Jon Drysdale busts nine myths of buying and selling a practice.
There are quite a few misconceptions about buying a dental practice and I hear them all on a regular basis. Having been in a position to see things from both the buyer and the vendor’s perspective I can shed some light on the myths and realities if you are planning to buy a practice. Prospective vendors also take note as an understanding of your buyer can be useful when you come to sell.
Myth one: an agreement in principle can be transferred
Buying a business is not like buying a residential property – the loan arrangements are entirely different for one thing. There are a number of points to mention here but, fundamentally, banks will not supply an agreement or a decision in principle to a buyer without first examining the financials of the target practice. So, when a buyer makes an offer on a practice claiming to have pre-arranged finance, perhaps from a previously failed purchase transaction, the sales agent is unlikely to accept this for the reason that no two dental practices are the same. Before you make an offer, I recommend, where possible, you and your lenders consider the following.
Projected profit and loss accounts:
The bank needs to be sure that your new business will generate sufficient profit to repay the finance costs and supply you with enough income to live on. The best way to demonstrate this is by asking a dental accountant to prepare projections based on how you fit into the new business. The level of fees you personally generate can significantly affect profitability. Other adjustments will need to be made for expenses particular to the outgoing owner. For example, do they employ their spouse? Do they have other costs that go through the business that won’t continue beyond their ownership? Further to this, your profit and loss projections need to reflect the amount you wish to borrow at a ‘stress tested’ rate acceptable to the bank. By stress tested I mean taking into account possible rises in interest rates. For example, the actual interest rate achieved may be three per cent plus the Bank of England base rate (0.5 per cent at time of writing) but for the purposes of the projections the bank will assume rates are five per cent plus base rate. A good dental accountant will have experience of this and be able to include the appropriate figures.
The practice profile:
Fundamental information for the bank includes a breakdown of the fee income (NHS/capitation scheme/fee per item). They will be interested to know, for example, if you are purchasing a practice with high levels of fees per item how you intend to sustain this. Will the outgoing principal be staying on for a transitional period? Conversely, if you intend to replace a practice owner who performs high levels of UDAs can you demonstrate an ability to replicate this?
Sales agents are experienced at identifying whether a potential buyer’s finance arrangements have been given due consideration by a bank. Often, they will ask for direct confirmation from the bank that the case has been past a credit sanctioner or credit analyst. In order to get your proposal in front of a credit sanctioner you will need to provide a significant amount of personal information as well as the practice financials. Preparation of your personal information in advance of your practice search is worthwhile because presenting this quickly to a bank when you find a suitable practice may mean you are able to progress your finance case faster than other prospective buyers.
Myth two: all commercial banks understand dentistry
Relatively few commercial lenders actually understand the complexity of a dental practice purchase. While your local commercial bank manager may sound like they are keen to progress your lending proposition you should consider whether or not they are the right person for the job. If they are not, this could lead to a number of negative consequences. First, there will be a delay while they get to grips with your case. A delay of a just a few days could mean you lose out buying a popular practice where the agent has set a closing date on offers. Second, they will offer a rate that is not competitive. General commercial lenders who don’t offer a specialist dental lending service will probably offer a rate that is similar to other higher risk commercial enterprises. This means you could get the same interest rate as a local restaurant or hair salon. In my experience, banks that offer a specialist dental lending division also offer the keenest interest rates with the best service.
Myth three: using a broker is expensive
There tends to be a myth that using a broker to source finance will add cost to your transaction. This doesn’t need to be the case. Using a broker who is a member of the NACFB (National Association of Commercial Finance Brokers) means that such costs are kept to a minimum. Further to this, NACFB brokers are required to commit to minimum compliance standards and high ethical standards.
The other advantage of using a broker is that they will submit your case to multiple lenders and you should receive multiple finance offers. This allows you to select the best offer for you. For example, one lender might offer a slightly lower interest rate but a shorter loan term than a competitor. Another lender might insist on you using a residential property as security, others may not. The broker will negotiate rates on your behalf and help you decide on the appropriate offer. A broker will also have an appreciation of what rates should be achievable.
Myth four: it’s best to buy through a limited company
The tax advantages of purchasing a practice through a limited company are enticing. Effectively, this would allow you to buy a business out of income that you haven’t had to pay personal tax on – the purchase would be a business expense of your company. However, if you are purchasing an NHS practice the option to purchase through a limited company is unlikely to be on offer. This is largely because the vendor will not want to stand the risks involved in the transfer of the NHS contract to a limited company because of the risk that the local area team imposes a ‘change of control clause’ in the contract – effectively devaluing it. A vendor (and his or her advisers) will simply not take the risk of this scuppering the sale. Insisting you wish to purchase an NHS practice through a limited company is unlikely to be productive.
Where you intend to purchase a private practice, things are different as the contract transfer is not a factor. However, you should seek appropriate dental accountancy advice to ensure the purchase is structured correctly. Consideration must be made to your eventual exit strategy at the outset, with issues such as who owns the shares and in what proportion on the agenda for discussion.
Myth five: you should always negotiate directly with the vendor
Where the vendor has a number of buyers to choose from it is likely they will take a variety of factors into consideration before selecting a purchaser. Availability of finance is key to this as mentioned previously. Other factors will come into consideration by the vendor. Often you will be purchasing through an agent and your communications with the agent are important. Attempting to negotiate with the vendor directly will more than likely be counterproductive. Vendors tend to use an agent to avoid being put under direct pressure.
Myth six: the sales agent is acting for both vendor and buyer
The sales agent is key to helping the vendor select the most suitable buyer. Simple things such as turning up on time for a practice viewing and keeping in regular contact with the agent can help your cause. You may also be required to be flexible over points of negotiation. A potential buyer who is using a non-dental lawyer could be a red flag to a sales agent because of their likely inexperience with the complexities of dental practice transactions. This usually causes complications with the purchase further down the line and agents will be nervous of a potential buyer who is not supported by specialist legal advice.
A further red flag is a potential buyer who has withdrawn from a previous sale without good reason or explanation. It is important to only make offer on a practice you definitely wish to purchase, having considered the financial projections as described above. Many practices that come to market, and especially ones with an NHS contract, will receive multiple offers. You will be one of a number of potential buyers and it is likely that the vendor will go for not only the highest offer but also the offer that the sales agent perceives as likely to succeed – on the basis of who is making the offer and how serious they seem to.
Myth seven: there are penalties for paying off loans early
Commercial loans tend to be more flexible than residential property mortgages and there is usually no penalty for early repayment. The banks tend to consider the serviceability of your loan as a key factor. This simply means that they need to be reassured that after your personal drawings you are able to repay the monthly loan costs. I referred to providing projections earlier as a means of demonstrating this and it is worth considering that the term of your loan has a fundamental effect on these projections. Opting for a longer loan term reduces the monthly finance costs as per table 1.
While opting for a longer term will mean a higher amount of total interest, it may be advisable to do so to ensure the serviceability of your loan is acceptable for your bank application. Once your loan has started there is nothing to stop you overpaying – this incurs no penalty and has the effect of reducing the term of borrowing.
Myth eight: specialist legal advice is expensive
A non-dental solicitor may provide an estimate of fees for a purchase transaction that they can’t deliver on. This is usually because they have limited or no understanding of the NHS contract process or such issues as CQC transfer of ownership requirements. This will mean that first, they may not be suitably experienced to provide you with appropriate advice and second, they will take longer on the transaction than is necessary, probably with additional fees due for unexpected work. Conversely, a dental solicitor will provide a fixed fee quote with confidence that they have included all the relevant factors.
Myth nine: a practice valuation is not always necessary
Most practices on the open market tend to find their value naturally. You should still take care with any purchase to ensure you are paying a fair price. This might involve instructing an independent valuation of the goodwill and equipment of your target practice. The need for a valuation is never more apparent than where you are buying as an associate in situ. This is true whether you are buying into a partnership or purchasing the entire practice. Often a practice owner will get a (free) price ‘evaluation’ of their practice from a sales agent keen to sell it on the open market and use this as a guide when negotiating with an incumbent associate. You should beware of this method of so-called valuation. Buying 50 per cent of a practice is not necessarily worth half the entire open market practice value.
Choosing a suitable valuer is important. They should be independent of your target practice and a specialist in their field. Beware of using your accountant if they aren’t a dental specialist. Anyone using a percentage of turnover as a guide to the value is probably way off the mark and this should never be relied on as a valid valuation method. Banks will expect you to have a valuation on an EBITDA (earnings before interest, taxes, depreciation and amortisation) basis. This reflects the true profit of the business you are purchasing and is the prevailing valuation method for dental practices.
Summary
A successful practice purchase relies on identifying which factors are important and which are simply myths. Taking specialist advice from those who arrange dental finance regularly or those whose work in the industry such as dental lawyers, dental accountants and dental finance brokers is a good starting point. As demonstrated above, this will enhance your buyer credibility with a sales agent, which can be especially useful where you find yourself in competition with other buyers.