Key Considerations During a Dental Practice Transaction

August 2019 | Article

By Chad Flanagan | Kristin Taffe and Scott Haberman

A key consideration for many dental practices is growth. While this may occur through the addition of physicians or expansion of a building, it can also happen through acquisition.

The acquisition of a new dental office can happen for any number of reasons. Two dentists may join forces to conquer an existing geography together. Or, a dentist may purchase an existing practice from a retiring doctor.

If you’re considering expanding your dental practice through acquisition, there are several items to look for and important considerations to keep in mind.

Purchase Agreement
New practice owners often overlook the details in the purchase agreement. You want to negotiate the best deal to purchase a practice, but what does that look like from a tax perspective? To understand this, you need to consider if this is a stock sale or an asset sale. 

In a stock sale, the buyer is buying the equity of the existing business, and therefore stepping into the shoes of the exiting owner in terms of operations. Because of this, the buyer is unable to benefit from restarting the depreciable lives on the equipment purchased. The buyer is also responsible for the liabilities of the company, which could have a future impact on operations.

  • In a stock sale, the buyer is buying certain assets for a specified price. Common assets purchased and the buyer’s tax treatment of those items is as follows: Supplies and inventory: these items have the potential to be deducted for tax purposes in the year of purchase.
  • Fixed assets: these depreciable lives of these assets are restarted and the buyer is able to depreciate the value of these assets for tax purposes
  • Intangible assets, such as goodwill: goodwill can be amortized for tax purposes over a period of 15 years instead of deducted in the year of purchase. With time value of money in mind, a deduction today is worth much more than a deduction 15 years from now.

The type of sale and the allocation of the purchase price can impact the tax consequences therefore, it is critical to take this into account during negotiations.

EBITDA
A key factor in any transaction is EBITDA, or earnings before interest, taxes, depreciation and amortization. This is a measure of the company’s overall financial performance. EBITDA is an important measurement in due diligence because it considers profitability within an organization without the impact of certain management decisions, including capital purchases (reflected in depreciation) and debt load (reflected in interest expense). A buyer should consider normalization adjustments to EBITDA, including market compensation and market rent expense, to ensure the profitability of the company is properly reflected. This is why a due diligence process is essential to the purchase of a new practice.

Due Diligence
Another important aspect to consider in an acquisition is the state of the company you’re purchasing. This is another area in which due diligence comes into play. The due diligence process ensures all the information associated with the transaction is considered and up to date. This includes financial, operational, tax, and human resources.

Want to learn more about due diligence? Check out this step-by-step guide.

Why is due diligence necessary? The financial statements and pro forma from the selling practice are not audited or verified. The profit and loss statement can be misleading. Due diligence allows a team of advisors to review the business’ information and look for errors, omissions, outdated information and so on. This information is key as you try to get a full picture of the practice you’re looking to purchase.

Here are a few questions to consider as you look at buying another practice:

  • What are the practice’s projected growth goals? Are they concentrating on a particular customer? If so, how will that affect you?
  • Are there unique events in revenue streams artificially inflating historical earnings or cash flow?
  • Can current technologies meet your demands? Or will additional investments be required post acquisition?
  • When was the last independent audit completed?
  • How will working capital be treated in your negotiations?
  • What has overhead looked like in the past few years? Is it reasonable?

These are just a few of the questions to consider as you examine the overall current and future health of the practice you’re looking to acquire.

Measure Success
As with your current practice, it’s important to solidify what measurements you’ll use to determine success as your practice grows. Developing metrics that will help you make informed decisions is critical. As your new practice becomes part of your existing entity, what will you measure? How will you benchmark progress?

The first step is to keep it simple and choose a few metrics to track. Then, benchmark those numbers against industry standards or a goal you’re hoping to achieve. Also, ensure you know who is responsible for each metric and its success.

Go Back to the Basics
Throughout the entire life cycle of your practice, it’s important to remember to start with the basics. Ensure the financials for your existing company are in good working order. Are your systems up to date? Are they giving you the information you need to make sound business decisions? Do you have the correct documentation for your own financials as well as what you need for a future acquisition?

Having a clean set of financial statements that you can read and interpret is very helpful when it comes to obtaining the best financing and making the best decisions.

What is a balance sheet?

The balance sheet is a snapshot of the assets of the business such as bank accounts; equipment and goodwill, as well as liabilities such as credit cards and practice loans. The difference between the assets and liabilities is your equity, or net worth, of your practice. Want to learn more?

You can prevent pitfalls by taking the time to invest resources into the accounting and finances of your dental practice. Here are a few simple steps to consider.

The Moral of the Story
There are several things to consider as you look to grow your practice. Accurate records combined with a clear view of the practice you’re looking to acquire and overarching goals for your business will help you ensure this purchase is right for you.

Have more questions? Contact your Eide Bailly professional, Chad Flanagan, Scott Haberman, or a member of our dental practice team for more information.

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