The dental attorneys at Nardone Limited regularly assist our dental clients in the purchase and sale of their dental practices. From a buyer’s perspective, there are certain due diligence steps that a buying dentist should go through, both from a business and legal perspective, prior to deciding to purchase a dental practice. We are going to prepare a series of blogs, focusing on the business terms that should be addressed, beginning with analyzing and identifying a target dental practice to purchase. There are many business issues that arise during the purchase process. This particular blog discusses one aspect of the purchase process, as it relates to understanding the financial statement of the selling dental practice, specifically net earnings.
Background on Net Earnings
Before we discuss how net earnings impact our decision in purchasing a dental practice, we first have to understand net earnings. So, what is net earnings? Net earnings is the number left over after you have reduced gross revenue by: (i) cost of goods sold/services; (ii) operating expenses; (iii) interest expense; and (iv) taxes. Basically, after all of the expenses and taxes have been deducted from the dental practice’s revenue, we get the dental practices net earnings.
Why Are Net Earnings Important and What Are We Looking For?
Generally, we want to see a historical upward or consistent trend in net earnings. A single year of data concerning net earnings, however, is not helpful. We want the historical data. Dental brokers or selling doctors generally only want to give the buying dentist up to 3 years of financial data. Yet, 1 to 3 years of data will not allow the buying dentist to understand the historical data. Thus, we should push for more. We want to see an upward and consistent trend in net earnings over a period of 5 to 10 years. We cannot see that picture and fully understand the economics without that data.
We then want to focus in on the percentage of net earnings to total revenues. We want to work with and purchase dental practices that report a higher percentage of net earnings to total revenues than their competitors. As my friend Jim Boltz has asked clients, rhetorically, time and time again: would you prefer to acquire a dental practice that is earning $200,000 on $1 million in total revenue (Dental Practice #1), or a dental practice that is earning $500,000 on $10 million in total revenue (Dental Practice #2)? In most instances, we want to purchase the dental practice with a higher percentage of net earnings to total revenue. Thus, we will purchase Dental Practice #1 that has a net earnings ratio of 20% ($200,000 / $1 million) versus Dental Practice #2 that has a net earnings rate of 5% ($500,000/10 million).
We are also looking for dental practices that have a net earnings ratio of 10% to 20%. If the net earnings ratio is less than 10%, we need to really scrutinize the potential purchase and ask a lot of questions to better understand why the percentage is so low. There may be some good reasons for it. We should also be concerned about dental practices that have a net ratio of over 20%, since we may not be able to duplicate the efforts and operations of the selling doctor. Either way, do not jump into a dental practice purchase without fully understanding the numbers. So, the message here is: be careful about the total revenue number alone, which may tell us very little about the economics of the dental practice. Rather, focus in on the ratio of net earnings to total revenues. And, ask for 5 to 10 years of data, and do not be satisfied with 1 to 3 years of data.
Nardone Limited Comment: Finally, remember, do not make decisions primarily on emotion. When you allow emotion to control a decision, it will negatively impact your judgment and cause you to intentionally or unintentionally ignore objective-time-tested prudent steps in acquiring a successful business, in this instance a dental practice.
Contact Nardone Limited
If you have any questions regarding your acquisition of a dental practice or expansion of your current practice, you should contact Nardone Limited. Nardone Limited, a Columbus, Ohio law firm, provides specialized dental practice representation. The business attorneys at Nardone Limited specialize in representing dentists in such diverse areas as: (i) dental practice business succession planning; (ii) buys and sells of dental practices; (iii) real estate matters including lease agreements and other commercial real estate transactions relating to dental practices; and (iv) employment matters. We, at Nardone Limited, understand that a dental practice is a business, and we strive to handle transactions to minimize our client’s time spent away from the office. Whether your practice is beginning, transitioning, or encountering adversity, Nardone Limited provides the legal guidance your practice needs. Contact Nardone Limited today.