I want to share with you an example of a dental practice that I was recently asked to take a look at from a valuation perspective. An independent private practice, which offers a full range of family maintenance services and a significant bias towards the provision of cosmetic and advanced treatment. One of “those practices” that would win an award at a dental awards ceremony. A practice that has been around for a while and that has an excellent management team and great systems as well as very experienced owner clinicians and well-trained associates and hygienists. In fact, it all looks absolutely fab-u-lous darling. Reading up to date management accounts I find that the practice has got total revenues of £1.2m and a pre tax profit of £300k per annum, split equally between the two owner clinicians. That’s a very commendable commercial result. The owners are reaching “the autumn of their career” and are beginning to look at exit options and, therefore, they have popped along to one of the independent valuers and asked them to take a look at the place. Said valuers have visited and have produced a report which indicates that the goodwill value of the practice including fixtures and fittings is in the order of £800k in the current market place. The freehold, which is owned by the partners, can of course be valued independently and may or may not form part of a sale. Along comes another dentist who looks at the numbers, has a look at the practice itself and is delighted by what he or she sees. In fact, the new dentist is very interested in living in this geographical area, keen to send his kids to local schools and relieved that his wife has told him this would be a lovely part of the country in which to raise a family. He’s also looked at a 25-year-old patient database and a very long established team and realises that in actual fact he can walk through the door of this place, pick up the patients from the retiring and departing dentists and probably generate a very similar level of profitability in a short space of time. There are two owners in the practice at the moment so he’s probably going to have to find a very good quality associate and/or a partner to go in on the deal with him so that he guarantee that each new owner’s average daily productivity is maintained. On this analysis, he needs to find £800k to buy the goodwill and is in a situation to put £250k of that down as a result of personal savings/family money/sale of a previous practice and he’s therefore tapping on the door at the clearing banks and asking them to support him on the other £550k. The good news is that the bank have been in, they’ve had a look at the proposition and have told him that provided that there is adequate bricks and mortar security either from his existing property portfolio or via the purchase of the freehold then they will more than likely support him on the purchase. So this story is heading for a happy ending. However, the existing owners wonder what it would be like if they pulled in an opinion from a dental corporate. So along comes the acquisitions manager from the corporate and carries out a different financial analysis.
What happens if we buy this practice and leave the existing owners in there as associates for the next 5 years?
What happens if the existing owners are now moved on to a 45% associate contract based on their own personal production? If we do that and if we run the numbers based on our own operating costs and the revised associate payments then what do we come out with as a bottom line proft (what the accountant would call the adjusted EBITDA)?
Well the interesting thing is that the adjusted EBITDA for this practice if we put the owners back in as associates is £50k per annum. So here we have the classic example of what’s known as “a lifestyle business”. This is a fantastic business designed to pay the owner’s an income and stop there, because there is no responsibility to provide a return on investment for shareholders. Hence the reason that most of the corporates are not buying private dental practices and equally the reason that those corporates who have bought private practices have often had their fingers burned. There seems to be a fundamental conversation which is missing in the goodwill valuation marketplace and that is: “Am I a dentist who is buying this practice as a lifestyle business and I want to replace the existing owners lifestyle with my lifestyle. Or, am I a corporate who is seeking to grow market share in this sector of the marketplace?” I would argue that the lifestyle valuation of this business is £800k but that the corporate valuation of this business is going to be closer to £200k (equivalent to four times adjusted EBITDA). That’s why at the back end of 2008 I performed over 70 independent private practice valuations on behalf of the IDH private and specialist division and did not make one single acquisition. In fact, after four months of very hard work, we realised that we were in the wrong place at the wrong time and my work shifted to improvement within the existing portfolio of private and specialist practices – a job which I thoroughly enjoyed and look back on with very fond memories. Here we are three years later with exactly the same problem in the marketplace. Which would seem to indicate that the only way that the owner of an independent private practice can get “out of the rat race” is to sell to another independent dentist who is prepared to pay “the lifestyle price” and step in! For me, this represents a challenge to the existing owners in finding the right purchaser but also of course as the freshly baked Managing Director of a new private dental corporate it presents us with a huge challenge in terms of acquisition. What I am definitely not going to sanction is a repeat of the mistakes made by earlier private corporates, some of which are still self evident in the marketplace. So, we have to “re-write the rule book” and start again with a completely new philosophy and a new approach to corporate acquisition of private practices. Right now I am working very closely with my management team to design that new approach. What will it look like? Well, at this particular point its too early to flesh out the detail but if you were to ask me to guess I would say that we need to come up with a brand new acquisition model which gives the existing owners another 5 – 10 years in the business of dentistry but with the opportunity of significant wealth improvement over that time – as stake-holders in the corporate. In simple terms, my conversation with the existing owner is to say “I can’t pay you £800k for your practice today but I can pay you £200k and give you generous share options in the corporate that we are building”. Some will say “well why shouldn’t I take my £600k now (the gap between what you will pay me and what an independent purchaser will pay me) – and then I’m out of the game and risk free?” Others may take the view “I’m interested in becoming involved in a venture in which I have share options and which could in a relatively short space of time return to me a multiple which would be far higher than anything I could achieve in independent private practice”. It’s that debate and how we flesh it out in numbers and at the same time give the prospective vendors security that is consuming my mind at this point in time. We hope to have some answers for you in the very near future but it’s an exciting proposition if we can get it right.