You are thinking about buying your first practice, and your stress meter is red-lining. You’re lying awake at night with numbers tumbling in your head. You’re trying to get through your day, but the numbers keep flashing through your mind. The ratio of the lab bills to the overall collections, the ratio of staff salaries, the rent, the supplies, the equipment have twisted themselves into a giant knot that bangs around in your head like a super-charged ping pong ball.
Chief among them, of course, is the selling price – that massive, bold number that stood out on the page like a gigantic mushroom cloud of doom on day one. It was the first number you saw when this all began, and it is still the first number you think about whenever you contemplate the project. It is the number you have questioned more than any other number you have about the practice. Is it fair? What should it be? How did they calculate it? How can I be assured that I am not paying too much?
Here is the irony: the price of the practice is probably the last number you should be looking at when you are planning your career as a practice owner.
Wait! Does that mean the price is not important? It is probably the biggest single number you have ever considered paying for something in your life! It is, in essence, the debt you will be tying yourself to for a long time. We all know debt is bad and it is already everywhere in your life. You’ve got student loans. Your car is coughing for some unknown reason. You’d like to have a family, and that means you will need a home and a mortgage. Debt. Debt. Debt. You’ve got enough debt!
Of course the price is important. It does represent a significant amount of debt, but in the end, it is not the most important number you should be considering and certainly not the first number you should look at when you are considering a practice purchase. The first number you should be looking at is usually the last number you see in any financial examination of a dental practice – the net, after expenses, after debt-service cash that you could put in your pocket after a year of operating the practice. It is essentially your paycheck before taxes! Knowing how much that is going to be will help you determine just how significant any of the other numbers are – including the price!
Before we talk more about your paycheck, let’s examine that debt issue a little. Yes, generally it is wise to avoid debt. However, a tremendous difference exists between debt that decreases your paycheck and debt that increases it. While they may enhance your lifestyle, credit card debt, non-essential automobile debt and depreciating asset debt (like boat debt, for example) all decrease your paycheck. However, debt incurred to buy a lucrative dental practice can definitely increase your paycheck … sometimes by far more than you ever imagined.
So, how can you figure out what that paycheck will be? Well, any good Dental Transition Company should give you a reasonably good notion about that immediately – actually before they give you the sales price of the practice. They should have sifted through the practice numbers and ferreted out the truly significant ones. But, if they don’t, here is how you can take a fairly good guess at how much that all-important number will be. First, assume that you will be able to do the same amount of dentistry and collect the same amount after you purchase the practice as the owner did in the previous year. (f you don’t think you can, then perhaps this is not the right practice for you to buy in the first place. Then, take any “compensation of officers” listed on the tax return of a Corporation or an LLC and add to it the “taxable income” listed near the bottom of the first page of most corporate tax returns or the “Profit” listed near the bottom of the Schedule C of a non-incorporated owner. One way or another, that money will eventually end up as part of the money that goes in your pocket.
That’s it? Add two numbers together and you have it? Not quite. In most tax returns, there are many other items that were expenses to a seller, but could easily be considered income to you.
The IRS allows certain personal expenses or a portion thereof, to be included among the general expenses of a business to reduce the overall tax burden incurred by that business. It is good to be an owner! Some sellers take advantage of this opportunity, some do not, and still others abuse the privilege. Regardless, many of the personal items included in the expenses of a practice are essentially money that could be in your pocket.
Let’s look at a simple example.
Often there will be an entry in the tax return for “Repairs.” There are always repairs that need to be made in a dental practice – some simple, some drastic. Say a suction machine could not be repaired and had to be replaced for $5000. It would be reasonable to expect that the new suction machine will last for many years and you will not have to pay that particular expense again for a long time. That $5000 could be added to your list of income. It is money you will save and therefore, money you will have available to spend on something else.
Expenses for employee pension and profit-sharing plans are often allowed by the IRS and are also included in the seller’s expenses. However, it is not uncommon to find contributions made into these plans for the seller of the practice as well. That portion of this expense can also be considered income to you.
There may also be expenses incurred by a seller, which you will not incur, simply because you don’t have to. Doing the payroll and cutting the paychecks every week or two is a good example. Actually doing it is not difficult. The guidelines for withholding and FICA calculations are readily available and the math is not hard to do. Finding the time to do it or having the inclination is another thing altogether. Frequently, veteran sellers will hire companies to do this for them. In your lean years, it may be something you could do yourself and avoid the expense and thereby add the money you would save to your paycheck.
There are usually two sides, so keep in mind the old adage “All that glitters is not gold.” It is not uncommon to find situations within a particular practice that will cost you money rather than save it. You may have to pay more for some things than a seller would. Take for example a seller whose wife works in the practice in some capacity and does not take a salary. If she leaves when he leaves and the remaining staff cannot pick up her duties, you will have to hire someone who can. This will increase your expenses and decrease your pay.
And then, there is that pesky debt thing. Yes, you will have to pay it and those payments will definitely reduce the cash you can derive from the practice. But, there is a silver lining. Every payment you make will reduce that debt and increase the equity you have in the practice. Your increasing equity, coupled with the tax benefits you will accrue, and your paycheck will add up to the Total Economic Advantage you will attain from owning the practice and that is truly the first number anyone contemplating the purchase of a dental practice should consider!