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Corporatization of Dentistry – Thoughts From the Front Line…

By January 31, 2017November 28th, 2019Dental Service Organizations, Selling A Practice

We’ve helped many dentists sell their practices to dental organizations over the past few years.  Here are some thoughts from the front line…

Why Is It Happening?

It’s pure economics: there’s a strong demand (lots of people want in), coupled with limited supply (dentists can cash out).

DEMAND

On the demand side, there are lots of dentists and investors who want to own and / or operate a dental practice.  And who wouldn’t want to?  Anecdotally, our law firm reviews a lot of appraisals and we expect to see an efficiently run practice operating above 30% adjusted profit margin (revenue minus expenses and without considering the dentist’s take home salary or discretionary expenses).  Some practices can control their costs better – particularly rent, staff and advertising – while producing a lot more than other practices due to niches, specialities, good locations, strong team, etc.!  And we’ve seen these practices operate at close to 50% adjusted profit margin.

Now for some facts… Based on the 2014 tax returns of all the dentists in Ontario (both incorporated and unincorporated):

  • 94% were profitable
  • The AVERAGE dental practice generated ~$596k in revenues and ~$198k in net income (33% profit margin).
  • The TOP QUARTILE dental practices generated ~1.446-million in revenues and ~$449k in net income (31% profit margin).

Just keep in mind that these figures likely overstate expenses (because they were submitted for tax purposes).  That means the dentists were probably doing things like including family members on salary (who weren’t actually working) and putting other personal discretionary expenses through the business (e.g. car, etc.).  But it’s still a good gauge.  Bottom line: dental practices are GREAT BUSINESS investments.  Much better than what you could be getting by investing in stocks and bonds and with much less risk!

SUPPLY

I guess-timate that there are a few thousand dental practices that will need to be sold in Ontario in the next five years – and that’s just based on the number of dentists with their own practices and who have been at it for a while.  Have we seen a FLOOD of dental practices hit the open market?  Not really… but there is definitely an uptick in people getting appraisals (from Matt Bladowski of Dental Strategy for example), which means they are 1 step away from listing with us (on www.DentalPlace.ca).   What this also means is that there is a shortage of dental practices on the market.  With banks (like TD) giving 100% + financing, dentist buyers don’t really pay for anything out of their pockets up front.  Even legal fees are covered (that means they’re either amortized over the term of the loan or used in the Line of Credit).  So it’s a seller’s market and sellers with good practices can generally dictate the sale structure (shares instead of assets to get the better tax treatment) and other terms of the sale.  So why would sellers sell to dental organizations?  Simply put: they are serious buyers offering more favourable terms (price, associate remuneration, taking over leases, dealing with staff, etc.) who can GET THE DEAL DONE fast and don’t have financing problems.

Like I said: it’s pure economics.  Can you (or should you) blame a dentist who worked their entire lives and wants to get the best deal possible for their practice – if that means selling to a dental organization?  And what’s wrong with dental organizations anyways?  Is there any hard evidence that they put profits before patients?  Aren’t they supposed to be following the same legal, ethical and professional obligations that any other dentist owner / operator would?  Part of the reason I think some dentists don’t like them is because they don’t understand them, have heard horror stories from a disgruntled few, or don’t want dentistry to be perceived as a BUSINESS, but rather as a PROFESSION.  The latter  is how it used to be with LAW as well.  I entered into law and I met some lawyers who thought we were professionals first and not business people. They were repulsed at the idea. I think we’re way beyond that now.  And market forces have gotten us there: because when you apply business principles to a profession, it’s supposed to give greater access to the general public, increase competition, and reduce fees (think: Walmart).

Yeah, but is it Legal?

Dental organizations are sophisticated.  They have resources.  They can command big discounts on supplies (like 20%).  They can get financing privately or borrow from a traditional bank.  They have lots of people at their disposal. They are constantly hiring new talent.  They can take care of all the business and administrative functions of running a dental practice.  So naturally, the question that comes up is: can they LEGALLY own / operate a dental practice?  If it’s a dentist on their own, that’s not an issue… of course they can own the assets or the shares of a dentistry professional corporation.  But what about a dental organization that involves both a dentist and a non-dentist person (like a corporation)?

Well, the answer to that isn’t straightforward.  Let me explain.  First, if you look at the definition of practicing dentistry in Ontario’s Dentistry Act (which differs from province to province and state to state in other countries), it’s a very clinical definition.  That means that non-dental persons CANNOT practice dentistry.  But what about all the business and administrative tasks / functions that go into operating a dental practice?  Can a non-dental person fulfill those functions?  Yes.  They already do.  Landlords provide space.  Marketers run campaigns.  HR companies hire staff.   Order equipment / supplies from vendors.  All for the dental office.  So what if one person performed all of these functions on behalf of the dental office?  I recently found out that almost anyone reputable can PURCHASE dental equipment from a supplier, but only those with HARP qualifications can actually use them.  What about dental records?  Well, that’s where things get even more interesting.  I’ve written a lot about this in articles you can read HERE.  There are arguments on both sides of the equation in terms of who can OWN vs. ACCESS them.  And until we have a judge ruling on them (because the legislation is pretty silent on this topic) in light of a public dispute, some things will just be kept underground.

Preparing to Sell to a Dental Organization

When preparing to sell a dental practice, if you want to maximize the sale price and other terms, you’ll want to make sure you:

  • Have a good lease in place (the number of years left isn’t as important as are the terms and absence of bad terms – like demo clauses and relocation clauses).
  • Have staff on contracts which are assignable to the purchaser and which limit the vendor / purchaser’s liabilities when it comes to terminating them (and also includes restrictions like non-solicitations).
  • Incorporate your practice so you can sell shares of a dentistry professional corporation and take advantage of the lifetime capital gains exemption (as opposed to selling assets).  Hopefully you can also use family members to MULTIPLY the lifetime capital gains exemption by including family members.  Make sure this is done properly 2 years in advance because if you don’t do it properly, you / your family members won’t qualify (for the potentially $200k maximum capital gains tax savings!).
  • Clean up your practice – physically, financially, etc. before you sell!
  • Show financials on the incline or steady year over year (as opposed to a decline).  You’ll want to perhaps engage a practice management company (like Dental Strategy) to help you with your team and brand building for the 2 years before you sell.
  • MARKET YOUR PRACTICE through DMC LLP (of course ;-)!

Now, some dental organizations will try to buy a dental practice before a lot of these steps to ‘clean up the practice’ are done.  If they offer a seemingly good price, it could be worth it to move forward with them.  BUT remember this: you only have 1 option to sell, so you should do it properly.   And you’ll never know if they’re offering you ‘fair market value’ unless you actually market the practice and have offers in hand from willing buyers.  Even if you do plan to sell to a dental organization, if you’re wondering if they’re giving you a good price / terms, it would be worthwhile to put it on the market (just for the purpose of getting offers and a better bargaining position).

In my experience, dental organizations don’t necessarily offer better / worse remuneration than what the rest of the market offers (e.g. 40-45% being the average) for sellers who stay on to associate afterwards.  They do, however, push the limits on restrictive covenants.  With their business minded hats on, they definitely build in a number of extra protections for themselves – some of which I question are necessary or even legally enforceable.  They come in the shape of chart fees (e.g. you pay $1,000 for treating a patient elsewhere) or genuine liquidated damages (e.g. paying $250,000 for hiring an existing staff member elsewhere or violating a non-compete), which could resemble a punishment (which is not legally enforceable).  Just be sure to equip yourself with the right legal team (eh hem…) before starting negotiations with any purchaser – including a dental organization.

Selling ASSETS vs. SHARES

Some dental organizations (non-dentist persons) are weary of purchasing professional goodwill directly in case it turns out that they cannot do so legally (which is a grey area as noted above).  So instead they want the seller to sell professional goodwill (an asset) to a dentist or dentistry professional corporation on day 1.  Then, the dental organization (usually non-dentist corporation) will purchase the shares of what’s left of the selling dental practice on day 2.  I know this sounds complicated.  And it is.  It adds to the seller’s legal and accounting costs because of the extra steps involved.  And, starting January 1, 2017, there will be an additional 13% of taxes (that would otherwise have been paid) on the sale of the goodwill on day 1.  Now, if you don’t compare this to what was happening January 1, 2017, it won’t make a difference.  But if you do compare it and if you’re able to take advantage of the lifetime capital gains exemption (and hopefully multiply it) and would rather sell shares entirely to a dental organization in one shot but they refuse, then it becomes a question of PRICE: is what they’re offering a good deal when you look at things like: what are they offering when compared to the increased taxes, legal and accounting costs you’ll be paying, as well as what other purchasers would be offering (who would probably be doing straight up share sales)?  Just some things to consider…

My Recommendation

Irrespective of who you’re thinking of selling to, make sure you do some homework: it’s highly advisable to pay a little bit NOW to clean up your practice to maximize the PRICE and BEST TERMS you can get when you eventually sell. You only get one opportunity to sell, so do it properly.  I would also recommend marketing the practice (regardless of whether you’re going to sell to any one particular person – including an associate, friend, or dental organization) so you can appreciate what you can get for it and create leverage during the sale process.

As always, if you need assistance in preparing for sale, contact me (michael@dentistlawyers.ca | 647.680.9530).

DMC