Seller’s information

For practitioners considering selling your practice, this can be a highlight in your career, enjoying the “fruit” of very hard work. For many practitioners, it can be the opportunity to supplement the retirement funds. It can also be a nightmare if not planned properly.

The bad news is that selling a business involves several components and there is no “clear cut” checklist as to what the buyer or the Banks may look for.

The following is a list of items a seller may consider having in place before selling a practice, it is not an all-inclusive list and certainly more issues will come up when selling a practice.

1.     Tax returns: This is probably the most important thing Banks will look for. Therefore, it is very important for sellers to have them well prepared and readily available. Typically, Banks will look for the last 2 years Tax returns, however, 3-year returns should be available. More specifically, there are certain things Banks and accountants will look for when evaluating a Tax return.

                        i.         Consistency. Ideally the gross annual collections should be stable over the last 3 years, or, ideally, steadily growing 2-10% per year. Typically, the Banks will appraise the practice based on the last 2 years Tax returns, however, if the numbers are dropping, they will either consider the last year’s return exclusively or “project” the rate of income reduction in the appraised value. There is a very possible scenario where Banks may not consider financing all together a practice if the numbers are dropping year by year.

                       ii.         Itemized expenses must be reasonable and “make sense”. W-2 expenses should ideally be around 23% of the gross annual collections with an acceptable range of 20-27%. These are the “vital signs” of a practice. Excessive payroll will damage the transferability because the perception will be that staff are either overpaid or that the practice is overstaffed. Too little payroll may raise a suspicion based on the premise “too good to be true”; a suspicious buyer may question the legitimacy of the gross collections if the staff expenses are too low for what the practice allegedly produces. Laboratory expenses (unless there is a specialty practice) should be in the 8-13% range. The seller must be able to justify too high laboratory expenses (i.e. not doing endos or surgeries which will bring the percentage of restorative work higher) or too low laboratory fees (i.e doing lots of surgery which brings the percentage of restorative work lower). Supplies should be 3-5% with 8% being the top of the mark. Seller should be able to explain too little expenses on supplies (i.e. bought a lot of supplies as stock the year before) or too high (i.e. got a “deal” to buy more volume for less – consult with your CPA to see if some of the supply qualifies to be considered as “inventory” in lieu of having excessive expenses on supplies). Rent should be 6-8% with 10% being the top of the mark, although there is little to do about this, sellers need to know that rent expense above 10% of the gross income might be perceived as excessive which might ultimately damage the marketability of the practice.

                     iii.         Separate personal expenses from business expenses. Having too little net income will damage the valuation of the practice. It is very important for the seller to visualize how the Banks will see the practice. They will typically finance the practice with the assumption that the buyer will be able to sustain his expenses based on the NET income of the office. They typically want to see if the buyer will be able to cover his personal expenses, his existing student loan payments, other financial obligations (i.e. car payments, mortgages, notes to third parties), and the practice acquisition loan based on the practice’s net income. With that being said, it is of paramount importance that the net income (minus a 10% or more safety margin) is high enough to cover all these expenses.

2.     Employee information: A list of currently working employees is mandatory. The list shall include at the minimum the employee’s position, payrate, benefits, length of employment, and recent raises. It is important to keep in mind that a seller cannot guarantee that the existing employees will continue working for the buyer. Typically, an employee’s salary should be within 20-27% of the practice’s gross collections. Any gross deviation from this range should give the seller an initiative to investigate the possibility for the office to be overstaffed or staff members to be overpaid. This should be done well before considering selling a practice. Current employees’ handbooks must be readily available for potential buyers. The general rule is that a buyer would not and should not attempt to make any significant staff changes shortly after the transition.

3.     Accounts receivable (A/R). This is an item that is very often neglected. Excessive A/R gives an indication that the front office does a poor job collecting. The seller needs to be working on the A/R well before the practice is put up for sale. A/R need to be itemized based on history, i.e. they need to be categorized as “current” which is typically up to 30 days, then 31-60 days, 61-90 days, 90-120 days, and delinquent which is over 120 days. The existing A/R needs to be readily available upon opening an escrow while the A/R at the time of closing shall be part of the office purchase agreement.

There are two schools of thought regarding A/R: One school of thought is to sell the A/R to the buyer while the other school of thought indicates that the seller gets to collect his/her A/R after the sale. There is no “right” or “wrong” on how to handle the A/R and a lot of times this is something that can be decided after opening an escrow. Some buyers may want to purchase the A/R and use them as working capital, some others would decline and have the seller collect them.

4.     Lease agreement. This is one of the more important elements of transitioning a practice. While some practitioners may own the building of their practice, the majority have their practices under a lease agreement. The prudent seller should first contact the landlord to assess his position in transitioning a practice. Consulting with an experienced attorney to review the existing lease and identify areas of the existing lease agreement that may pertain in transitioning the practice may be highly recommended. Many lease agreements may have clauses making transitioning more difficult. Some landlords may want the seller to be “on the hook” for a certain period after the transition, especially if the option to transition the office is “silent” in the existing lease agreement. Being “on the hook” means that in case the buyer defaults on the rent, then the seller should be liable for the buyer’s debt. The big premise is that the landlord must be willing to offer a lease agreement to potential buyers for the length of the loan, which is typically 10 years. The landlord’s intentions need to be investigated well before offering the practice for sale. The seller needs to have a qualified real estate attorney available.

5.     Existing business loans. The seller needs to have recent statements available on any existing business loans. Original loan amount and residual balance need to be readily available.

6.     Current business license and DBAs. Current permits, DBAs, and business licenses should be readily available.

7.     Current profit and loss statement (P&L). A current profit and loss statement is of paramount importance to demonstrate current and up to date financial status. The P&L should be from the time of the last filed tax return up to the time the practice goes on the market for sale. Some Banks may request for the Tax return to be prepared by a licensed CPA.

8.     Bank statements. The seller must furnish at minimum 2-year (or ideally 3-year) business bank statements.

9.     Dental insurance plans. A list of currently enrolled PPO or HMO plans is mandatory. More specifically, the list shall include at the minimum the contracted fee schedule for all PPO plans, and an itemized list of the HMO capitation checks for the last 6 months.

10.  Advertisement. The seller needs to have all advertising contracts readily available. At the minimum, the list should include the advertisers’ names, contact information, for how long they have been advertising for the office, results of the existing advertising campaign if available, and any remaining contractual obligations.

11.  Production/collection reports. There are many reports that will be needed. At the minimum, production/collection reports for the last 3 years, along with month-to-month production/collections reports should be available.

12.  Dental Practice management software. The seller needs to contact in advance the practice management software to investigate their policy on transferring ownership of the license agreement. Most practice software companies charge a transfer fee.

13.  A detailed list of equipment, inventory, and excluded items. The seller needs to have handy a detailed list of inventory. Ideally, the list should include the manufacturer, serial numbers of the equipment, any existing servicing plans, age of each piece of equipment, previous service performed and existing warranties, along with maintenance information. Excluded items should be written down in detail as well.