If you’re thinking of selling now or in the next 2-3 years, you need to look at your financials right away (and this assumes that you have a dentistry professional corporation that owns your dental practice). Why? By looking at your balance sheet, you’ll know right away if you need to do some cleaning (corporate purification) in order to qualify for the lifetime capital gains exemption. Further, by looking at your income statement, you’ll get an idea of what your practice is worth. I’ll touch on both topics.
Balance Sheet: Cleaning Required?
Look at your balance sheet. This shows your corporation’s assets, liabilities and owner’s equity. Look at the assets. How much cash was sitting in your corporation at the fiscal year end date (this is a specific date, mind you, a picture in time). If you have too much cash sitting in your corporation, you will definitely need to move it out before a sale. Why? Because you’re selling shares of a dentistry professional corporation that contains only certain assets at the time of your sale (e.g. equipment, supplies, leaseholds, goodwill, computer hardware and software, etc.). But you’re not typically getting paid for other assets – like cash. So, if you have too much cash sitting in your corporation, you need to move it out as part of a corporate re-organization prior to a sale.
The same principle applies to other types of assets – like investments, real estate, vehicles, whole-term life insurance policies, etc. You’re not selling these assets as part of your dental practice sale, so you need to move them out.
The other reason – in addition to because you’re not getting paid extra for them – for wanting to move these assets out is because keeping them in your corporation may DISQUALIFY you for the lifetime capital gains exemption. The capital gains exemption is something that dentists can use to save up to ~$250k in capital gains taxes on the sale of their shares of their dentistry professional corporation. They can even multiply it across family member shareholders (there are lots of tests that need to be met, so be sure to receive legal and accounting advice here). One of the tests for qualifying for the capital gains exemption is that your dentistry professional corporation CANNOT, for the 24 months prior to the sale of the shares of your dentistry professional corporation, have more than 50% bad assets in it. Your dental practice is a good asset. Too much cash is a bad asset. So if you had a dental practice worth $900k and $ 1.1 million worth of cash sitting in your corporation for the 24 months prior to doing a share sale, then you’d be offside the test (because you’d have $ 1.1 million of bad cash asset of the $2.0-million total value of the corporation’s assets, which puts you offside the no more than 50% no bad asset test).
The same principle applies for all other redundant or bad assets – like real estate (that’s not used to house the dental practice), investments, securities, inter-company loans (loans made by the dentistry professional corporation to another corporation to buy investments, real estate, etc.) and whole term life insurance. So, once again, you need to monitor your balance sheet to make sure that your assets are ONSIDE the capital gains exemption test.
Income Statement: What’s My Practice Worth?
If you want to get an idea of what your practice is actually worth on the open market, then you need to get a sense of how profitable it is. Dental practices typically hover around the 30% -40% profitability mark for owner/operators and less (e.g. 10-20%) for investor owners like dental service organizations.
To find out your “normalized” profitability (also known as adjusted net income or Earnings Before Interest (on a Bank loan), Taxes, Depreciation Amortization (called “EBITDA“), then take a look at your NET COLLECTIONS (what’s actually produced by the dental practice minus lab, which is a flow-through). You should absolutely be including cash that you may not record otherwise because you want the full story here.
From here, you’ll want to only deduct expenses that are related to generating the collections. This would include things like:
- Advertising and Promotion
- Salaries and Wages (don’t include anything you pay yourself or family members who do not actually work there; also, if you do pay your family members, make sure the amount you include is REASONABLE for the job that they’re doing).
- Employee Benefits (if any)
- Professional Fees (we don’t care about professional development dues because those are personal to the dentist; the same goes for personal insurance)
- Office Insurance
- Utilities (not personal)
- Phone (again, should be related to the dental office)
- Repairs and Maintenance (we don’t want large capital purchases included in one shot here as those expenses should be amortized/spread out over the life of the equipment).
- Office and General
- Bank Charges
- Supplies
- Rent
We are not deducting lab, because we’ve already accounted for it in coming up with the NET COLLECTIONS (see above). Note: these expenses need to be legitimate and verifiable and not personal expenses or beefed-up expenses for the purposes of lowering your taxes.
So, certain expenses should be in line with the overall industry. For example, rent should be 5% of Net Collections. Supplies and Lab should be around 6% each. Office insurance should be around $4k. Professional fees for doing bookkeeping, accounting and annual minute book maintenance should be $8k. Wages and salaries should be around 25-30% (wages have gone up a lot recently mind you!). And then you’re left with your adjusted net earnings or EBITDA number.
From here – and depending on a multitude of other internal and external factors – buyers and their bankers will apply a multiple of 3-4x for an owner/operator to offer to pay to purchase the dental practice. So, for easy math, if the EBITDA on a practice that has net collections of $ 1 million is $300k, then the buyer should be offering $900-$1.2-million for the dental practice.
What kinds of internal and external factors could impact the multiple to use? LOTS! Including:
- Interest rates
- Labour shortages
- Inflation
- Spending per capita by patients (whether they’re spending less generally)
- Number of active patients
- Hygiene vs. dental production as a percentage
- Opportunities for cost-control (too many staff, spending too much on supplies, wasting money on ineffective marketing, etc.)
- Location (city, outside the city, ground floor, etc.)
- Number of operatories
- Space to grow
- Number of active patients
- Number of hygiene days per week
- Whether there are proper staff contracts in place
- Whether the lease is good
- Marketing opportunities
- Opportunities to keep cases in-house (bring in specialty services)
- Signage and Parking opportunities
Remember: if you’re thinking of selling now or in the next few years, reach out to me at 647.680.9530 or michael@dentistlawyers.ca for a complimentary and private consultation on the possible sale of your practice.
