Let’s Buy a Dental Practice – Part 2

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Let's buy a dental practice!

This article is the second in a series about buying a dental practice. I based all of these articles off of a Student Doctor Network thread by the name Let’s Buy a Dental Practice and written by user The Hammer. I found the original thread on SDN to be very insightful back when I first read it in 2010 and I always wanted to adapt it into an article. Although the original thread is now eight years old, many of the ideas and concepts are still useful today.

Where Should You Live?

Hammer argues, contrary to popular opinion amongst dentists, that cities are centers of opportunity for new dentists. He says that more dentists are retiring every year than are graduating from dental schools. However, he couldn’t have foreseen that seven new dental schools would open after he created this thread.

As you will see shortly, I believe that this part of the original thread is probably the weakest. Much of what Hammer says here is either untrue, or perhaps half-baked. I offer evidence contrary to his claims not to diminish the value of everything else he says, rather to present you with a more accurate account of the realities we face in this profession.

After a bit of research, I found some data from the ADA’s Health Policy Institute (HPI). According to HPI, the supply of dentists in the United States is actually expected to grow. Many factors are contributing to this. First, the average dentist in 2001 retired at 64.7 years old. In 2015, that number was 68.8 years old. Second, on average, a new dental school opens in the United States every year. The Health Policy Institute estimates that the number of dentists per 100,000 population will increase from 61.7 in 2013 to 63.3 by 2033.

All of that aside however, Hammer still makes some good arguments. It is true that larger cities tend to fair better in economic slumps than do small cities and rural areas. Also, small towns tend to rely more on one industry, a phenomenon Hammer dubs the “Detroit Effect.” Ironically, Detroit was one of the largest US cities at one time, so that may not be the best example of a small one-industry town.

Rural benefits

Hammer sees many advantages to working in rural communities. Practices may be had more cheaply than their urban counterparts, and starting a new practice is probably more likely to succeed than in more populous areas. Cost of living is cheaper, and startup costs are lower. You probably don’t need to spend as much on marketing because word of mouth will probably suffice in rural communities. Employees will probably demand lower compensation, and the cost of goods and services in the community will be cheaper.

Many of the cons Hammer lists for rural communities are standard fair. Everyone knows each other, which can be a good thing, but it can also diminish your prospects for real privacy. You will almost certainly have to treat children, so if that’s not your bag then think twice. Because rural communities experience a dearth of specialists, you may be forced to perform procedures outside of your comfort zone. Dentists in rural communities may also have to accept PPOs and Medicaid.

Real World Examples

Hammer gives us some example practices and then asks which one we would choose to buy, all with an assumed overhead of 65% for simplicity:

Practice 1:

  • Average Gross: $583,000
  • Operative: $450,450
  • Hygiene: $132,550
  • Days: Mon-Fri 8-5
  • Active Patients: 3,400 (80% insurance, 20% cash) general dentistry some endo, no ortho
  • Building: Rent with option to buy. Freestanding
  • Equipment: Purchased within the past 10 years. Computers w/EagleSoft, no digital x-ray
  • Price: $429,000 ($394,000 plus $5000 agent fee, $30,000 working capital)

Practice 2:

  • Average Gross: $1,130, 613
  • Operative: $ 791,429
  • Hygiene: $ 339,184
  • Days: Mon-Thurs 7-5
  • Active Patients: 4,000 (Insurance 50%, cash 50%) general dentistry, implant placement and restoration, some ortho
  • Building: Rent
  • Equipment: Bought within the past 5 years all up to date digital, computers etc.
  • Price: $904,000 ($850,000 plus $54,000 working capital)

Practice 3:

  • Average Gross: $365,158
  • Operative: $237,350
  • Hygiene: $127,808
  • Days: Mon, Tues, Thurs 8-5, Weds 8-12
  • Active Patients: 1,200 (Insurance 60%, cash 40%) maintenance dentistry, dentist is 70 and retiring
  • Building: Rent with option to buy
  • Equipment: Chairs and delivery units good, no digital, no computers, old x-rays, new panoramic x-ray, everything else is old
  • Price: $289,000 ($239,000 plus $50,000 working capital)

Practice 4:

  • Average Gross: $850,000
  • Operative : $450,000
  • Hygiene: $400,000
  • Days: Mon-Fri 7-6
  • Active Patients: 5,500 (40% Insurance, 30% Medicaid, 20% HMO, 10% cash)
  • Building: Rent
  • Equipment: Bought in the last 10 years, computers, no digital x-ray
  • Price: $600,000 ($570,000 plus $30,000 working capital)

If you read the Practice Acquisitions article I wrote a few weeks ago, you may remember that George told us to look closely at hygiene. If the hygienists are contributing more than 20% to the gross production, then there is plenty of room for growth. Notice that hygiene accounts for nearly 50% of total production at practice 4. Also notice that hygiene isn’t much different between practices 1 and 3, even though practice 1 generates somewhere around 40% more annually.

However, other factors come into play. For example, practice 4 has very undesirable hours. Practice 2 is the most expensive, and probably has less room for growth than some of the others. Practice 1 is priced right for a new graduate and seems to offer enough production to make it worthwhile.

Before we jump into the numbers, remember that none of these calculations take into account student loans. Whatever your final net income turns out to be, it will be a lot lower once you pay back Uncle Sam.

Practice 1 – The Sure Thing

  • Average Gross: $583,000
  • Operative: $450,450
  • Hygiene: $132,550
  • Days: Mon-Fri 8-5
  • Active Patients: 3,400 (80% insurance, 20% cash) general dentistry some endo, no ortho
  • Building: Rent with option to buy. Freestanding
  • Equipment: Purchased within the past 10 years. Computers w/EagleSoft, no digital x-ray
  • Price: $429,000 ($394,000 plus $5000 agent fee, $30,000 working capital)

Hammer says that practice 1 is an ideal situation. Regular insurance, no reduced-fee plans except Delta Dental, no Medicaid, and decent hygiene recall. The practice is well established, having been at its present location now for decades. The equipment is aging but doesn’t require immediate replacement. Hammer likes that you have the option to buy the freestanding building.

According to Hammer, the asking price of $394,000 (67% of the $583,000 production) is acceptable. George Hariri explained why the percentage of production measurement is mostly useless, but for the sake of this article we’ll go with Hammer’s info.

Running the numbers for the sure thing

The loan will amount to around $429,000 (in 2010 dollars) at 7% over seven years. That brings your monthly note to roughly $6,474. The practice will make $48,583 per month with an assumed overhead of 65% for simplicity’s sake. You will be left with $17,004 before servicing your debt and $10,529 after. That will land you somewhere north of $120,000 gross take home pay annually.

Hammer says that his first practice was similar, producing about $400,000 annually. Seven years later he says that he was producing $890,000. In his opinion, this is a great purchase opportunity.

Practice 2 – The Cadillac

  • Average Gross: $1,130,613
  • Operative: $ 791,429
  • Hygiene: $ 339,184
  • Days: Mon-Thurs 7-5
  • Active Patients: 4,000 (Insurance 50%, cash 50%) general dentistry, implant placement and restoration, some ortho
  • Building: Rent
  • Equipment: Bought within the past 5 years all up to date digital, computers etc.
  • Price: $904,000 ($850,000 plus $54,000 working capital)

The asking price is higher than the previous practice relative to gross production ($850,000 is ~75% of the gross production). Again, Hammer is going with the flawed metric of comparing price to production. He does offer anecdotal evidence that the asking price is too high for the area however. Because the price may suggest that the owner thinks more highly of it than he should, Hammer believes that he may reneg on a sale and leave a potential buyer in the lurch. He insists that it happened to him straight out of dental school.

Hammer also jumps to the conclusion that the seller may need the money badly for retirement. Again he says that in his anecdotal experience, this is a common occurrence. He worries this will make the seller inflexible with the price.

Running the numbers for the Cadillac

The loan will be $904,000 (in 2010 dollars) at 7% over seven years. That amount will demand a loan payment of $13,643.

The practice is grossing $1,130,613 then it really earns $1,108,000 with a collection rate of 98% (the amount you actually receive for billings). Your practice will therefore earn $92,333 per month. With 65% overhead, your pre-tax take home monthly salary is $32,316. Subtract the loan repayment from that ($13,643) and you are left with $18,672.

$224,064 seems like a fairly healthy income, but Hammer insists that there is more going on here than initially meets the eye. First of all, the ADA and private management companies tell new owners to expect a 25% drop in production after purchasing a new practice. This may be due to a variety of factors including loss of patients, the new dentist may be less efficient than the selling dentist, or the new dentist may under-diagnose patients to avoid arousing suspicion from patients.

A 25% drop reduces your income from $92,333 per month to $72,250 which, accounting for 65% overhead, works out to $25,287. Subtract your loan repayment and your pre-tax income is now $11,643. Not bad still, and though you may hope to recover that 25% loss it could turn out to be somewhat difficult.

Work like a dog

Realize that the current dentist is producing $791,429 to create the gross production of $1,130,613. That is a lot of pressure for a new dentist and will likely lead to burnout rather quickly. For a practice with gross production this high, you have to ask how the dentist is doing it. Because Hammer personally knew the seller, he was able to provide some insight into the methods he employed to produce so much.

  1. Placing immediately loaded implants and advertising “same day implants” to his patients.
  2. Producing a high volume of conventional orthodontics and Invisalign.
  3. Using high pressure sales techniques to increase case acceptance.
  4. Running marketing campaigns on television, billboards, radio, and in print publications.

Hammer also mentions that this practice is running closer to 75% overhead. That, with everything mentioned earlier made this deal unattractive to him. In summary, these are the reasons he passed on this practice:

  1. The asking price was too high.
  2. He saw little financial security in case of lost production due to the expensive loan.
  3. A buyer will have to run the practice almost the same way as the seller to maintain such high levels of production.
  4. Hammer doesn’t place implants or do orthodontics without taking care of the whole mouth.
  5. High overhead is a problem.
  6. Hammer worries that the seller is too emotionally involved with his practice to be reliable.

Practice 3 – The Goldmine

  • Average Gross: $365,158
  • Operative: $237,350
  • Hygiene: $127,808
  • Days: Mon, Tues, Thurs 8-5, Weds 8-12
  • Active Patients: 1,200 (Insurance 60%, cash 40%) maintenance dentistry dentist is 70 and retiring
  • Building: Rent with option to buy
  • Equipment: Chairs and delivery units good, no digital, no computers, old x-rays, new pano, everything else old
  • Price: $289,000 ($239,000 plus $50,000 working capital)

Hammer, like George Hariri, looks closely at hygiene numbers. In fact, he says that the hygiene department’s production numbers jump out at him immediately. At roughly 1/3 of total gross production, the hygiene department indicates that this is a healthy practice with plenty of room to grow. Hygiene is clearly doing a better job here than at practice 1, and slightly better than at practice 2 when compared to the total gross production.

My own personal observation, this is an older dentist working 3.5 days a week. Obviously there is plenty of room to grow the schedule out, and unless this older dentist has kept up with his CE, there may be lots of treatments he could offer and doesn’t. Despite the light schedule, he still has 1,200 active patients which suggests he has built a trusty patient base and a trusted practice.

Running the numbers on the goldmine

The loan amount would be $289,000 (in 2010 dollars) and you would need another $50,000 to put towards improving the practice. Hammer starts us with a $339,000 loan at 7% over seven years. The monthly payment works out to $5,116.

The practice is producing $365,118 which will earn you $357,854 assuming 98% collections. Assuming our 65% overhead you are left with $125,249 which comes to $10,437 per month. After paying for the loan, you are left with $5,321 per month.

Remember that this is how much you make working 3.5 days per week at the pace of a soon retiring 70 year old dentist. There are many reasons that Hammer sees this opportunity is a gold mine:

  1. You will almost certainly be working faster than a 70 year doctor who is nearing retirement even when you are fresh out of dental school.
  2. The current doctor’s fees are low. Hammer says that you can increase them while still remaining the lowest in the area and boost your production by 21%. He insists that patients won’t notice.
  3. He says that the practice’s overhead is actually 52%.
  4. The community this practice is in has 36,000 people. At 44 years old, Hammer says the buyer would be the youngest dentist in the community by a decade.
  5. Located across the street from a hospital, it is ideally located. It is in a plaza with 8 other doctors. The building is owned by an LLC consisting of other doctor tenants and the seller owns 1/6 of the LLC. He is willing to sell his share to you for $130,000 at 7% over ten years and he will carry the loan. This means that the buyer gets the tax deduction of paying rent, and because they is a partner in the LLC the rent money comes back to him to pay off his loan.

It’s a steal

There are a couple of additional items that make this practice a steal.

  1. It is situated between two oral surgery offices, allowing the buyer to be the main restorative dentist for both.
  2. The practice is also located between two periodontal offices which is good for the same reasons.
  3. This office is 30 minutes away from Hammer’s old office, meaning ads for his new location could attract some of his patient base from his old office.
  4. A nearby dentist is retiring due to health problems. He would agree to sell charts to the buyer of this practice for $10 per chart. The dentist has 2,100 charts that are now in the care of Hammer. He would charge a $25 copy fee for any patient needing a copy of their chart but not wanting to join the practice.

More to think about

Hammer was asked three questions by another user. The first was how quickly he will hike his fees after taking over the practice. The second was what kind of technology he would plan to buy. And the last question was how his previous partner feels about him moving back into the area after selling his share of their practice. He answered the questions as follows:

  1. He would increase restorative fees immediately but not by much. Over the next two years he will increase them steadily to increase production by the amount discussed earlier. He will leave hygiene’s fees alone because patients expect free cleanings even if they have to pay a lot for a crown.
  2. Hammer plans to install a digital x-ray system. He also plans to replace two e-ray units with new Gendex units (2010 remember), a new autoclave, converting the panoramic x-ray to a digital system and installing a new computer system because the practice currently does not have them. He also plans to install 35″ HD plasma monitors in the operatories for patients to watch cable and so he can show them intra-oral images and radiographs. Hammer plans to spend $52,000 for all of this.
  3. Long story short, Hammer sold his share of the practice to his partner but not before his partner went to an attorney behind his back and used Hammer’s divorce to leverage a better deal for himself. The moral of the story here I suppose is that where money is concerned, you really can’t trust anyone.

Hammer then talks about some very personal details in his life. He and his wife were expecting but lost the child. Their marriage disintegrated as he was trying to build his practice. The stress got to him and he was eventually burned out on dentistry. These are all of the things you can’t really factor into your business decisions but you hope will never happen to you.

Practice 4 – The Shiny Trap

  • Average Gross: $850,000
  • Operative : $450,000
  • Hygiene: $400,000
  • Days: Mon-Fri 7-6
  • Active Patients: 5,500 (40% Insurance, 30% Medicaid, 20% HMO, 10% cash)
  • Building: Rent
  • Equipment: Bought in the last 10 years, computers, no digital x-ray
  • Price: $600,000 ($570,000 plus $30,000 working capital)

The numbers

The asking price is 70% of the gross which Hammer says is a little high. A loan of $600,000 at 7% over seven years is a monthly note of $9,055.

The average gross is $850,000 which is $833,000 with 98% collections. That will net the buyer $69,417 per month. Accounting for 65% overhead the buyer is left with $24,296. The loan cost of $9,055 leaves $15,240 per month or $182,880 annually.

The trap

We learned from George, and I think Hammer tends to agree, that hygiene as a percentage of production is very important. Hammer points out that hygiene is producing 45% of the total production at this practice. George thought that hygiene above 30% was a strong indication that the practice has lots of untapped potential. But Hammer finds the 45% number to be disconcertingly high for the following reasons:

  1. The dentist is just slowing down like the 70 year old owner of practice 3. However, this practice is working 55 hours a week, so that doesn’t seem likely.
  2. There isn’t enough operative work. But with 80 new patients per month on average, this shouldn’t be a problem.

Given that this practice has 5,500 active patients and operates 55 hours per week, Hammer asks where is the money? Looking at the active patient numbers, we see that 30% are Medicaid and 20% are HMO (reduced-fee). The dentist is working a lot, doing a lot of operative procedures, but because reimbursements are so low (sometimes just breaking even), the dentist is making far less than he/she should be.

No escape

Getting out of Medicaid may not even be an option at this practice. Doing so drops your gross by 30% according to Hammer (though really, it wouldn’t since Medicaid doesn’t reimburse fully). Going with his numbers though, you would lose $255,000 from your $850,000 gross. That drops your overall production to $595,000 which is $49,583 per month. Take out 65% overhead and you are left with $17,354 per month. After paying your loan you would be left with $8,298 per month which is a little less than $100,000 per year.

If you are working the 242 hours per year demanded by the office’s hours, then you will be making just $34.30 per hour. Once you buy into this practice, dropping any of the plans will hit you hard. It looks busy and you think you could turn a healthy profit, but really you just end up in a shiny trap. Hammer uses a Chinese proverb to describe this situation: “he who rides the tiger finds it difficult to dismount.”

If you use an EFDA and are okay working like a machine, then you will be just fine. But this kind of practice is not for the faint of heart. It isn’t a bad practice for everyone, but it takes a certain kind of person to run and manage it well.

Predicting the Future

Hammer was asked to predict where dentistry is headed over the next 5-10 years (in 2010) which would mean that he was predicting the market today. Although his predictions on graduates versus retiring dentists were a little off, something I discussed earlier in this thread, he did accurately predict that more mid-level providers would come online throughout the country. Dental therapists now practice in Minnesota, Vermont, Maine, Washington, Alaska, Oregon, and likely soon right here in Arizona.

He believes there are two solutions for dentists dealing with mid-level providers:

  1. Employ them the same way MD’s/DO’s employ them. This still won’t change the fact you will have to compete with big dental practices who have multiple mid-level providers on staff.
  2. Ensure that you are able to do things mid-levels can’t. He points out that big discount hair stylists still haven’t driven smaller salons out of business. Hammer also points out that McDonald’s hasn’t driven nice steak houses out of business either. For the same reasons he says mid-levels won’t put the best dentists out of business. Don’t compete with bargain dental shops, you will lose that battle. Provide high quality dental care at a premium price and Hammer says you will probably avoid the more troublesome patients that are more likely to frequent bargain shops anyway.

Additional Reading

At this point in the thread, Hammer makes some book recommendations for future practice owners. The books he recommends are as follows, notice that Rich Dad, Poor Dad was also mentioned by George Hariri in the Practice Acquisitions interview. (I am not paid for posting any of these links here)

1. The E-Myth revisited – Brian Gerber

2. The Truth About Managing People – Stephen P. Robbins

3. Rich Dad, Poor Dad – Robert T. Kiyosaki

4. The Millionaire Next Door – Thomas J. Stanley

5. Blink – Malcolm Gladwell

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I thought it was interesting that dental practices are more likely to succeed in rural areas. Is this because there is less competition? My friend wants to buy an old dental office, but he hasn’t been sure where to look for a seller. I’ll share these tips with him, so he can learn about the advantages to urban and rural dentistry.