Valuation of Dental Practices

Valuing Dental Practices

Robert M. Mundy, CPA/ABV, CVAW. James Lloyd, CPA/ABV, ASA, CFE

www.aicpa.org/fvs

Forensic and Valuation Services Section 2

Speaker BiographyW. James Lloyd

W. James (Jim) Lloyd, CPA/ABV, ASA, CFE is a Principal with Pershing Yoakley & Associates (PYA), an accounting and consulting firm specializing in the healthcare industry. Primary areas of focus include valuation, transaction advisory, and dispute related services.

Healthcare industry experience includes: ambulatory surgery centers, cancer centers, dental practices, dialysis facilities, imaging centers, hospice, hospitals, long-term care facilities, managed care, pharmacies, pharmaceutical manufacturers, physician practices, and physician compensation arrangements among others.

Frequent speaker at national and regional conferences on valuation and dispute related topics.

Past chair: American Institute of CPAs' ABV Credential Committee. Past member: American Society of Appraisers' Board of Examiners.


Speaker BiographyRobert M. Mundy

Robert M. Mundy, CPA/ABV, CVA, is a Senior Manager with Pershing Yoakley & Associates (PYA), an accounting and consulting firm specializing in the healthcare industry. Primary areas of focus include valuation, transaction advisory, and dispute-related services.

Healthcare industry experience includes: general acute care and specialty hospitals, diagnostic imaging centers, ambulatory surgery centers, skilled nursing facilities, assisted living centers, cancer treatment centers, and a variety of physician practices.

Co-authored “The Valuation of Hospitals” chapter in Business Valuation Resources’ Guide to Healthcare Valuation.

Forensic and Valuation Services Section

Agenda

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5

Overview of the dental industry

Valuation and compensation trends

Current trends affecting dental practices

Overview of regulations affecting healthcare and dental industry

Key operating benchmarks and data resources

www.aicpa.org/fvs 2


Overview of Dental Industry

Over 195,000 professionally active dentists in the U.S. as of 2012

Segments of the dental provider industry:• General dentistry• Oral and maxillofacial surgery• Prosthodontics• Orthodontics• Pediatric dentistry• Endodontics• Periodontics

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General dentists comprise the vast majority of dental providers in the U.S.

80.2%

3.5%

2.5%5.1%

3.2%2.8% 2.7%

Number of Active Dentists by Specialty

General dentistOral surgeonEndodontistOrthodontistPediatric dentistPeriodontistOther

Source: American Dental Association, Dental Data, November 2012

www.aicpa.org/fvs 4



Restorative, preventative, and diagnostic services comprised the majority of dental services in 2013

6.90%

22.20%

15.60%8.80%

9.80%

14.90%

5.40%

2013 Services Distribution

OMFS

Restorative dental services

Preventative services

Fixed prosthodontics

Orthodontics

Diagnostic services

Non-surgical endodontic services

Source: IBISWorld, Dentists in the U.S. Industry Report, December 2013

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Current Trends in Dental Industry

Positive Trends for the Dental Industry

Aging population

Profitability still high for the industry, even during economic downturn

Improved economic conditions• Increased access to employer-sponsored health insurance; however, many

employer-sponsored plans do not include dental benefits

• Increases in disposable income should lead to more dental procedures

Greater awareness and focus on oral health

Increasing access to coverage through healthcare insurance exchanges

Trend toward more cosmetic procedures

According to Centers for Medicare & Medicaid Services, dental spending

is projected to increase from $110.9 billion in 2012 to $191.3 billion in

2022, representing a 5.6% compound annual growth rate

www.aicpa.org/fvs 6



Challenges Facing the Industry

Rapid advancements in technology

Rising costs of operations

Volatile prices for nonferrous metals

Better preventive care by patients leads to fewer patient visits

Only 60% of U.S. has some form of dental benefits1

Shift from private insurance to more public coverage and out of pocket payments

Potential cuts to Medicaid for adult dental coverage

Changing demographics among dental providers

1 2013 National Association of Dental Plans / Delta Dental Plans Association Joint Dental Benefits Report on Enrollment

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Trend Toward Consolidation

Shift from solo practitioners to group practices• Rising operating costs and capital requirements• Economies of scale• High costs of dental education and student loans make solo practice less

attractive

Growing interest with private equity and dental practice management companies (DPMCs)• Potential for high-profit margins with sufficient volume

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Dental Practice Management Companies

Publicly traded company

Birner Dental Management Services, Inc. (BDMS)• 66 offices throughout Colorado, New Mexico, and Arizona• Revenues in excess of $64 million in 2013• Market value of invested capital (MVIC) to Revenue = 0.65x• MVIC to EBITDA = 11.75x

www.aicpa.org/fvs 9


Dental Practice Management Companies

Privately held companies

American Dental Partners, Inc.• Acquired for $398 million in 2011 by private equity firm JLL Partners

InterDent, Inc.• Provides support services to over 150 affiliated dental offices• Employs over 450 dentists

Smile Brands Group, Inc.• Provides support services to over 400 dental offices• Employs over 1,300 dentists

Pacific Dental Services, Inc.• Provides support services to over 275 dental offices

www.aicpa.org/fvs 10


Dental Practice Key Statistics

Practice Gross Billings

Gross Billings per Practice Hour by Number of Chairside Assistants

Source: American Dental Association, 2010 Survey of Dental Practices, median values

All Independent Dentists

No Non-Owner Dentists

Includes Non-Owner Dentists

General Practitioners $700,000 $650,000 $1,163,250

Percent Collected 95.6% 95.9% 94.4%

Specialists $1,000,000 $900,000 $1,700,000

Percent Collected 96.0% 96.0% 95.6%

1 Chairside Assistant 2 Chairside Assistants 3+ Chairside Assistants

General Practitioners $299 $377 $510

Specialists $326 $430 $624




Percentage of Practices Employing Non-Dentist Staff

Average Number of Non-Dentist Staff per Dentist

Source: American Dental Association, 2010 Survey of Dental Practices

Dental Hygienists Chairside Assistants

General Practitioners 76.0% 94.3%

Specialists 28.6% 97.0%

Dental Hygienists Chairside Assistants

Total Non-Dentist Staff

General Practitioners 1.8 1.6 4.5

Specialists 1.6 2.5 5.1




Staffing Expenses as a % of Gross Billings for General Practitioners


1Q Median 3Q

Salaries for shareholder dentists 18.8% 25.6% 35.8%

Salaries for employed dentists 3.9% 8.0% 13.7%

Salaries for non-dentist staff 17.5% 22.7% 26.8%

Payroll taxes for all staff 2.4% 3.5% 6.5%

Employee benefits for all staff 2.3% 4.5% 8.4%

Total staffing expenses 44.9% 64.3% 91.2%




Staffing Expenses as a % of Gross Billings for Specialists


1Q Median 3Q

Salaries for shareholder dentists 21.6% 31.2% 43.8%

Salaries for non-dentist staff 14.0% 19.5% 25.7%

Payroll taxes for all staff 2.2% 3.1% 6.7%

Employee benefits for all staff 2.9% 5.0% 7.9%

Total staffing expenses 40.7% 58.8% 84.1%



Dental Practice Benchmark Resources

American Dental Association• Survey of Dental Practice Fees• Survey of Dental Practice Expenses• Survey of Dental Practice Employment• Survey of Dental Practice Income

Rosen & Associates• “See How You Compare” Survey

Dental Economics – www.dentaleconomics.com



Overview of Healthcare Reform

Patient Protection and Affordable Care Act of 2010 (PPACA)• Signed into law on March 23, 2010.• Primary goals: Provide healthcare coverage for many uninsured. Reform healthcare system to improve quality. Reduce overall healthcare costs.

Health Care and Education Reconciliation Act of 2010• Signed into law on March 30, 2010.• Includes several amendments to PPACA.



Key Healthcare Reform Provisions Affecting Dental Practices

• Individual insurance mandate Tax penalty for non-compliance beginning in 2014. Each state must establish healthcare insurance exchange by 2014. Stand-alone dental plans must offer pediatric oral essential benefits

without annual and lifetime limits• Expansion of Medicaid Expands eligibility to cover individuals up to 138% of the federal

poverty level. Extended funding of Children’s Health Insurance Program (CHIP) States that provide CHIP coverage through the Medicaid expansion

are required to cover basic dental services Supreme Court ruling allowed states to opt out of expansion.



State Adoption of Medicaid Expansion



Key Healthcare Regulations

HealthcareRegulations

Stark Law

Anti-KickbackStatute

Stark Law

False Claims Act

IRS 501 (c)(3)Anti-Inurement

Rules



Stark Law• Also called the “physician self-referral law.”• Prohibits a physician from making referrals for designated health

services to entities in which the physician (or a family member) has a financial relationship.

• Designated Health Services (DHS): Currently 12 health services. Includes hospital inpatient and outpatient services, as well as

clinical lab, physical and occupational therapy, radiology, certain imaging, DME, home health, and various other services and supplies.

• Is a “strict liability” law.• Contains various “safe harbors.”• Provisions enforced by the Centers for Medicare & Medicaid

Services (CMS), although Department of Justice adjudicates false claims arising from violations of the Stark Law.



Stark LawStark Law Definition of Fair Market Value:

The value in arm’s-length transactions, consistent with the general market value. “General market value” means the price that an asset would bring as a result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement. Usually, the fair market price is the price at which bona fide sales have been consummated for assets of like type, quality, and quantity in a particular market at the time of acquisition, or the compensation that has been included in bona fide service agreements with comparable terms at the time of the agreement, where the price or compensation has not been determined in any manner that takes into account the volume or value of anticipated referrals.



Anti-Kickback Statute

1 2 3 4

Prohibits the payment or receipt of remuneration to induce or reward referrals for Medicare or Medicaid services.

Criminal statute that requires proof of “intent,” i.e., knowingly and willfully paying for referrals.

Contains various “safe harbors.”

5

Enforced by the Office of Inspector General (OIG) and the Department of Justice (DOJ).

If one purpose of the payment is to induce referrals, then the Anti-Kickback Statute (AKS) is violated, even if there are other legitimate business reasons for the payment.



False Claims Act

Imposes liability on any person who submits a claim to the federal government that the person knows (or should know) is false.

Civil statute.

Often “piggy-backed” with the AKS and Stark.

Subject to qui tam (“whistle-blower”) suits.



Penalties for Violations of Stark & AKS

Penalties for violation can include:1. Denial of payments.

2. Refund of payments.

3. Civil monetary penalty up to $15,000 per claim.

4. Civil monetary penalty up to $100,000 for each “scheme” designed to circumvent the law.

5. Civil monetary penalty of up to 3 times the amount of claims.

6. Possible criminal penalties, including jail time.

7. Exclusion from the Medicare or Medicaid program.



IRS 501(c)(3) Anti-Inurement Rules

501(c)(3) tax exempt entities must avoid “excess benefit” transactions.

Transactions must be at FMV and be consistent with the entity’s charitable mission.

Violations can result in loss of tax exempt status

Rules



Valuation Approaches

Asset Approach

Income Approach

Market Approach

Provides an indication of value based upon market date derived from other similar businesses.

Provides an indication of value based on the anticipated future economic benefits of ownership.

Provides an indication of value based on the cost to replace or replicate the tangible and intangible net assets of the business.



Valuation Methods for Each Approach

Asset Approach Income Approach Market Approach

• Adjusted Net Asset Value Method

• Excess Earnings Method

• Discounted Cash Flow Method

• Capitalized Net Cash Flow Method

• Guideline Public Company Method

• Comparable Transactions Method



Asset Approach

Cash and accounts receivable are often excluded unless the transaction is structured as a stock purchase.

Fixed assets (equipment, real estate/improvements), and supplies must be adjusted to their current value.

Intangible assets must be identified and valued. Common examples include: • Workforce-in-place• Non-compete agreements• Trade name/trademarks

As a general rule, intangible asset values should be supported by an appropriate level of economic benefit (i.e. cash flow).



Income Approach

Discounted Cash Flow (DCF) Method or Capitalized Income (CapInc) Method.

CapInc Method utilizes a constant growth rate and is normally more appropriate for mature entities with stable operations.

DCF Method requires cash flow projections and is normally more appropriate for growth companies.



Discounted Cash Flow Method

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2

1

Step #3: Develop appropriate discount rate and determine present value of the projected cash flow.

Step #2: Prepare or review cash flow projections (revenue, expenses, working capital, cap-ex).

Step #1: Analyze historical financials and operations. Make normalization adjustments as necessary to develop baseline for future years.

4Step #4: Adjust as applicable for any non-operating assets or liabilities.



Normalization of Earnings

Historical financials often require some level of normalization to be used as a basis for projecting future cash flow.• Common examples of normalization adjustments for dental practices:

- Overstaffing and/or excess salaries to family members- Above or below market rate rent expense- Discretionary/personal expenses- Non-recurring or non-operating income or expenses- Billing or coding issues (past errors anticipated to be corrected)

• Purpose is to restate earnings to a level that can be expected to continue in the future and/or improvements that a hypothetical buyer could effectuate

• Owner dentist compensation should be normalized to fair market value• Caution regarding synergistic type adjustments that may be applicable to

a specific potential buyer (if FMV is the standard of value)



Revenue & Expense Projections

Cash flow (i.e. revenue, expenses, working capital, cap-ex, etc.) must be projected until a stabilized level of operations is reached which can then be capitalized (terminal period).

For revenue projections, consider the following:• Dentist(s) age and historical productivity

• Local demographics

• Competition (current and anticipated future)

• Capacity issues (dentists and facilities)

• Ancillary services

• Historical trends and benchmarks

Revenue should generally be projected utilizing two growth metrics – patient volume and net revenue per applicable unit.

For operating expenses, segregate between fixed and variable.



General Dentist Compensation Trends

2009 2010 2011 2012 2013$152,000

$154,000

$156,000

$158,000

$160,000

$162,000

$164,000

$166,000

$1

56

,85

0

$1

58

,77

0

$1

61

,75

0

$1

63

,24

0

$1

64

,57

0

National Annual Mean Compensation

Compound Annual Growth Rate = 1.2%

Source: Bureau of Labor Statistics



Oral & Maxillofacial Surgeon Compensation Trends

2009 2010 2011 2012 2013$206,000

$208,000

$210,000

$212,000

$214,000

$216,000

$218,000

$220,000

$2

10

,71

0

$2

14

,12

0

$2

17

,38

0

$2

16

,44

0

$2

18

,96

0


Compound Annual Growth Rate = 1.0%




Orthodontist Compensation Trends

2009 2010 2011 2012 2013$175,000

$180,000

$185,000

$190,000

$195,000

$200,000

$205,000

$210,000

$2

06

,19

0

$2

00

,29

0

$2

04

,67

0

$1

86

,32

0

$1

96

,27

0


Compound Annual Growth Rate = -1.2%




Discount Rate

• Discount rates utilized in connection with the Income Approach should reflect the risk of the projected cash flows.

• Most common method for developing an equity discount rate for small- to medium-sized dental practices is the “Build-Up Method”:

Starts with a risk-free rate (usually 20-year U.S. Treasury bond).

Adds various risk premiums: Equity Risk Premium, Small Size Risk Premium, Industry and Company-Specific Risk Premiums.



Market Approach


Guideline Public Company Method• Difficult to apply for most small/medium-sized dental practices due to

significant size and operating differences

Comparable Transactions Method• Multiple databases available that include dental practice transactions

such as: Pratt’s Stats and BIZCOMPS®

• Often difficult to apply due to lack of transaction details such as: Dentist’s age, qualifications, and historical productivity Use of mid-level providers Competition, demographics, and local economic conditions Ancillary services, cosmetic procedures/products, etc. Post-transaction compensation terms

Often utilized as a “sanity check” to other valuation approaches


Market Transactions

2010 2011 2012 20130.30

0.40

0.50

0.60

0.70

0.62 0.63

0.59

0.62

Price to Revenue

Co

un

t =

24

Co

un

t =

27

Co

un

t =

28

Co

un

t =

44

Source: Pratt’s Stats and BIZCOMPS® databases (excludes duplicate transactions)



Questions???


Contact InformationRobbie Mundy, CPA/ABV, CVA

Senior Manager | PYA

[email protected]

(404) 266-9876

W. James Lloyd, CPA/ABV, ASA, CFE

Principal | PYA

[email protected]

(865) 673-0844

www.pyapc.com


Valuation of Dental Practices

Healthcare

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