Buy a Practice or Build Your Own
Which Option is Better?
Eugene W. Heller, DDS
Graduation from dental school for most new dentists is their second to last step before pursuing their ultimate career goals. The statistics still prove the majority of new dentists eventually become practice owners, most as sole proprietors. They become owners through either the purchase of an existing practice, or starting a practice from scratch. This article will discuss the advantages and disadvantages of each method of becoming a dental practice owner.
The Advantages of Starting from Scratch
One of the primary advantages of starting and building your own practice is related to the freedom to practice wherever you wish to live. Every geographic area has its more desirable and less desirable states. Within these desirable states, there are, of course, desirable and less desirable communities. Even within the communities there are desirable and less than desirable areas. Providing that the area demographics will support a new dentist, the primary advantage of a scratch start is being able to select where you wish to practice.
The second advantage we see is related to a lower start-up cost. A two-operatory facility can be made functional for approximately $125,000 to $150,000. This includes operatory and laboratory equipment, vacuum pump and air compressor, business office equipment including a computer and copy machine, and reception room furnishings. Starting from scratch allows you to select your own equipment and generally, this represents new equipment.
Beginning a practice from scratch and hiring your own staff allows you to develop a practice that reflects your own personality. You can also select employees that complement your own style and temperament. Similarly, as you attract patients, those patients who appreciate your style will continue to refer similar patients and eventually your patient base will also reflect your method and style of practice.
The final major advantage of starting your own practice is related to your personal development of business skills. You can develop your skills as needed over a longer period of time. You will need to learn about hiring practices, marketing procedures and methods, and accounting systems. Also included are recall systems, collections, and dealing with insurance companies and insurance programs. For many doctors, the thrill and excitement of building their own entrepreneurial venture is as rewarding as the resulting financial rewards that follow.
Disadvantages of Starting from Scratch
The most noticeable disadvantage of starting a practice from scratch is the lack of patients. It takes time to build a patient base, which translates into the opportunity to produce and collect for dentistry performed, i.e., generation of cash flow. Implementation of a good marketing program is imperative to overcome this disadvantage. Even at an ideal start of 25 new patients per month, and assuming normal attrition, it will take five years to develop a thousand patients in your base. While this is occurring, it may be necessary for you to supplement your income through employment and other means to make the required principal and interest payments on your start-up loan plus meet living expenses.
The second disadvantage is the fact that you do indeed have to develop and assemble the required business systems. All the items listed above relative to collection systems, insurance systems, marketing systems, hiring practices, etc., must be learned, developed, and implemented. Learning and placing these systems can be very time consuming and stressful.
Staff is another issue. Will the area in which you have elected to practice be capable of producing suitable staff? While it is ideal to have the luxury of selecting staff that match your temperament, personality and style, in some areas suitable candidates simply do not exist. If you are unable to locate and recruit experienced staff with prior training, it will be necessary for you to find the people, train them, and develop their skills.
The last disadvantage may be overwhelming and may prohibit the entire process of building a practice from scratch. Will funding be available for your project? In today’s financial marketplace, there is generally a major hesitation on the part of various lending institutions to finance a recently graduated new dentist with heavy school related debt. The bank looks at a new dentist’s lack of experience, the unknowns of funding a business with no existing or prior cash flow, and a new dentist’s basic lack of a track record. Their insecurity with these factors may make it very difficult to justify financing. Those financial institutions that will provide financing must be given a demographic survey indicating the suitability and likelihood of success, a detailed business plan demonstrating how you propose to develop this business, and they need to be very comfortable with your business knowledge. As a result of these factors it is becoming extremely difficult for a new dentist to find funding to do a scratch start-up (Figure 1).
Cash Flow Projection for a Start-up
The following table demonstrates a typical ideal startup from a statistical and financial standpoint. You will note that this projection assumes that there are 25 new patients per month from the first day of practice, that they will produce an average patient value of about $300 per year, and that a minimal $100,000 loan has been taken out to start this business. You will also note that the example assumes an interest rate of 12%, an amortization period of five years, and a 10% annual patient loss (considered to be normal attrition).
This example also assumes an adjusted overhead of 50%. By “adjusted,” we mean that only operating expenses, which would include rent, staff salaries, supplies, and laboratory fees, have been included. So called “elective/tax bookkeeping expenses” have not been included, which would be depreciation, interest, and elective expenses such as the dentist’s continuing education. Actual interest expense is subtracted later under the principal and interest (P&I) for the practice purchase. We have also added an additional $50,000 at the end of the third year for a third operatory and additional equipment purchases
Advantages of Buying an Existing Practice
It is fairly easy to summarize the advantages of purchasing an existing practice if we look at the previous discussion relative to the disadvantages of starting a practice from scratch. The primary asset acquired when one purchases an existing practice, typically representing 70% to 80% of the purchase price, is the “goodwill” associated with the existing patient base. As noted in the following example, the sample practice used will have an existing patient base of 1,333 patients. As noted from the above example, it took five years to develop 1,150 patients. Most importantly, this existing patient base immediately translates into income for the practice.
Our experience has been that if the practice is assumed in its current location, 90% to 95% of the patients will stay with the new practitioner. While it is normal to be fearful of a mass exodus of patients, we just simply do not see this in the marketplace. Patients are more than willing to give the new practitioner at least one chance.
The existence of an assembled staff and assembled business systems is another major advantage to acquiring an existing practice. While sometimes cited as a disadvantage, i.e., the new owner is “stuck” with the systems and staff that are there, it is truly an advantage. Whether a system does not meet the needs of the new owner over time, or the new dentist finds a staff member they are unable to work with, these things can be changed. It is, as they say, much easier to steer a moving ship than to create the initial inertia to generate movement!
The final advantage to acquiring an existing practice relates to the readily available funding for this type of business venture. There are several financing sources which have recognized that funding of new dentists for the purposes of acquiring an existing practice is much less risky than funding that same new dentist to start a practice from scratch. The failure rate of this type of transaction is minimal in comparison with the relatively high failure rate of dentists who attempt to develop their own practices. Therefore, in today’s marketplace, 100% financing is readily available.
Disadvantages of Buying an Existing Practice
The primary cited disadvantage of acquiring an existing practice is the price. Many new dentists are frightened by the so-called “sticker shock.” At first, by sheer size, the price of acquiring an existing business can seem to be formidable. However, a careful review of the cash flows and projected future cash flows will quickly point out that the purchase price can be readily supported.
The second major disadvantage is relative to the age and condition of the equipment being purchased. When considering this argument, one must still remember that the primary valued item in a practice purchase is the patient base. The equipment can be replaced and upgraded. However, the equipment has been producing the prior cash flow and therefore may be very serviceable at a much lower cost. Many new dentists, after working with the somewhat older equipment, have found it to be very functional and useful and delayed its replacement indefinitely.
The third disadvantage cited is possible undesirability of one or more staff members. When we are involved in counseling both the staff and the purchaser, we offer the following advice. To the new doctor, the staff will complete the transition of the patients to the new doctor. Therefore, for a period of at least six to twelve months, the new doctor is generally required to keep the existing staff people. To the staff, we say, they will have six to twelve months to prove themselves. Because the staff is an integral component to transferring the patient loyalties to the new doctor, we generally suggest any and everything be done to keep the staff intact for a six to twelve-month period. If the new buying doctor finds one or more staff people to be undesirable and/or unproven after this initial period, they can be replaced. We frequently see more patient loyalty to the staff than to the doctor and therefore every effort should be made to retain them. However, no individual staff person is indispensable and if necessary, they can be terminated and replaced.
The final disadvantage that we often hear is the need to accept the existing systems. We strongly encourage the new dentist owner to carefully learn the existing systems and after a three to six month period, make a decision as to what needs to be improved and/or upgraded. However, whether it is low fees, poor collection procedures, or mishandling of insurance, the new owner can easily correct all of these systems. They do not represent a substantial reason to not purchase an existing business.
The following projection for the purchase of an existing practice with gross receipts of $400,000 assumes many of the same conditions from the previous example. We have assumed a $260,000 purchase price plus an additional $50,000 borrowed for working capital. We have used the same average patient value, the same adjusted overhead percent, and the same interest rate and amortization period. You will note from this example that at the end of the first year of operation, this practice will generate approximately $117,000 in pre-tax and pre-elective expense income. Please compare this with the “Year 1” Pre-Tax Income of $10,807 from the prior “Start-up” cash flow projection. We have also assumed that the new patient in-flow in this existing practice equals the out-flow, and therefore there is no practice growth over the five-year period projected (Figure 2).
The Bottom Line
A comparison of the two projections results in a five-year $221,000+ pre-tax, pre-elective expense difference. This is a very conservative projection. We have seen differences exceeding $400,000, especially when a new practice averages less than ten new patients per month for the first three years. The purchaser of an existing practice should not only take comfort from the additional revenue over the five-year period, but the fact that the financial institutions which offer the funding for this type of practice acquisition are more than willing to do so because of the low risks and proven success rates they have seen in the marketplace. As with any investment, the financial institution expects not only a return on their investment (the interest) but also a return of their principal. Because it is their money that is really at risk, the fact that they make these loans indicates the relative safety of the concept.
There is no question that we are prejudiced in our approach to new dentists entering practice. However, we feel this prejudice is well substantiated by the bottom line. While the marketplace is constantly changing, we have found that most new dentists cannot wait for the five-plus years required to develop an existing patient base and resultant cash flow while slowly learning and developing their own system.