and chintzy wallpaper to imagine your interior design, you will see what the practice can become with your input and the passion of your team. There is also the subject of property. Corporates don’t want property because they cannot rely on market sentiment to uplift the multiple of a property valuation in their balance sheet or share value. They will offer the vendor a long lease, usually through a subsidiary company. As the owner of a micro-corporate, you DO want freehold property because that portfolio will form a valuable part of your overall asset base in 10+ years when you come to sell and aspire to be a landlord. In the meantime, your property portfolio will be a valuable bargaining tool with external lenders. The current owner may want the same, so part of your conversation is going to be about that and about the timing of a property purchase. I would advise against becoming the vendor’s tenant and press for a freehold sale at outset – the absence of that would make a deal a lot less attractive for you.

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