The orthodontic marketplace has changed significantly over the past 5 years and even greater changes are on the way. Practices have increased significantly in size mainly due to a demographic increase in children, many more adults accepting treatment and a booming economy.
The future looks very bright for the orthodontic practice as demand is increases and the supply of orthodontists decreases over the next 5-7 years. The prudent buyer will be greatly rewarded if he/she can maintain a high quality of service and treatment results.
All large purchases are much more ruled by emotions than based on logic, facts and expert advice. Too often the purchaser of a practice does not ask all of the right questions or lacks certain facts that will come to light only after the transaction is complete. This brief outline should be seen as an aid to help the buyer to ask the right questions and not an exhaustive discussion on the subject of practice acquisitions.
Unfortunately, even if one asks the right questions there is no guarantee that the answers provided are accurate or even available. In spite of readily available statistical tracking systems and forms, most practices keep woefully inadequate statistics. The focus of most acquisitions is on yearly gross income which does not tell the whole truth.
In the practice orthodontics, income numbers lie. The truth of a practice’s future potential and true value should be based much more on its yearly new charges, observation recall base and total contract balance. The game of accelerating income with payments in full, monthly payments spread out over 18-20 months and third party payers, has significantly hidden the true value of a practice. Asking the right questions can mean a difference in plus or minus 30% of a fair price for the purchaser.
Question #1: Am I capable of handling the size practice I am about to buy? Purchasing too large a practice just to watch it grow back to your level of competence is unwise. Work energy, ability to manage staff and handle stress are all important issues that need to be evaluated. Your approach to treatment and willingness to delegate are also strong considerations.
Question #2: Is the practice in a location where I would enjoy living the rest of my life? Obviously where you want to practice and live is a vital question. Unfortunately, you must temper this question by realistically evaluating the competition. Often, the most desirable areas have many more orthodontists for the population than areas that are COLD! The buyer may wish to consider that they can create a larger practice in a less desirable area and then take many more vacations and retire earlier with the higher yearly net income.
Question #3: Is their growth potential in this area? Many orthodontists go home every night and lament to their spouse that the office is not growing, yet they fail to realize that their area cannot sustain a significantly larger practice. Location will not guarantee a large practice, but it can guarantee a small one! The average orthodontist has 30,000 people to treat in the United States. Make sure you have your fair share of the population and that a large number are not military or retired.
Question #4: Will the staff stay with the practice or do I want the staff to stay? There is no more pressing problem in managing an orthodontic practice today, than having the right staff. You will never have a perfect staff, but a good staff, without a lot of turnover is vital to success and reduced stress. For some areas of the country it is still easy to find good quality people to hire. Other areas, especially those with that require dental assisting credentials, are a nightmare for attracting good staff. Exploring the skills and experience of the staff, the bonus programs in place and the “burn out” levels is important in buying a practice with your “eyes wide open.”
Question #5: Are the vital statistics in the practice growing? These statistics must include monthly new charges, income, new patients and starts. If the practice is in a slight decline or level, it may simply indicate a doctor who is neglecting his referral base as he, and they, sense he is on his way out. On the other hand, any significant decline should be a warning sign that something is not right with practice. A complete evaluation of the reasons for the growth and decline are important in determining practice value.
Question #6: What is the Total Contracts Balance? (Also called the Accounts Receivable Balance) This number is one of the least understood and most important to practice value. It is the amount of money owed to the practice, both present and future. As orthodontics is one of the few businesses that extends a monthly payment plan option, future money owed becomes an excellent indicator of monthly installment income. Many doctors, brokers and even some consultants do not understand this important number.
Low AR Balances are usually the result of accelerated payments. Collecting your money faster may be a good idea for the seller, but it can be disastrous for the buyer. The lower the AR balance, the fewer monthly payments will be coming in over the next two years. Accelerated payments can create a huge problem as a payment in full by a patient goes 100% into income with no allocation for future expenses that the patient will cost the practice.
Beware of purchasing a practice that gives 20-22% of income to staff members in a salary + bonus program. These offices often have a low AR balance, with highly paid staff members. Often staff members in these practices have been paid a significant reward of 20-22% of the case fee, just by collecting payments in full or pushing patients the direction of a third party payer. Cash flow from monthly payments can be severely crippled, yet not be noticed due to an acceleration in payments in full. Practices on this “slippery slope” often find a day of reckoning when monthly income drops significantly in spite of continued practice growth.
Question #7: What percentage of patients is referred by dentists verses patient/parent referrals? Understanding this percentage will give you excellent insight into the marketing and customer service of the practice. If the practice is more than 60% referred by the family dentists, it is possible that the customer service, scheduling and satisfaction of patient needs improvement. If the practice is more than 60% referred by patients and their families, it is possible that the area dentists consider the practice to have a poor reputation or are locked into other orthodontists. Another possibility is that the referral sources are aging.
Question #8: How many patients are on observation/recall? The total of patients on observation/recall is a very important number. Practices that do a significant amount of early treatment usually have a higher exam to start ratio, but may have few patients left on observation. A low observation base should reduce the value of a practice, especially for a buyer who chooses not to do early treatment. On the other hand, a practice that does little Phase 1 treatment and has a large observation base, can be a gold mine of ready patients to a buyer who does interceptive treatment.
Evaluating this area of the practice can be statistically difficult as many practices fail to add and remove observation patients as necessary from the computer counts. A clear understanding of the sellers treatment philosophy can give the buyer critical insight into this important issue. Matching up a heavy Phase 1 practice with a doctor who does little or no early treatment can be a financial disaster.
Question #9: What is the seller’s treatment philosophy and quality? Matching up treatment philosophies between buyer and seller is not crucial to a sale, IF there is a transition period of 1-2 years. A two-year transition would allow the buyer to start all of the new patients in his/her method while the senior doctor finished up his/her cases. Any transition time less than a year, can create significant turmoil for both doctor and patient. If the average transfer patient takes six months longer than estimated to complete, imagine trying to finish up an entire practice of patients that have been transferred to you! Matching up treatment philosophies and treatment goals will make for a much smoother transition.
Treatment quality is difficult to assess, but average length of treatment time for full cases is not. A practice that completes its full cases between 22-26 months is within an acceptable norm. Anything over 27 months can be a red flag on practice value. It is important to ascertain how many patients are in active treatment over 27 months and how any cases have completed paying on their contracts. Anything more than 10% of cases overdue in treatment can pose a significant hurdle to a smooth practice transition.
Question #10: What are the transition period and buyout terms? The ideal transition period depends on many factors, but usually ranges from 1-3 years. Perhaps a perfect transition would keep the selling doctor in the practice until 80% of the cases he started in his treatment technique and appliances are completed. A transition that requires the selling doctor to work two days a week the first year, and one day a week the second and third year, is excellent for maintaining the stream of new patient referrals.
The buyout terms are more important than the practice price! The buyer should focus on a 5-10 year Performa that allows him/her to live comfortably during the buy-in and shows excellent potential for earnings longer term. The buyer should consider buying the largest practice that that they can handle, in an area that they find desirable. Often, the larger the practice acquired, the greater the reward. Compared to most companies, the P/E ratio of the orthodontic practice is ridiculously low. It is for this reason that Wall Street is interested in our business.
Conclusion: Purchasing a practice can be frightening, but if you ask the right questions you can gain valuable insight into practice value and get a glimpse of the potential difficulties faced in the transition. Just as important as asking the right questions is the need for assurance that the answers provided are accurate. Having a consultant evaluate the practice for both buyer and seller is a small investment in obtaining a fair price. The golden era of orthodontics is back for those who wisely work towards excellence in treatment quality and apply sound management principles to their business.
Ken Alexander, Founder