American Association of Orthodontists Market Trends and ... Roger... · xMarketing xAdministration...

© 2013 Roger K. Hill, M.S.A., A.S.A.

Market Trends and Other Key Elements in Practice Transitions

Roger K. Hill, M.S.A., A.S.A.

American Association of OrthodontistsAnnual Session

May 3, 2013

AAO Membership Breakdown

69%

16%

6% 4% 5% Solo Practice

Partnerships

Associateships

Interdisciplinary Practice

Large Corporate Practice

New Market Context: Where Are We? New Market Context: Where Are We?

Key Changes◦ Decrease in Solo Practice◦ Increase in Partnerships◦ Emergence of Corporate Practices

Developing Trends

Strategic Partnerships with Pediatric and Dental PracticesEquity or Office Sharing AgreementDependence of Single Referral SourceFreedom from Marketing to Referring Doctors

New Market Context: Where Are We?

360Graduates Per Year

65Residency Programs

9,500Orthodontists (Largest Specialty)

136,000General Dentists (Active)

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Doctors Retiring Later: 401(k)s to 201(k)sAging Orthodontist PopulationAverage Age: 54Years In Practice: 23Both Are 30-Year Highs


25%21-30 Years

25%11-20 Years

30%6-10 Years

17%0-5 Years

Years In Practice by Age Group


Approximately 20% of Orthodontists Are Age 60 or OlderApproximately 200 per Year (on 10-Year Average) Will RetireApproximately 360 Graduates Per Year4.0M Children Born in 2000Turning 12 This Year (2012)

Is There Good News? Yes!


Corporate Practice of DentistryDSOs/DSMOs: What Are They?◦ Two Fundamental Types

OwnershipService Providers

New Market Context: Where Are We?Corporate Practice of DentistryDSOs/DSMOs: What Are They?◦ Function Based On Two Fundamental

PrinciplesFirst: Most Practice Overhead Is InefficientSecond: Revenue of Most Practices Can Be Increased

The Main Lesson: There Is a Lot of Money Available

New Market Context: Where Are We?Corporate Practice of DentistryOwnership Model◦ Some States Resisting, Most Are Not◦ Larger Companies:

Aspen Dental Coast DentalPacific DentalHeartland

◦ Approximately 3,500 Practices in 46 States

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Corporate Practice of DentistryService Providers◦ Provide an Array of Service Choices:

MarketingAdministrationBilling / CollectionLogistics / SuppliesCall Center


Corporate Practice of DentistryService Providers◦ Allows Doctor to Focus on Their Skill Set◦ Most Doctors Dislike Management

Activities

New Market Context: Where Are We?Corporate Dentistry◦ Definitely Here to Stay

Ownership Models Refined; Early Models FailedService Models Can Be Beneficial

◦ Market PenetrationCurrently Less Than 3.0%Medical Model Best Indicator – Likely No More Than 12.0% to 15.0% (Ortho)

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Fundamentals and QuestionsQuestion 1:

Are practice values decreasing?

Are Practice Values Decreasing?

Supply & Demand◦ Historically More Sellers Than Buyers◦ Situation has ReversedMaintaining Current IncomeExpect Values to Maintain or Increase

Important Questions!Are Motivated Buyers Available?◦ Fewer Available Opportunities

Full SaleBuy-In / Buy-Out

◦ Improved Seller / Purchaser Ratio◦ Financing is AvailableBuyers’ Other Options◦ Start-Up Practice◦ Associateship

Are Practice Values Decreasing?

Start-Up vs. Acquisition◦ Acquired (Full Sale or Fractional)

Financial RiskImmediate Income StreamEstablished Referral Base

◦ Start-UpFinancial RiskNo Income StreamNo Referral Base

A Comparison:Where Is Success Maximized?

Net

Inco

me

Time

Net Income of Acquired Practice:

Net Income of Start-Up Practice:

Opportunity Cost

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Opportunity Cost in Real Terms(An Example)

Assume Difference:◦ Year 1: $200,000◦ Year 2: $160,000◦ Year 3: $120,000◦ Year 4: $80,000◦ Year 5: $40,000

Difference is $2,318,400It Will Never Be Recovered!

5.0% Return

30-Year Career

The Main Lesson:

“It is always more efficient to acquire a benefit stream than to create one.”

Question 2:

Someone told me that my practice is worth 80% of a year’s gross collections. Is this true?

Practice A

•$1 million revenue

•3 chairs

•“vintage”equipment

Practice B


•6 chairs

•current technology

Are They Both Valued at $800,000?

Percentage of Income as Value

Practice A


•55.0% overhead

Practice B


•65.0% overhead

Percentage of Income as Value

Are They Both Valued at $800,000?

Appropriate Valuation MethodologyFair Market Value (FMV) Is the Sum of:◦ Tangible Assets

Orthodontic ReceivablesEquipmentFurnishingsLeasehold ImprovementsOffice EquipmentSupplies

◦ Intangible AssetsGoodwillCovenant Not to CompetePatient RecordsTelephone Number(s)

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Appropriate Valuation Methodology

What Impacts Intangible Value◦ Practice Growth Rate◦ Profitability/Overhead◦ Income◦ Location◦ New Patient Flow◦ Number of Referring Sources◦ Payor Sources (% Insurance)◦ Etc.

Determining Fair Market Value

1. Income / Earnings Approaches2. Comparable Sales Approach3. Multiple Approaches Increase Accuracy4. Transparent Methodology

Orthodontic Receivables

Three (3) Types of Receivables1.Contracts Receivable2.Accounts Receivable3.Prepaid Accounts

Orthodontic Receivables1. Contracts Receivable

• Sum of Scheduled Payments• Discounted For:

•Overhead Costs•Doctor Compensation•Uncollectibility

• Largest of the Three Types

Orthodontic Receivables

2. Accounts Receivable• Due Current Month, and• Past Due• Discounted Only for Uncollectibility• Generally Smallest of the Three Types

Orthodontic Receivables3. Prepaid Accounts

• Senior Doctor Has Been Paid

• Treatment Provided Without Payment

• Reduces Fair Market Value

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The Fulcrum(On Which the Lever Turns):

Cash Flow Projections

Limitations of Fair Market Value

• Fair Market Value (FMV) Does Not Define Financial Benefit

• FMV Defines:• Value of Tangibles• Value of Intangibles• Normalized Overhead Rate

“Beans and Weenies”

• Purchaser Needs to Know:

• After-Tax Cash Flow

• Seller Needs to Know:• Will Earnings Change?

Cash Flow Projections (Proforma)

• Illustrate All of the Above• Test Value• Increase Confidence• Enhances Financing Request

Proforma: Previewing Financial Outcome3rd Year 4th Year 5th Year

Proj. Prof. Income $1,111,980 $1,134,220 $1,156,904Practice Overhead (764,929) (779,708) (794,782)

Distributable Profit $347,051 $354,512 $362,122

Dr. New's Coll. Alloc. $0 $741,104 $954,823Associate Collections 0 194,997 0Hygiene Allocation 0 198,119 202,082

Total Allocation $0 $1,134,220 $1,156,904

Overhead Allocation $0 ($779,708) ($794,782)

Pre-Tax Profit $0 $354,512 $362,122

Compensation as Associate $160,620Practice Purchase Interest (43,209) (39,985)Depreciation & Amortization (60,921) (56,874)Equipment Purchase Interest (2,874) (2,520)Depreciation on Equip. Purch. (5,769) (5,769)Working Capital Interest (5,189) (4,192)Payable to Dr. Seller (58,499) 0Personal Deductions (22,700) (22,700) (22,700) Pre-Tax Income $137,920 $155,350 $230,081Estimated Taxes (41,837) (47,180) (71,161)

After Tax Income $96,083 $108,170 $158,920Practice Purchase Principal (41,530) (44,754)Depreciation & Amortization 60,921 56,874Equipment Purchase Principal (4,559) (4,913)Depreciation on Equip. Purch. 5,769 5,769Working Capital Principal (12,845) (13,842)Non-Financed Capital Exp. (10,000) (10,000)Personal Deductions 22,700 22,700 22,700

After Tax Cash Flow $118,783 $128,627 $170,755

Advanced Proforma Utilization

• Testing for:• Overhead Reduction• Increased Income• Desired Benefit• New Capital Purchases

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Transition Alternatives

Transition Alternatives: Prototypical Sale

Full SaleControlCash / Note RatioLittle Recovery Time, Least SecurePractice Size LimitationTime Frame 0-2 YearsAsset Sale

Transition Alternatives: Delayed Sale

Full SaleControl and Compromise for SecurityCash / Note Ratio ReducedTime Frame 1-3 YearsAsset Sale

Transition Alternatives: Fractional Sale

Portion of PracticeMore ComplexEmotional AspectsLarger Practices or Time Frame of More than 5 Years

Transition Alternatives: Hybrid (Fractional to Full Sale)

Begins as Fractional SalePredetermined Buy-Out DatePurchaser Owns 100.0% At EndManaging GrowthAdding Associate After Seller’s DepartureCan Progress to New Fractional Sale

Transition Alternatives: Mergers

Most ComplexSingle Survivor EntityLongest Time Frame (Generally 8-10 Years)Slow Down Merger

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Associateships

AssociateshipsHow Do You Know If You Need One?◦ Rapid Growth in Practice◦ Reduction of Time / Scope◦ Transition Planning◦ New Satellite Office(s)◦ Raising Barrier(s) to EntryPart of a Larger Plan

Associateships

Relationship Failures(1) Personality

Acid TestProfessional Assessment

Associateships

Relationship Failures (continued)(2) Unforeseen(3) Unfulfilled Expectations

Financial OutcomesLegal ArrangementsProcess

Question 3:

How do I know what to pay an associate?

Associate Compensation

Salary, (Full Time)Per Diem◦ Post-Sale for Sellers

Contract Status with Corporation◦ Part-Time Associate

Pro RataBenefit Package

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Associate Compensation

Is There a Way to Determine the Necessary Growth?

Break Even Point (BEP) Algorithm

Associateships

Break-Even Point Analysis (BEP)

$ Total Fixed Costs (TFC)= $ BEP

1.0 – Variable Costs (%)

Break-Even Point Analysis (Salary)

Assume:Compensation/Benefits = $150,000Additional Employee = $35,000Variable Costs = 10.0%

Then:$150,000 + $35,000

1.0 – 0.10 = $205,600

$205,600 / 12 months / 17 days = $1,007 per day additional

How Are Bonuses Determined?

Recovers Cost of Associate DoctorBonus Not CappedEasily Quantified and Tracked

Bonus AlgorithmCompensation / Benefits+ New Fixed Expenses

= Derived Additional1.0 – Variable Costs (%) Income

Derived Additional Income+ Current Practice Income = $ Bonus Threshold

Bonus Algorithm

• 15.0% - 20.0% Of Revenue in Excess of Calculated Threshold for Bonus

• Paid Periodically (Quarterly Most Common) • Escrow Amounts and Buying-In

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Fractional Sale (Buy-In and Buy-Out)

Structuring the Buy-In

Decision to Proceed

A. Trigger PointB. Financial StructureC. Income Distribution

FormulaNote: 1 and 2 = Financial

3 and 4 = Initial Legal

FMV and Proforma

Selection of a Transition Alternative

Search for Candidate / Interviews

(2)(1)

Employment Agreement

Buy-In Letter

(Letter of Intent)

(3)

(4)

Fractional Sale: Structuring the Buy-InPhase One Planning

1. Fair Market Value2. Proforma

A. Trigger PointB. Financial StructureC. Income Distribution Formula

3. Employment Agreement4. Letter of Intent

Financial Expectations

Legal Expectations

Defining Financial Expectations:Two Components

First Component◦ Fair Market Value

Due Diligence VisitMultiple Approaches to Value Increases AccuracyRegression Analysis if Associate Is in Place

Defining Financial Expectations:Two Components

Second Component◦ Cash Flow Projections (After-Tax)

Illustrate Financial OutcomeTest ValueIncrease ConfidenceAddresses Critical Issues (A & B)

This Is The A Of The ABC’s

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Fractional Sale: Structuring the Buy-In

(A) Trigger Point◦ Sufficient Collections◦ No Decrease in Earnings

This Is The B Of The ABC’s

(B) Financial Structure◦ Simultaneous Objectives

Affordable for Associate/PurchaserFair/Equitable for Owner/Seller

◦ Push / Pull in Tax Code◦ Basketballs and Minefields


Solving Financial Structure: Two Alternatives◦ Stock Sale (I)◦ Asset Sale (II)



Alternative Financial Structure I: Stock Sale◦ Most Practices Incorporated◦ Ownership Conveyed by Stock Purchase◦ Taxed at Capital Gains Rate (15.0% / 20.0%)◦ Good for Seller◦ Inefficient for Purchaser


Alternative Financial Structure I: Stock Sale (cont’d.)

Inefficient for PurchaserNon-DepreciablePaid With After-Tax IncomeInterest Not DeductibleHigh Cost Basis

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Inefficiency of (All) Stock Sale

$100,000 Purchase Price of x.xx% of Stock$ 18,800 Interest on Loan to Purchase Stock$118,800 Sub-Total/ 0.65 Income Taxes at (Assumed) 35.0%$182,700 Total Amount Needed

Fractional Sale: Structuring the Buy-InCan We Make This More Affordable?

Tangible + Intangible = Fair Market ValueTangible Component Typically Much SmallerProvides Benchmark for Stock Value

Fractional Sale: Structuring the Buy-InCan We Make This More Affordable?

Stock Sale: Affordable and Tax Efficient◦ Assign Portion of Value to Stock (Tangible)◦ Remainder Paid with Pre-Tax Earnings Shift

(Intangible)◦ Typically Paid Over 5-7 Years

Stock Sale: Affordable and Fair

Fair Market Value

Tangible Net Worth

Intangible(s) Component

Stock Management Fee(Pre-Tax Income Shift)

Fractional Sale: Structuring the Buy-InCan We Make This Tax-Efficient and Fair?

Stock Sale Made Affordable and Tax Efficient

Intangible Allocated to Management Fee

Imputed Interest – Known Return (%)Tax Differential – Splits Tax Burden

Stock Sale: Affordable and FairFair Market Value

Tangible Net Worth

Intangible(s) Component

Stock Management Fee Imputed Tax(Pre-Tax Income Shift) Interest Differential

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Components of Value

Capital Gains Ordinary Tax Income Tax

Tangible Net

Worth

Tax Differential

Management Fee

(Pre-Tax Income Shift)

Imputed Interest

IntangiblesStock Purchase


Financial Structure II: Asset SaleGenerally Two Sellers

Practice Sells TangibleDoctor Sells Intangible

ASSET SALE STRUCTURE (Prior to Buy-In)$ Income

(Overhead)$ Allocable Profit

100.0% of Fixed Assets/Supplies/

Receivables 0.0% of Fixed Assets / Supplies /

Receivables0.0% of

Intangibles

Seller (Individually)

Purchaser’s Entity100.0% of

Intangibles

Seller’s Entity

Partnership or LLC

ASSET SALE STRUCTURE (After Buy-In)$ Income

(Overhead)$ Allocable Profit

50.0% of Fixed Assets/Supplies/

Receivables 50.0% of Fixed Assets / Supplies /

Receivables50.0% of

Intangibles

Seller (Individually)

Purchaser’s Entity50.0% of

Intangibles

Seller’s Entity

Partnership or LLC

Fractional Sale: Structuring the Buy-InWhich Structure is Better?

Stock Sale with Management FeeAsset Sale with Three Entities


Which Structure is Better?Best Results From Looking at Both

Compare Financial OutcomesRequirements for Comparison:* Depth of Experience* Software Capability

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This Is The C Of The ABC’s Fractional Sale: Structuring the Buy-In

(C) Income Distribution Formulae: Basic Types

(1)Equity (Ownership)(2)Percentage (Productivity)(3)Multi-Tiered

Orthodontic Distribution FormulaMulti-Tier

100.0%

Days Worked50.0%

Productivity Diff.50.0%

Orthodontic Distribution FormulaProductivity Differential

50.0% 50.0%

S

E

L

L

E

R

P

U

R

C

H

A

S

E

R

60.0%

90.0%

80.0%

70.0% 30.0%

40.0%

10%

20.0%

(5 Years Illustrated – Can Be Varied)

Fractional Sale: Structuring the Buy-InPhase One Planning

1. Fair Market Value2. Proforma

A. Trigger PointB. Financial StructureC. Income Distribution Formula

3. Employment Agreement4. Letter of Intent

Financial Expectations

Legal Expectations

Fractional Sale: Structuring the Buy-InEmployment Agreement◦ Employs Associate Until Buy-In Begins◦ Compensation/Benefits Defined◦ Covenant Not to Compete◦ Term (Length of Employment)◦ Related Matters

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Buy-In Letter (Letter of Intent)Previews Partnership OperationsDaily Operational DetailsPreviews Buy-In/Buy-Out

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Full Sale: 100.0% of Practice


Decision to Proceed

Selection of a Transition Alternative

FMV and Proforma

Search for Candidate / Interviews

(1) (2) (4)

(3)Employment Agreement

Letter of Intent

Note: 1 and 2 = Financial3 and 4 = Initial Legal

Full Sale: 100.0% of PracticePhase One Planning◦ Fair Market Value◦ Proforma

PurchaserSellerNew Doctor(s)

◦ Employment Agreement◦ Letter of Intent

Financial Outcomes

Legal Arrangements


Proforma◦ Ten (10) Year Forecast◦ Illustrates After Tax Cash Flow for

Purchaser◦ Estimates After Tax Gain for Seller

Proforma: Previewing Financial Outcome1st Year 2nd Year 3rd Year

Projected Professional Income $1,931,250 $1,969,875 $2,009,273Operating Expense (982,432) (1,002,081) (1,022,122) Distributable Profit $948,818 $967,794 $987,150

Dr. There's Collections $834,346 $746,063 $373,032Hygiene Collections 896,904 923,812 0

Total Allocable Collections $1,731,250 $1,669,875 $373,032

Allocable Overhead Expense (880,691) (849,470) (189,762)

Pre-Tax Profit 850,559 820,405 183,270

Distributable from Dr. New $26,259 ($14,611)Compensation as Associate $130,561Personal Deductions (10,900) (10,900) (17,900)

Profit Before FIT $865,918 $794,894 $112,661Estimated Tax (312,406) (285,488) (36,768)

Profit After FIT $553,512 $509,406 $75,893Cash Payment at Closing 977,773Personal Deductions 10,900 10,900 17,900

After Tax Cash Flow - Dr. There $564,412 $520,306 $1,071,566

How Much is Enough?Based on Five (5) Factors

1. Tax Rate2. Investment Returns3. Longevity4. Gain From Practice Sale5. Monthly Living Expenses

Decisions of Magnitude

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Monthly After‐Tax Living Expenses

Amount Required at Age 65 (3% inflation)

$2,500 $811,500$5,000 $1,623,000$7,500 $2,434,500$10,000 $3,246,000$12,500 $4,057,500$15,000 $4,869,000$17,500 $5,680,500$20,000 $6,492,000$25,000 $8,115,000$30,000 $9,738,000

How Much Do You Need?When Can I Afford to Sell?◦ Quantify Amount Necessary to “Restock

the Shelves” (Retirement Savings)◦ Sale Proceeds Are Now More Critical to

Your Retirement◦ Implement Transition Plan to Support

Recalculated Timeframe

Decisions of Magnitude

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Strategies for ReducingTax on Gain

Full Sale: 100% of Practice

Allocation of Purchase Price◦ Assign Specific Value to Each Asset Class◦ Seller and Purchaser Must Use Same

Allocation◦ Push / Pull in Tax Code

Strategies for Reducing Tax on the Gain

Full Sale (100.0% of Practice)◦ Asset Sale (Not Stock)◦ Generally Two Sellers (One Purchaser)

Corporation Sells TangiblesDoctor Sells Intangibles

Full Sale: 100% of Practice

o Allocation of Purchase Price• Order of Allocation:

Receivables Consumable SuppliesFixed AssetsPatient RecordsCovenant Not to CompetePersonal Goodwill

Corporation Sells

DoctorSells

Allocation of Purchase Price

Amortizable Over 15 YearsCapital Goodwill

Amortizable Over 15 YearsOrdinaryCovenant

Depreciable Over 5-7 Years

Generally OrdinaryFixed Assets*

Amortizable Over 15 YearsCapital**Patient Records*

Expensed, Years 1-2OrdinaryAccounts Receivable

Amortizable Over 15 YearsCapital GainNet Contracts Receivable

Expensed, Year 1OrdinaryConsumable Supplies*

PurchaserSellerAsset Class

* If the practice is incorporated these items must be sold by the corporation. **If the corporation is a C-corporation, gain will be taxed at ordinary rates.

Full Sale: 100.0% of PracticeAllocation of Purchase Price

◦ Incorporated PracticesCorporation Sells:

ReceivablesSuppliesFixed AssetsPatient Records

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Full Sale: 100.0% of PracticeAllocation of Purchase Price

◦ Incorporated PracticesDoctor Sells:

Assignment of Personal Goodwill/CovenantDistinct From CorporationDocument Language Critical

Tax Strategies for Full Sale• Pay Sale Expenses Through Corp

Legal FeesCommissionsAccrued Expenses Payable

Maximize Retirement ContributionsThese Minimize Ordinary Tax Burden


Tax Strategies for Full Sale: Reduce Capital Gains Taxes on Proceeds

Capital Loss CarryforwardCreate New Capital Losses


Tax Strategies for Full Sale: Post-Sale◦ Keep Corporation and Use Service

AgreementMinimize Payroll Taxes for Both PartiesContinue to Fund Retirement PlanMaintain Family “Perks”


The Golden WindowThe Most Efficient Use of Your Assets◦ More After-Tax Gain Due to Current Tax

Rates◦ Living On After-Tax Gain

Capital Gain Portion Often 60.0% to 80.0% of Practice SaleUse Gain From Sale for Living Expenses Before Tax-Sheltered Savings

◦ Sheltering Gain and Post-Sale Employment

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PersonalPerspectives

Personal PerspectivesWhat Senior Doctors Really Want in An Associate◦ Time Off / Reduced Scope of Treatment◦ Locking In Transition Plan◦ Willingness to Actively Help Grow Practice◦ Sharing Administrative Responsibilities◦ Appreciation / Acknowledgement◦ “Act Like a Partner Before You Are a Partner”

Personal PerspectivesReality Check: What Do Associates Expect?◦ Reasonable Compensation

Available ProductionStructure (Draw, Commission, Etc.)

◦ Acquisition OpportunityAnd a Transition Plan to Follow

◦ Employment Agreement

Personal PerspectivesReality Check: What Do Associates Expect?◦ Opportunity to Grow◦ Mentoring by the Senior Doctor

Clinical (Periodic Conferences)Administrative

◦ Respect: No “Junior Doctor”◦ Payor Sources

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“I Wanna Talk About Me” Question 4

“I’m not certain if it would be better to bring in an associate leading to partnership, or practice solo for a few more years and then sell. How can I know this?”

…A Complex Decision Due to:

1. Quantitative IssuesA. Valuation of PracticeB. Length of TimeframeC. Tax ConsiderationsD. Income NeedsE. Personal Financial Status

…A Complex Decision Due to:

2. Qualitative IssuesA. Current AgeB. Family ConsiderationsC. Quality of Life ConcernsD. Health StatusE. Ready to Go or Ready to Go

3. How We Really Make Decisions

4. What the Smart People DoA. Model Quantitative Scenarios

• Partnership Pathway• Solo Practice for ___ Years, Then Sell• Sell Practice and Work Post-Sale• Review and Consider Each Scenario• Define Pathway 2-5 Years in

Advance

The Big Take AwayThe Transition Success Formula

1. Defined Expectations• Financial Outcomes• Legal Arrangements• Process (Planning Protocol)

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Now, when we get up in the air, we better read

the manual.

Where Do We Go From Here?

Getting Underway Withouta Transition Plan…

Getting Underway With a Transition Plan

Will SucceedThe Most Successful Plans Begin With the VisionPlanning Provides the Structure Plans (Financial and Transition) are Implemented / RealizedYou Deserve Nothing Less

8816 Red Oak Blvd.Charlotte, NC 28217

(877) 306-9780www.mcgillhillgroup.com

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American Association of Orthodontists Market Trends and ... Roger... · xMarketing xAdministration...

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Transcript of American Association of Orthodontists Market Trends and ... Roger... · xMarketing xAdministration...