Five things to consider when selling your dental practice

Attorneys Casey Gocel and Jonathan S. Rhone offer tips to prepare for one of the biggest transactions in a dentist’s career 

 If you are considering selling your dental practice, but do not know where to begin, you have come to the right place. Selling your dental practice will likely be the biggest financial transaction in your career, so it is important that you are properly prepared to sell and properly protected after the sale occurs. The work you do upfront can potentially save you money and headaches in the future.  

Before selling your practice, it is important to have your house in order. That means that your practice is in good financial, legal, and operational condition. A potential buyer will likely conduct extensive due diligence on your practice and will ask to review your tax returns, financial statements, insurance policies, associate contracts, vendor agreements, provider agreements, accounts receivable history, real estate leases, and more. If you conduct your own diligence ahead of time, you will be much better prepared by knowing the status of your practice and potential issues that need to be addressed before the time comes to enter into an agreement to sell. Below is an outline of five key items that you should consider reviewing, preparing, and understanding before exploring a sale of your dental practice 
in earnest.  

1. Know what kind of buyer you are targeting 

 The type of buyer you are targeting will greatly impact your preparation for, and negotiation of, a sale. There are three different potential buyers for your dental practice: a DSO, an outside dentist, or one of your associates. Typically, a sale to a DSO yields the highest total sale price; however, DSOs pay selling dentists using more complex payment structures that could result in less cash in your pocket at closing, and DSOs usually place very restrictive non-competes and employment requirements on their dentists. Let’s consider an example where a DSO values your practice at $1.5 million, while another dentist or one of your associates is prepared to buy your practice for $1 million. While it is enticing to take the higher offer, there are several considerations you must take into account before deciding which offer to take.  

DSO sales often include non-cash consideration such as rollover equity, earnouts, holdbacks and indemnity escrows. Generally speaking, a DSO buyer will pay at least 30% of your total purchase price in the form of rollover equity, meaning that 70% (or less) of the total sale price will be paid in cash. Using the example above, your closing cash payment only will be $1.05 million of the $1.5 million valuation. While the DSO equity may be a fruitful investment that pays in the future, it is not guaranteed, and often times, doctors are left with illiquid or even worthless rollover equity.  

Further, some of the sale price may be tied to an earnout. An earnout is a mechanism by which the DSO will pay you a sum of money if certain metrics are attained over time. The earnout criteria will likely be drawn out over several years. Sticking with our $1.5 million valuation example, if the DSO offers an earn-out worth $250,000, that amount will also be reduced from your payment at closing, with no guarantee that you will hit the earnout metrics. Your closing cash payment is now reduced to $800,000. Additionally, DSOs often require an indemnity escrow, which is money that the DSO will hold back, usually for 1 year, to be able to protect itself from any lawsuits or liabilities that arise from your former ownership of the practice. If this money is not used, it will be returned to you. The indemnity escrow further reduces the cash paid to you at closing. To recap, in this example, the seller will only get $700,000 of the $1.5 million purchase price in the form of cash at closing, with the remaining amounts being allocated to the rollover equity, earnout, and indemnity escrow.  

In a sale to an outside dentist or an associate, the closing payment is usually paid fully in cash at the closing. Therefore, the $1-million private sale valuation could yield more cash in your pocket at closing than a $1.5-million DSO valuation. Keep in mind that the upside of selling to a DSO has the potential to be more profitable. If you are able to hit the earnout metrics, and the DSO is well run and able to increase the value of your rollover equity, your total consideration for the sale could be significantly higher.  

Another factor to keep in mind is that DSOs typically require selling dentists to sign a 5-year employment contract, with severe financial penalties imposed if the doctor leaves before the 5-year term expires. Further, as a holder of rollover equity, the selling doctor becomes bound by the term of the DSO’s operating agreement. These operating agreements typically contain very restrictive non-competes that prevent the selling dentist from setting up a new practice or working elsewhere. Meanwhile, if you sell your practice to an outside dentist or an associate, the buyer may only require a short transitional employment period, typically 6 to 12 months, to transition the practice smoothly. The restrictive covenants that a dentist buyer places on a selling dentist are typically far less restrictive and give the seller much more flexibility in the future. Your individual circumstances and future plans are a key part of deciding who should buy your practice.  

2. Know what you are worth

 Having accurate and complete financial reports is critical because this is how potential buyers will value your practice. You should know what you are worth and how much debt your practice is carrying before entertaining offers from buyers, otherwise you will have less negotiating leverage because you will not know whether you are being valued fairly.  

 If you are thinking of selling to a DSO, we recommend hiring an accounting firm to perform a sale-side quality of earnings (QofE) analysis to determine your earnings before interest, taxes, depreciation, and amortization (EBITDA) and, ultimately, the value of your practice. If you are thinking of selling to an outside dentist or an associate, a simpler valuation can be prepared by your accountant based on historical collections. 

You should also run lien searches on yourself and your practice to determine what debts will need to be paid off at closing. This is also a great way to find out if you have old liens on the practice that should have been terminated. Tracking down old creditors to get these liens removed can be very time consuming, and it’s best to clean this up prior to engaging in a sale transaction.  

3. Assess how you are classifying your associates 

 It is important to make sure that all associate dentists are properly classified as employees or independent contractors. DSOs and other buyers will examine all staff members in the practice to determine if they are properly classified. If a dentist is improperly classified as an independent contractor when they should be an employee, the buyer will make an adjustment in their projections based on the expense of that employee going forward. Misclassification could have a negative impact on your EBITDA (i.e., your purchase price), not to mention that it may cause problems with both state and federal regulatory agencies.   

4. Understand your lease or real estate situation and whether it’s part of the sale 

The real estate aspects of a transaction often disrupt dental deals because if a seller leases its property, the buyer will need to assume the lease. That almost certainly means that the parties must obtain the landlord’s consent to assign the lease to the buyer. It is important to review leases early in the sale process to understand what rights the landlord has with respect to assigning a lease, if there are requirements for personal or corporate guarantees, and if the landlord or lease terms provide for unreasonable demands to assign the lease. Oftentimes, a landlord will request to review the financials of the buyer before consenting to the assignment, which could take time. If the lease is not addressed early in the process, and the parties move towards the closing date without landlord’s consent to assign the lease, the entire deal can unravel if the lease cannot be assigned.  

If you are the owner of the real estate, you must decide if you wish to sell the real estate or lease it to the buyer. In each case, you will want to have a clear understanding of the value of the property (if you are selling) or the fair market rent for the property (if you are leasing) prior to commencing negotiations.  

5. Conduct reputational due diligence

Reputation matters. It is important to understand what publicly available information exists about you before pursuing a sale. DSOs and other buyers typically do basic research on Google, ChatGPT, and social media sites on selling doctors, and may even run background checks. That means you should remove provocative and inappropriate pictures from social media and be aware of any negative articles that exist about you. It is important to be truthful and forthcoming about potentially damaging publicity. In one case, a selling doctor, when asked by a DSO, informed them that he had never been arrested. The doctor, in fact, was arrested several years earlier, but the arrest had since been expunged from his record. However, a news article from many years ago was unearthed by the DSO through a Google search. The DSO terminated the transaction, not because the doctor was arrested, but because he lied about the arrest.  

It is never too early to start thinking about your exit strategy. Whether you sell to a DSO, and outside doctor, or an associate, preparation is the key to maximizing your purchase price.