Inflation and Dental Practice Valuations

The economy is always top of mind, but so far in 2023 the concerns for most people are more prominent than usual, and the dental industry is certainly paying close attention.

Kyle Francis, president and founder of Professional Transition Strategies, says private equity interest in the dental industry will rise in 2023; however, transactions will look different. For example, he expects to see the continued rising interest rates to have a downward impact on the values of practices that make $1 million in revenue. Also, Francis expects roll ups of EBITDA (earnings before interest, taxes, depreciation and amortization) to become more prevalent for doctors looking to transact.

With inflation and a possible recession on the minds of many, Francis answers these 6 key questions from Dental Products Report® in an effort to educate dental practice owners and to offer suggestions designed to assist everyone during what can be difficult times.

DPR: Based on what you’re seeing and your experience, how can inflation impact the acquisition landscape for the dental industry?

KF: First, we need to take a look at the landscape for the last 15 years. In theory, it’s expected that there would be an inverse relationship between interest rates and a practice’s value to an individual buyer. But, looking back on the extremely low-rate environment we experienced for over a decade, we never saw an increase in practice values to those individuals from post-2009 recession levels.

The biggest reason is that if an individual’s practice has a strong cash flow, then the bank’s aversion to provider risk is the only real limiting factor in the business’ value. Take this example: A practice in 2007 that did $1 million in revenue would receive 80% of its revenue as its valuation metric for a total of $800,000. Now take that same practice in 2022. It may have done something like $1.5 million; however, the valuation methodology would still be the same with the 80% metric.

The “value” would have increased by the rate of inflation – and the cash flow would also go up concurrently if the revenues and expenses also went up by the same rate. All in all, that means the net result for the dentist may not be much different compared to what it was over 10 years ago.

Now, let’s take a look at the current environment. If a high rate of inflation persists, then it’ll take a little longer for costs to catch up. Typically, supplies and lab prices go up first followed by employee costs.

To counter these costs, fee-for-service providers can increase the prices to the patient as they undergo these changes. Conversely, it’s more difficult for in-network providers to do the same because they’re beholden to how much an insurance contract is willing to pay for a procedure and aren’t allowed to adjust prices at will.

But the good news is that revenue will eventually catch up with new cost structures while the market sorts itself out. We’re presently seeing fee increases from insurance plans in a variety of states to counter the lost net income to the provider. When it comes to an acquisition, if the practice undergoes higher costs and the revenue hasn’t caught up yet, then the practice may show unusually low profit margins, which can decrease the value of the practice until the catch up occurs.

DPR: What makes dental industry consolidation resilient in times with high inflation?

KF: Repeatedly, the dental industry has shown us that it’s extremely resilient – whether it be overcoming COVID-19 shutdowns or the 2008 recession. With its proven track record of surmounting major economic challenges, I don’t expect to see inflation having enormous effects in the mid- or long-term.

With that, we’ve seen some practices’ values decrease over the course of the last 3 years. Typically, these practices are small and don’t provide much in terms of profit for the owner. This makes it difficult for doctor-owners to be granted loans on the assets because most banks would rather lend on assets to startups than to lower-profit practices. Another important factor to keep in mind is that if a practice is located in an area with a declining population, it often takes much longer to identify the right buyer for that practice.

So, in these scenarios, I’d expect to see inflation and economic conditions further increase the gap between these types of practices and what the remainder of the market experiences with the compounding effects of these headwinds.

DPR: How does inflation affect my earning power or the value of my doctor’s salary?

KF: If you are an owner, you will probably see some contraction in how much you can take home on a yearly basis in the short term while you wait for revenues to catch up with the cost of supplies and employees. Because of that contraction, it can feel harder because the cost of most goods outside of the practice have also gone up. However, just know that this is a temporary adjustment and keep your focus on making up that gap as soon as insurance allows.

If you are an associate, your earning power will change differently based on how you are paid. If you are on a salary – which is rare in the dental field – your ability to pay for personal items will have gone down unless you can get an increase in that salary. If you are paid on a day rate, the same theory applies since you are trading your time for a certain amount of money and that money is worth less in comparison to what you are trying to purchase. But, if you are compensated off of collections, the impact will be much less because the price of the procedures that you are doing is going up and should be able to keep up with the price of inflation in short order.

DPR: Should I wait to sell my practice until inflation and the economy stabilize? Why or why not?

KF: When it comes to determining if it’s best to sell your practice after the economy stabilizes, it’s imperative to understand your options first.

Despite experiencing inflation, the industry is still undergoing a consolidation wave – giving practice owners more options than ever before to leverage up the long-term value of their practice through equity arbitrage. This financial concept is all about how valuable the equity is in your practice currently and how much more equity is available after the sale of your practice. By shifting where your equity lives into a new environment, it can help grow your returns long after the practice is sold.

With that said, it could be time to consider the options at your disposal other than selling to an individual to maximize equity arbitrage. These buyers could be a dental service organization (DSO), private equity or even consider a roll-up of other, similar practices to sell to a group.

Another option worth considering if you want to sell your practice at this time is using an earn-up. An earn-up is when a practice transacts at its current value and then, if the profitability improves over a specified time period, a higher price is paid out in the future. This gives doctor-owners the opportunity to still sell despite an uncertain economy while also giving the practice a chance to normalize.

DPR: Does the state of inflation make it a buyers’ or a sellers’ market? Why?

KF: I think this all comes down to perception. In a time of uncertainty, buyers can take advantage of certain aspects of the market to buy assets less expensively than sellers may normally be willing to sell them for because the seller is looking for certainty in their exit. In these cases, buyers have some leverage over their counterparts.

However, there is nothing systemic about this advantage. If sellers allow themselves the time to make a good decision and, more importantly, become educated in what kinds of options they have, then they will see that their practice is just as attractive in the right marketplace. The cost of capital is still below most averages over time and there are a finite amount of great dental practices to buy. Sellers just need to understand how to leverage these facts to their advantage in a time of inflation.

DPR: What’s your advice to dental practice owners who are looking to sell despite recession on the horizon? Is there anything you recommend they watch out for?

KF: The biggest piece of advice I’d give to practice owners looking to sell is to consider all the options available and to work with an experienced dental specific M&A advisor throughout the transition process.

I touched on it earlier, but there are more opportunities than ever before for practice owners to sell to a group, private equity, a DSO or even an individual. For instance, there are over 350 DSOs out there, which gives rise to more deal structures and options for doctor-owners to find the right plan for their transition needs.

Another option worth considering is what it would look like if you brought in a partner – if you own a practice that could support one – with plans to sell to them in the future. In a transition plan like this, you should always agree on the roadmap upfront to help make the shift as easy as possible when it’s time to sell.

With so many opportunities out there, it’s difficult to sift through the options and find the right buyer who will fulfill your transition needs. That’s why working with a seasoned dental practice broker can be incredibly beneficial. They’ll market your practice and place it in a more competitive environment to leverage up offers so you can get the maximum value. Not only that, but they’ll guide you through every step of the way so you feel supported throughout the entire transition process.

By taking a step back to understand what these options could mean will allow you to have some certainty in your approach.

For more information on PTS, visit https://professionaltransition.com/.

About Kyle Francis

Kyle Francis is the president and founder of Professional Transition Strategies (PTS). After receiving his bachelor’s degree in Entrepreneurship and Professional Sales from Baylor University, Kyle completed the MBA program at the University of Colorado with specialties in Finance and Strategy.

In 2007, Kyle created PTS (formerly Headwaters Practice Consultants) to facilitate the sale of over 400 dental practices exclusively as a seller’s representative. His M&A work has resulted in over $2 billion in total deal flow for his clients. His specialty is offering unique options to sellers allowing them to explore individual, group, and private equity investments to achieve the transition goals of his clients.

Along with his M&A work, Kyle has consulted for practices, medical device companies, and groups of practitioners. He has used this knowledge to help build more than 100 medical and dental start-ups and has helped construct another 100 locations. More recently, he has been an advisor to many practice groups across the country. He has owned all or part of more than 30 practices and has been an investor in multiple DSO concepts.

He and his family live in Colorado Springs where he enjoys golfing, skiing and hunting as often as he can.