Oct 20, 2016
Negotiate the Accounts Receivable When Buying a Dental Practice
Written By: Brian Hanks
On Friday I experienced a parenting moment that reminded me of trying to negotiate buying a dental practice and how quickly things can go badly.
I had promised the kids each a small bag of M&Ms after work. I followed through and delivered. I tallied the dad points in my head. Then, of course, I watched as the 2 year-old ripped open the bag and one single, solitary green M&M escaped and fell, rolling onto the floor.
Her 3 year-old sister was fast.
She jumped down, snagged it, and popped it in her mouth in full view of the 2 year-old who still had an entire bag of chocolate happiness, minus one escapee.
You know what happened next.
The 2 year-old dissolved in tears and threw a fit. One escapee M&M made her so angry that the rest of the bag in front of her didn’t even register.
This is the very definition of a scarcity mindset. If you’re read Steven Covey’s “7 Habits of Highly Effective People,” you remember this principle. Dr. Covey outlines how zero sum thinking makes people sad, jealous, and greedy. Scarcity makes you think there’s only so many M&Ms in the world and if you share any of them with anyone you’ll miss out and starve to death. This kind of thinking happens when negotiating buying a dental practice all the time.
Most often when negotiating a dental practice purchase, it happens around the purchase price. The selling doctor gets a price in their head of what their practice is worth and throws a fit when they get an offer is less than what they think they “deserve.” I know of one selling dentist who almost derailed a deal over $5,000 on a purchase price of over $1.5 Million. A single M&M rolling away is the perfect analogy for a deal like that.
But what if you are buying a dental practice and you don’t think the practice is worth what the selling doctor wants? What if you love the practice, would love to buy, but you’ve talked with the seller or broker and have been told “there is absolutely no wiggle room on price?” (Let’s assume for this example that this is true). But your dental accountant is telling you the practice is not worth what the seller wants – what now?
Let’s look at an example.
Let’s say you’re trying to negotiate buying a dental practice for sale in a city where you want to live, with a phenomenal staff, great patient base and an office location that is perfect. The seller wants $1,000,000 for the practice and won’t take a penny less. Your dental accountant is telling you the practice is only worth $900,000.
$100,000 is a big difference. What now?
You could just split the difference and offer $950,000. But both parties would likely feel frustrated – the seller thinking they are getting less than the practice is worth, and the buyer feeling like they’re overpaying.
Or you could just overpay and say, “Oh well. I guess this is what I have to pay…” your monthly payments on a 10-year, 4% loan would increase from $9,112 to $10,125 – over $1,000 a month. That’s $1,000 cash you could invest in the practice or use at home to pay down student loans. Not good.
Not only would you pay $100,000 more in the principal on the loan, but your total interest payments over the life of the loan would increase from $193,447 to $214,942 – an additional $21,494 you’re paying the bank on the larger amount the seller wants.
Are you stuck? Are you out of options? Do you suck it up and overpay?
Step into my dental accounting office, let me get out my green eye shade and calculator and allow me to introduce you to two ways you can get some of the difference back.
The two additional areas where you can negotiate buying a dental practice that will put real dollars in your pocket besides the asking price are: 1. Buying the Accounts Receivable, and 2. the Asset Allocation. I’ll talk about the former in this post and the latter in the next post.
Negotiate Buying the Accounts Receivable
When you negotiate buying a dental practice, you are buying an income stream. The day you own the practice, there will still be patients that owe the practice money. The seller owns the money that is still owed. However, you can buy that money owed to the seller by offering to purchase the accounts receivable.
When you pull an accounts receivable report from the practice management software system, the system will separate the total accounts receivable into different “vintages.” Current accounts receivable is for any procedure done in the last 30 days, the next oldest is for anything 31-60 days old, and so on.
In the Letter of Intent, the buyer will offer to purchase the accounts receivable on a sliding scale that reflects the format of the system generated A/R aging report. The scale will reflect the fact that “fresher” bills are more likely to be paid, and bills that have been outstanding for a while may never be paid. It can be a hassle for the seller to keep track of, and ultimately collect, on the accounts receivable so often times the buyer will offer to purchase the accounts receivable at a discount.
This is like offering to buy a stack of cash, for a slightly shorter stack of cash.
The seller is usually happy to make the trade because you’re relieving them of the responsibility of collecting the money – they can make a clean break from the practice after the sale! Additionally, banks typically will add on to the practice loan the amount needed to purchase the A/R.
Back to our example.
Let’s assume the $1,000,000 practice has $100,000 in outstanding accounts receivable, broken out into the buckets or “vintages” in the table below.
So, the buyer would offer a percentage discount off the amounts in those buckets of accounts receivable. Typically, in a letter of intent, the A/R offer will take the form of a table similar to this one. (Full disclosure: as we work as buyer advocates, this table is skewed in favor of the buyer).
Applying those percentages to our example of $100,000 in accounts receivable, yields the result of ultimately paying $79,050 for $100,000. Remember we felt like we were overpaying for this practice by $100,000. By offering to buy the accounts receivable, we’ve made up $21,000 of the difference already! An important assumption here is that you actually collect all $100,000. But, even if the amount ends up being less, you’ve likely still paid less for the total amount you’ve collected when all is said and done.
Of course, every purchase will have its own specific numbers. The amount of accounts receivable on the books of a practice will vary greatly from practice to practice. Ironically with our example, having a low amount of accounts receivable is actually a good thing – a sign of a healthy practice collecting quickly on the dental work it performs! (Which, incidentally, could be one reason why the seller feels justified in a higher asking price!)
The point here isn’t the math. The point is when you feel stuck with an asking price higher than you feel like you want to pay as a buyer, one way to feel better about the deal and to feel like you are coming away with some real dollars in the negotiations is to offer the seller to make a clean break from the practice and negotiate favorable terms to buy the accounts receivable.
In my next blog post, I’ll discuss how you can negotiate the asset allocation of the purchase price as another way to put real dollars in your pocket when buying a dental practice.
Once you’ve found a good dental practice to buy, deciding what price to pay is important. You never want to overpay if you can help it. Knowing where and how to negotiate buying a dental practice will help. By knowing that there are is more than one area to negotiate on with a seller, you’re more likely to find common ground where both parties can stand and say, “I feel good about how this deal ended up.” When both parties are happy at the end of the deal, the chances that other aspects of the hand-off go well are increased – a good thing for all involved!
Know someone about to buy a practice? Share this article with them! Or have them reach out directly to me via email firstname.lastname@example.org to help them through the process.
Read more below about dental transitions because you don’t want LeBron to cry ever again!
Four Things Your Attorney Should Do for You When Buying a Dental Practice
A Letter of Intent Should Include This When Buying a Dental Practice
Why You Should Buy a Dental Practice BEFORE Your Student Loans are Paid Off