Buying a Practice: Understanding the Senior Dentist’s Perspective and Living the Junior Dentist’s Reality
Kevin J. Klatte
I would like to share with you a personal experience that I went through during the negotiations of buying my practice. I hope this example might help to prevent this kind of problem happening to you!
As a graduating orthodontic resident, I had found a practice that I wanted to buy and had already agreed to a fair price that both the senior dentist and I felt was fair. (Most importantly, I could afford the financing, and he was happy with the cash value.) In the past, many deals like this one used to go awry because of the financing details, particularly when the seller was the only viable option to finance the buyout. However, with today's savvy financiers, such as MBNA Practice Solutions, an endorsed vendor of PDA, few financially sound deals should ever have to fall apart due to the lack of funds. These financiers basically have come to learn that investing in dentistry is a winning proposition for all parties involved, with minimal business risk of failure.
In my case, it was only a minor detail that became the sticking point in my negotiation: How to deal with the accounts receivables? In talking with other recent graduates, this ugly monster of accounts receivables, or AR, tends to spoil more and more deals, especially for practices that do more comprehensive restorative/treatment plans that are paid over an extended period of time (such as orthodontics or practices emphasizing extensive crown and bridge or implant procedures). AR is a dollar subtotal of what patients are behind in paying the dentist. Dealing with AR seems to be a lose-lose proposition at first. Basically, the senior dentist wants to get paid what he or she feels is due to them for past services rendered. However, the junior dentist might feel as though he is being asked to pay for the mistakes of the senior dentist. In reality, the impact on the cash flow that the junior dentist has available to run the daily operations is what both parties should really be thinking about in deciding what is truly a "fair" way of dealing with AR.
The impact that AR has on cash flow works like this: Assume a practice is collecting $10,000 per month, has an overhead of 70 percent (or $7,000) and an outstanding balance of 10 percent AR on annual production (10 percent of annual collections of $120,000 or $12,000). One could argue this is poor AR management, but unfortunately it is realistic for many practices! So, basically only $3,000 is left over to service the debt of the practice buyout and provide the salary for the junior dentist. If those patients who owe the practice money now begin pay (thereby paying off the AR), at an amount of $3,000 per month and these payments went straight to the senior doctor (after all, these payments are for work the senior doctor did some time ago!), this arrangement means the junior dentist would have zero cash flow available to service his or her debt and earn a living for up to four months. In the case AR payments exceed $3,000 in a month, the junior dentist would actually see a negative cash flow, meaning additional money would have to be borrowed just to stay at a zero bank balance, while the funds flow to the senior doctor. I would hope neither side of the practice buyout finds this to be a fair compromise.
I devised a solution which kept the senior dentist first in the AR receiving line, while giving me the assurance that I would have the cash flow to stay in business: as "fair" of a proposition as I could envision. It worked as follows: we capped the amount of AR that would be paid to the senior doctor during any individual month, and the unpaid balance, if any, going into a reserve that would be recalculated for the next month. We set the amount that was to be paid each month at a level, which assured me of a positive cash flow (in the example above, an amount of $1,500 would probably be acceptable to both parties). If I collected $2,000 of AR in one month, then the senior doctor received only $1,500 with a reserve of $500 for the next month. If in the next month, $900 in AR was collected, then $1,400 ($900 + $500 reserved) was paid to the senior doctor.
The senior doctor at first will have trouble accepting the fact that cash flow could really be a problem. After all, he was running his business this way for 35+ years and never had a cash flow issue. What differs now is that the buyout represents a new time point, with some monies now going to the senior dentist and some monies now going to the junior dentist. The cash flow of the practice could very well be inadequate to service the cash needs of the junior dentist, if the senior dentist has significant financial demands. The solution I offer here is one possible scenario, and in my personal case, it worked the best. For me, capping the AR paid to the senior doctor was critical to the deal, as I didn't want to enter into an agreement that could prove to be financially unworkable. Another obvious solution is to anticipate this cash crunch and borrow more initially, thereby creating a reserve of some working capital, but this solution can be expensive depending upon your individual case (especially if the AR is relatively high to the monthly cash flow!)
A myriad of issues will arise in any deal, and almost every one of those issues can ultimately kill an otherwise good practice transition, if you allow it to. Hopefully, by highlighting one point here that reared its ugly head during my personal negotiations, you’ve seen an example of how to work out a problem. The real keys to making a deal happen are establishing a dialogue to work through the issues, attempting to understand the other party's circumstances, and working fairly to resolve the issues in a way that both sides can live with. And don't forget: a contract is only as good as the parties going into the agreement, so make sure you can trust the other side! Good luck!