Kyle Francis: Inflation? Don’t Panic

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Kyle Francis: Inflation and dental practice value – don’t panic!

Author Kyle Francis is president and founder of Professional Transition Strategies based in Colorado Springs. Here he provides an insight into the U.S. dental practice market.

Last year, US inflation rose to its highest level in 40 years. It appears to be stabilising, but many economists believe inflation and other economic pressures will trigger a recession. Dentists who are thinking about a practice transition may wonder what that means for their practice value and how it will affect private equity interest in the dental industry.

The answer depends on individual circumstances, but it’s important to know that the industry has demonstrated amazing resilience over the years. Here’s a look at how industry fundamentals have evolved, what current conditions might mean for your practice and what you need to know about making a practice transition in uncertain times.

Weathering Economic Storms

Inflation rises and falls, but rates were low in the decade before the recent spike, so sticker shock comes into play. As context, remember that even with double digit inflation from 1979 to 1981 — far worse than what we’re seeing now — there were still plenty of practice transitions.

The dental practice market also weathered a huge challenge during the 2008-2009 debt market crash. Equipment costs and other factors make the debt market critical in the industry, and yet even after the crash, the sector grew. The pandemic shutdowns are another example. Dentistry wasn’t classified as an essential service, and practices closed for weeks or months in 2020, and yet most bounced back to have their best year ever in 2021 due to pent-up demand.

Also keep in mind that the dental practice marketplace has changed significantly. In the dental practice market, supply and demand is determined by how many dentists are exiting versus how many can buy a practice. Baby boomers are retiring, and subsequent generations of dentists carry a much heavier student debt load, which constrains their buying power.

But while that situation suggests a bear market and lower practice valuation, private equity groups’ entry into the marketplace has kept practice valuations and transaction volumes higher than they would otherwise be.

The Market’s #1 Fear — Fear Itself

Another factor to consider is that dental practices tend to be an undervalued asset. Rising interest rates affect cash flow, which in turn affects valuation, but because dental practices are undervalued, the overall effect is unlikely to be significant.

For example, a $1 million practice that leverages $500,000 in equity might have paid $10,100 per month before inflation rose and may now pay $11,300 due to higher rates. But even if rates drive payments as high as $12,400, the annual cash flow hit is only around 7%. Higher rates stoke fear, but they don’t drive dramatic cashflow loss or make a major difference in valuation.

From a private equity perspective, debt is the key factor, and debt covenants aim for specific earnings before interest, taxes, depreciation and amortization (EBITDA) to justify cashflow. Some are extremely aggressive, levering up to eight times EBITDA, but that’s typically a small subset of total private equity deals and generally affects higher-end practices. The vast majority don’t lever up the maximum amount, so there’s wiggle room remaining to execute transactions.

To take a spin on what FDR once said, what people with a stake in the dental practice market should fear most is fear itself. The market is resilient, but some dental service organisations (DSOs) have already laid off business development staff because of recession worries, which are in turn driven in part by inflation concerns. At this point, fear is driving more action than inflation.

You May Feel a Slight Pinch…

The bottom line? Inflation exists, and dentists need to be concerned about cash flow and prepared for a possible downturn. Many dentists are experiencing a pinch presently because costs have risen and revenue hasn’t yet caught up. If you’re in that situation, there are steps you can take. For example, if you’re a PPO dentist, make sure you’re billing for the maximum amount since insurers may have raised reimbursement rates without notifying you.

If you operate on a fee-for-service basis, make sure charges are pegged to the consumer price index so you can handle additional expenses, and if you haven’t raised prices for a while, now is the time. A best practice is to raise prices by a modest amount twice a year so patients don’t fixate on a certain price. For example, if you charge $109 for a cleaning and raise it to $111, you’re unlikely to get pushback, whereas a 10% increase may trigger a negative reaction.

Dentists who are contemplating a practice transition have options too. If you’ve experienced a margin decrease due to higher staff and supply costs, you can either see what the market will bear now or wait six to eight months until revenue catches up with the cost curve.

Earn ups in a transition agreement can also take timing out of the equation — that’s when a buyer purchases a practice as-is and pays a higher price point in the future if profitability improves.

Your best bet is to discuss your options with a professional team that understands the market and can explore various scenarios with you. But remember that you’re in an extremely resilient industry and that fear is driving more negativity than inflation at the moment, so don’t panic.

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