Buying a dental practice is an exciting time in a dentist’s career. It’s also an important time to ensure that you are getting the right, trusted advice from your accountant and solicitor.
But there are financial matters that need to be considered before making that next step of purchasing a practice.
We’ve asked Helen Wilson, Senior Client Manager, for a rundown on the financial issues that need to be well thought out during the 3 P’s- practice purchase process!
Over to you Helen…
As said above, one of the most exciting times for a dentist is when they have the opportunity to be able to purchase their very own practice. Like with any huge life changes, there are various things that need to be considered and thought through, before taking that leap and beginning the buying process.
Buying a dental practice – from initial valuation to purchase
I’ve outlined below why the valuation of a dental practice and knowing the importance of cash flow are important, before making that all important decision.
The early financial considerations
We usually first hear from our clients about buying a dental practice when they’ve researched and found some practices of interest through various dental sale agents.
The first things to consider when purchasing the practice are:
- Is the goodwill or share valuation a realistic valuation for the dental practice?
- What is the current business structure of the dental practice and what will be the business structure if I purchase the dental practice?
- What deposit will I need for the purchase?
- What will the actual cash flow be if I were to run this business?
- Is the property being sold?
- Can you see areas of improvement or growth that can be implemented to increase profits at the practice?
The two most important issues to consider first are the valuation and the expected cash flow.
Valuation
Dental practices are commonly valued as a multiple of the adjusted Earnings Before Interest, Taxation, Depreciation and Amortisation (EBITDA). EBITDA is a measure of operating profit and has its advantages and disadvantages when analysing the dental practices finances.
Sales agents will consider a number of years of historic financial statements for the practice, as well as year to date financial information. They will create an adjusted EBITDA for the dental practice for prospective purchasers to review. It is important to recognise that these figures will paint the practice profit in the best light, and the sales agents will adjust for various expenses, such as non-recurring repair costs, the outgoing principal’s professional costs etc.
Adjusted EBITDA may be calculated on an owner-led basis or on an associate-led basis. If you are going to buy the practice and work there as the principal dentist, it is important that you consider how much turnover you realistically think you will generate, as the principal dentist, taking into account the additional administrative duties you will be required to undertake, compared to when you are an associate. If you are going to generate more or less fees than stated, the EBITDA needs adjusting.
The adjusted EBITDA figure will then be multiplied by a valuation factor, to arrive at the valuation of the dental practice. The higher the EBITDA, the higher the valuation. However, the valuation factor can differ depending on:
- The type of income the practice generates
- The location of the practice, size of the practice
- State of repair or disrepair of the practice etc
A dental practice with an adjusted EBITDA of £200,000 located in Manchester, may have a significantly different valuation than a practice located in East Anglia with the same EBITDA for example.
EBITDA is a fairly useful metric, but cash flow is the most important metric when buying a dental practice. Which brings me to my next point…
Cash flow
‘Cash is king’ – this phrase is often stated in business and when purchasing a dental practice, cash flow should be your number one concern and is much more important in understanding the financial viability of purchasing the dental practice compared to EBITDA.
When buying a dental practice, two of the largest expenses a dentist will have each year are the tax liabilities on the profit and the loan repayments for the loan taken to purchase the practice. EBITDA considers neither of these and so its value is limited compared to cash flow.
A cash flow forecast should be prepared, which considers what the free cash flow of the dental practice will be. Free cash flow can be calculated as expected EBITDA, less repayment of borrowings, less tax and less expected capital expenditure.
It is free cash flow that the dentist will see each month for their own drawings, and each dentist will have their own idea on an acceptable free cash flow for the investment they are making into a dental practice. It is free cash flow that will be used to pay for the dentists personal living expenses, and it needs to be high enough to ensure standard of living is maintained.
Free cash flow will be impacted by the following:
- Business structure – is the dental practice being purchased as a sole trader, in partnership or by a limited company
- How much do you need to borrow?
- What is the interest rate on the borrowings and is this fixed or variable?
- What term length is being offered on the loan?
- Is the property being purchased or leased?
The business structure will impact on the level of tax payable by the business and the timing of the tax payment. Purchasing the business as a sole trader will result in you paying income tax and national insurance on the profits in full, whereas purchasing in partnership with another GDC registered individual will see the profits being split between the partners, and the tax liabilities may be lower. A company buying the dental practice will see the company paying corporation tax on the profits and the overall tax, (including income tax on the dentist’s income from the company) is likely to be lower than the tax paid by a sole trader or partnership.
Business structure is an important decision to make, and this can be made when looking at cash flow. The business structure will depend on the type of practice being bought, and whether the dental practice assets are being sold, or the shares in an existing dental practice trading company.
Borrowings will need to be assessed to determine the monthly loan repayments payable by the dentist. At this part of the purchasing process, you may not know exactly how much you will need to borrow, the interest rate or how the loan term but the free cash flow forecast can be adapted, to factor in different scenarios and how this affects cash flow.
Once free cash flow has been calculated, the dentist can then make a decision on whether the financial rewards of the practice are enough to warrant the purchase of the dental practice. The extra responsibility taken on as a principal dentist, as well as the additional borrowing should come with increased financial reward for the dentist, compared to being an associate dentist.
We’re here to help
If you are considering buying a dental practice but aren’t sure where to start, we can help. We will take a look at all aspects of the practice purchase- from valuations, free cash flow forecasts, helping you with the funding of the practice, financial due diligence and much more! To speak to our team on how we can assist, give us a call on 0151 348 8400.
