Have a Plan – Avoid the Predators
Whenever you have significant environmental changes such as the COVID-19 pandemic there will inevitably be parties who will look for ways to take advantage of the situation. We will be addressing two issues in this week’s blog post, the “predatory threat” and our recommended solution. As we begin to emerge from the pandemic (and to be clear that we are only just at the beginning of this process), there will be a lot of uncertainty about what has happened to practice values and what has happened to the dental practice market.
We are being constantly asked by dentists how the value of their practices have been affected by the COVID-19 shutdowns. Even the ADA has suggested that it could be a long time before practice revenues get close to pre-COVID-19 levels and I will address these speculations a little later.
Let us start however with addressing the predators.
We have a number of affiliated brokerage offices across the country, and because of this we interact with a lot of different types of buyers. For the most part, buyers have been fair and understand that value is a function of profitability and so long as the profitability is there so is the value. Most of our clients have recovered more quickly than anyone thought, though we do occasionally encounter a buyer who is convinced that post COVID values have been permanently damaged.
In order to understand why this is not true, we need to take a quick look at how practices should be properly valued.
Practice value is a function of two factors: net profit and risk. Net profit is defined as Earnings Before Interest, Taxes, Depreciation and Amortization or “EBITDA”. Risk is expressed as Return On Investment or “ROI”. Practice value is EBITDA divided by ROI or can also be calculated as EBITDA multiplied by the inverse of ROI which is called the Multiple. EBITDA is determined by analyzing the practice’s Statement of Profit and Loss. ROI or the Multiple is a function of a number of factors most of which are related to things such as current base interest rates, and for the most part are out of the control of either the seller or the buyer. While EBITDA can vary pretty significantly, ROI is largely a function of factors that cannot be easily modified. Practice values vary largely as a function of higher or lower profitability (EBITDA), not as a function of arbitrarily altered Multiples.
One of the predatory tactics that we have encountered is the argument that the valuation Multiples should be reduced because of the pandemic, even though interest rates have remained largely unchanged and stock markets have certainly not reflected any loss of equity value. What has changed and has changed dramatically is practice EBITDA. Therefore, if practice values have changed post-COVID-19 it should be as a result of impaired EBITDA and not as a result of arbitrarily reduced risk factors or Multiples. What we are finding however are buyers who are trying to make case for the dramatic reduction of practice values by arguing that the risk factors or multiples have changed. For example, one corporate buyer has claimed to have lowered their multiple from between 7.0 or 7.5 to 5.5 because of the effects of the pandemic. The truth of the matter is that one of the big factors in determining the expected ROI is the Government of Canada’s 10-year bond rate. The lower the rate, the higher the multiple. The 10-year rate has actually fallen 0.5% between the beginning of January 2020 and the end of July 2020.
On a practice with $500,000 of EBITDA, worth about $2,500,000, this change in the ROI would effectively increase the practice value by about $60,000. The difference in the value of the same office using a 5.5 multiple as opposed to a 7.25 multiple would be $875,000 – big difference!!
The real question then is how do you side-step these tactics? The answer is to have a well thought out strategy for selling your practice and to stick to that strategy.
Let’s talk about how to create your strategy. The steps can be summarized as follows:
- Appraisal – The first step is to determine what your practice is actually worth using valid criteria. It’s hard to plan a transition strategy if you don’t have an accurate approximation of what your practice is worth. Get your dental office appraised and make sure you can get the appraisal updated at no cost in case you decide after setting up your transition strategy that you want to hold off a bit. Your appraisal should be considered a work in progress between you and your appraiser.
- Dream – Take the time to imagine what your perfect transition would look like, sound like and feel like. Let your imagination run wild, and don’t worry – we will let you know when you come up with an idea that is not feasible (rarely happens). Besides, we can coach you through the exercise if you just ask. Don’t rush through this process because you might just get what you ask for, so make sure you ask for the right stuff.
- Reverse Engineer – Your appraisal will tell you where you are today, and your “Dream” will tell you where you want to be. All we need to do then is reverse engineer the steps required to get you from where you are today to where you want to be. It’s not that hard if you really know where you want to get to and are committed to getting there. As yogi Berra once said, “If you don’t know where you are going you probably won’t get there”.
- Overcome Inertia – Inertia is the tendency to do nothing or to remain unchanged. You can’t get from where you are today to where you want to be if you don’t overcome inertia. Technically speaking, you will continue in your current state (of rest) unless that state is changed by an external force. The key here is that most people need an external force to change their state. So, the next step is to hire an external force that can start you up! The diet guys always say “If you could do it yourself you would have done it by now” – Perhaps a little corny but also true. We excel at breaking inertia and creating a direction.
- Execute – Once you get to where it is you want to go, then you need to execute. There used to be a button-kind of thing that you would stick into the breast of a turkey when you were cooking it and when the turkey was done a little stick indicator would pop up letting you know your turkey was done – we used to call these things Turkey Poppers. You need a Turkey Popper of sorts to let you know when it is time to execute your transition strategy.
- Who not How – All this may seem a little daunting, how are you going to go about organizing and executing all of this!? The truth is, if you’re smart, you’re not going to even try. Everything set out above has already been done before by someone else, so your task is not to figure out how to do all this stuff yourself; your task is to find the person who can guide you through the process. If you find the right guide, everything we have set out above as well as your predator detection can be done for you by someone who specializes in the field.
In summary, you need to be aware that there are some very skilled predatory buyers out there and they are looking to profit from those dentists who do not have a well thought out and defined transition strategy.
We know how to do this and would be delighted to be your who. If you would like some help guiding you through any part of this process please contact Derek Hill (firstname.lastname@example.org) at 905-984-5816.