When Selling a Dental Practice, EBITDA Multiples Don’t Matter

DC STUDIO / STOCK.ADOBE.COM

The “multiples” topic frequently comes up when doctors discuss selling dental practices, often when swapping stories of the multiples they’ve heard about friends getting for their practices. It refers to the multiplication factor applied to a practice’s EBITDA (earnings before interest, taxes, depreciation and amortization) to calculate the offer.

For example, a practice with $2 million in revenue and an EBITDA of $400,000 might get a 6X offer, meaning the $400,000 is multiplied by 6 for a sale price of $2.4 million. Sounds like solid math, right? But there are many variables that go into calculating EBITDA.

Investors–much like doctor-owners–may have a lot of questions when calculating EBITDA and determining the right multiple for a practice. But what an investor is looking for will be different than a dental entrepreneur. Investors are looking for a degree of safety in their investment. So, when it comes time to determine what they’ll offer to pay for a practice, there are many ways to play with the numbers, especially the multiples.

Ego and Optics Versus Enterprise Value

Let’s start by defining what enterprise value is. Enterprise value measures a dental practice’s total value and it’s comprised of how much a buyer is willing to pay for a practice, when they are willing to pay and what kind of capital is used (i.e., cash, debt, or equity). Normally this can be condensed down to what the practice’s EBITDA is and what kind multiple is applied to that cash flow.

Now, when groups make an offer for a practice, they want the same outcome you want when buying a car or a house: to pay the least amount possible for the item you want. There’s nothing nefarious about that if there’s no deception involved; their fiduciary duty is to show their investors that they’re making the best decisions and right moves with their money.

What that means for dental entrepreneurs is that oftentimes dental service organizations (DSOs) use an adjusted EBITDA to account for factors that affect practice value from a profitability standpoint. The way we often break it down to clients is that EBITDA can be “squishy” or manipulated to make it appear like they’re getting a higher multiple for their practice, despite the enterprise value staying the same.

Here’s how it can work. An investor who wants to buy a practice may calculate the existing EBITDA by weighing management expenses or new cost structures that the current owner doesn’t have, by lowering doctor compensation or rent (if the building is owned by seller), or a myriad of other techniques. However, they’re not going to tell the owner that—instead, they might offer a higher multiple.

So, the same $2 million practice mentioned earlier with $400,000 EBITDA that got a 6X offer of $2.4 million might get an 8X offer on a reduced EBITDA of $280,000, which also results in a $2.24 million sale. The enterprise value is better in case one, but the doctor would have more bragging rights with an 8X multiple rather than 6X. Just keep in mind that’s more about ego and optics than actual value.

Focus on What Matters Instead

As these examples show, there are many ways of making multiples look better than they are. Doctors who are selling a practice need a level-set technique they can use to understand true enterprise value and break it down into categories that actually matter, which doesn’t include multiples. Deal structure should address these 3 meaningful components of a sale:

• Safety: how much cash the seller gets
• Equity: the investment growth opportunity
• Future: additional reward if the practice grows

For selling doctors, safety and equity are typically the first priorities, and future practice growth potential is icing on the cake. This is a better way of thinking about offers than multiples because it is connected to enterprise value and what sellers can lock in via a deal rather than EBITDA calculations that can be manipulated according to what, how and why certain items are counted.

There are many types of deal structures, including old-school DSO offers that provide cash up front with an earn-out to keep sellers on board during a transition as well as an equity portion. Joint ventures in which doctors sell a percentage of the practice are another option, preserving seller agency while automatically doubling or tripling the multiple.

Equity roll arrangements are common in practice transitions, providing cash up front as well as the opportunity to build wealth via multiple recapitalization events. The deal that’s best for selling doctors depends on their goals and time horizon, but in every case, optimizing the enterprise value to reach the seller’s objectives is the best course of action.

It helps to have an experienced partner who knows how to optimize practice value and the competitive environment. Take this for example: One doctor received a DSO offer of $2.8 million for a practice with $2.6 million in revenue. After working with a practice transition expert to put the practice in a more favorable position, the owner sold it to the same DSO that made the original offer for an extra $1.3 million in value. The multiple for the first offer was higher, but the second offer delivered more value.

So, if you’re thinking about a practice transition, keep in mind that not all offers are the same. Deal structures vary, and the right one for your practice depends on your objectives. Keep safety, equity, and the future in mind, but forget about multiples—they don’t matter.