Our thoughts . . . 3-25-09
LET'S DO THE MATH on PURCHASING vs. STARTING A PRACTICE
Finding this article where you have and knowing that the writer is a practice broker, you would have every reason to believe that the text will be biased towards practice purchases always being the better choice. While that may be the conclusion we reach, it's probably not for the reasons you believe. In fact, I have personally done three scratch start build-outs, three complete back-to-the-studs rehabs, and one cosmetic makeover during my 30+ year career in dentistry. There is a time and place for a scratch start, and we will discuss those towards the end of this article. The real bias towards practice purchases in 2009 is due to the economic opportunities they represent and the results of a few mathematical computations. I promise to keep it simple if you will follow along.
Let's begin by designing and building out a four-operatory office in a nice Midwestern suburban neighborhood. The space is located in a mixed-use commercial space along a recognized route through the area in which you desire to establish your career. I will assume that you intend to finish the 1,500 square foot space with modest decor and materials and that only three of the four ops will be equipped. Current finish costs are running around $125.00 per square foot, so your net cost will be $187,500 for those 1,500 square feet. In some instances, part or all of this cost can be included in the rent, but you are still paying for it, one way or another. Finishing and equipping the three ops with good quality, middle of the road equipment will cost another $100,000, which includes digital x-rays, ultrasonics, and handpieces. but no lasers or air abrasion units. Add in another $100,000 for infrastructure items like suction pumps, air compressors, panoramic x-ray, and computer servers. Lastly, let's allow another $50,000 for start-up supplies, instruments, furniture, and office equipment. So what do we have so far?
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$
187,500
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Leasehold Improvements Three Operatories Infrastructure Furniture, instruments, supplies |
I will tell you that we are a little conservative here in the Midwest and that the national average is closer to $475,000. We haven't discussed operating capital needs yet for which I would advise access to at least $100,000. All of this and you have no patients, no staff and no revenue. Broker bias? Maybe, but just to help make it more fun, let's assume that I've lost my mind (probably from going through one of the aforementioned build-outs) and that I'm 20% too high on all of my estimates. In that case:
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$
437,500
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Original Estimate Operating Capital "LOST HIS MIND" DISCOUNT New Cost |
In the current market, if you can find a lender that will do these kinds of loans, your monthly payment will be about $5,200 on a 10-year payback. (I will acknowledge that there may be two separate loans for the base mortgage and the operating capital, which may be on different payback schedules, but I promised to keep this simple. You have to pay it back one way or another.) Remember that $5,200 is after the 20% discount. The "full price" payment would be a little over $6,500. Where you end up is a function of how carefully you control your wants and needs. Lop off an operatory and save (for now) $15,000 - $20,000. Still no patients, staff, or revenue, however.
At this point, a prudent person would have to ask themselves; what else could I buy for $5,200 per month? Remember that in our recalculated cost, $80,000 ($100,000 less 20% discount) was allocated to operating capital. Since a typical practice acquisition would not need that much to get them over the hump, I would offer that the $430,000 could be allocated as $375,000 to purchase price and $55,000 to operating capital along with any "urgent" capital improvements. In this market, $375,000 should buy you a nice practice with $525,000 to $ 650,000 in annual revenues. For this example, let's agree on $600,000 with a normalized overhead of 60% and gross profit of $240,000. Annual debt service of $62,600 leaves a pre-tax profit of $177,400 for take home pay. For the same cost as our partially equipped start up example, you can have patients, staff, revenue, equity development, and net profit.
The irony though is that this is not a one-year phenomenon. The real effect of choosing one of these two models comes in the income differential between them over a period of years. As shown on the graph below, the gap in earned income widens even more for the first 2-3 years. While the purchaser is enjoying increases in production, capital improvements, and net income, our start-up doctor is getting further in the hole. Even if the start up doctor really likes the taste of beans and wieners, the most dramatic result of this early decision may be most noticeable at retirement. The power of compound earnings can create a huge future nest egg from only a small percentage of the practice purchaser's early net income. In fact, the purchasing or investment potential of that income differential may be so great that the start-up doctor never catches up. Do your own math.
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So when is the right time and place to do a start up? After all, there must have been good reasons for me to have done so many in a relatively short period of time, right? I think there are opportunities for start-ups with manageable risk if:
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2. 3. 4. 5. 6. 7. |
You have an outside source of revenue for living expenses. For example, a
pension, book royalties, lottery winnings, rich uncle, etc. You are not the primary provider for your family and can live off your spouse's salary for a long time. You cannot find a practice within a reasonable travel distance from where you need to live. Note: 'need' not 'want'. Points #1 and #2 will still apply. You locate an area with a very high patient-to-doctor ratio. This is probably going to be a rural practice. You locate an area with NO other provider. Again, probably rural. You can locate an office that is not in current use with leasehold improvements in place and can equip the office with used equipment in order to keep costs to a minimum. MATSCO has an application only loan product that may be helpful if you are able to stay below their maximums. Points #1 and #2 will still apply. You are able to find an "Avoided Cost" scenario as we discussed in the last issue. Points #1, 2 and 6 will still apply. |
One last point: I may have been optimistic about the potential cost of funds you may encounter in order to finance a start-up. Many lenders simply consider the risk to be too great to risk their money in 2009. As Brannon Moncrief of Professional Practice Capital, a large practice funding company out of the Houston, Texas area, stated, "PPC has not and does not provide start-up financing due to the fact that we view these types of transactions to be much riskier than practice acquisitions." So, unless that rich uncle is going to give you a blank check, know what you are getting into and proceed very cautiously.
Steve Wolff, DDS
UMKC Class of 1977