The impact of inflation and higher interest rates on practice values
When I speak with about 200 physicians of all specialties each month, I ask them informally about their costs and fee schedules. The survey results so far in 2022 have been straightforward: Costs are rising universally, especially with labor, supplies, and equipment. Very few physicians have benefited from increases in reimbursement rates and/or increased fees. The simple term for this is margin compression. Practice operating profit as a percentage of recoveries is down at many practices.
While most of the dental practices for which we review financial data in our assessment process have achieved revenue growth over the past 12 months, their rate of growth is slowing. The recent five-year record low in the University of Michigan Consumer Confidence Index (below mid-COVID-era levels) is a harbinger of potentially weaker collections in the near future. This is not positive for practice values.
One of the key metrics for determining the practice’s values is its operating profit, or earnings before interest, taxes, depreciation and amortization and after physician compensation (EBITDA). Collection growth rates are also a key driver of practice values. If a practice is valued at seven times EBITDA on the current $500,000 growth in EBITDA over the past 12 months, its value is $3,500,000. If EBITDA were to drop to $400,000, its value would decline by $700,000 (seven times $100,000), or probably more due to declining, not increasing, profitability.
Also by Chip Fichtner:
Are you considering an ISDO partnership? Consider your age first
Why dental practice consolidation is accelerating
Fortunately, the “buyer” universe continues to grow
There are hundreds of Invisible Dental Support Organizations (IDSOs) in all 50 states that want to partner discreetly with general or specialty practices. IDSOs invest in good practices by purchasing 51% to 90% of a practice in cash up front. Physicians remain owners in the balance and continue to run their practices with their brand, their team and their strategy for years or decades. Physicians benefit from the resources of a larger, quieter partner to grow, better, and faster and increase the property value of both partners over time; some stock market values have tripled, quintupled and even 10 times or more over time.
The value of practice may change, but the options in IDSO partnerships are growing
Today, any quality practice of any specialty with $1.5 million or more in collections will have at least five qualified bidders, and some will have 10 or more. IDSOs have been active for over 30 years and dozens of new IDSOs have already been formed in 2022. Some are better than others, and unfortunately a few IDSOs will fail. You need to choose your partner wisely.
The consolidation of dental practices over the past three decades has proven to be a very lucrative investment for private equity groups, family offices and even sovereign wealth funds. In 2021, investors in IDSOs and the physicians who have partnered with them over the past five years reaped billions of dollars in profits from the ultimate sale of their practice capital last year. And there will be more departures of investors and doctors in 2022 than in 2021.
The impact of higher interest rates
Your practice’s EBITDA, by definition, is not affected by interest charges or principal repayments on loans, so rising interest rates will not directly affect your practice’s theoretical value. . However, almost all DSOs and IDSOs finance their acquisitions or partnerships with debt. When interest rates rise, their costs rise. Higher rates will potentially impact the record values we have been able to achieve for our customers over the past two years. Low interest rates have enabled higher values for physicians.
Exit liquidity for investors/dentists may also be affected
In the first quarter of 2022, private equity investor exit transactions decreased by 57% compared to the fourth quarter of 2021. In addition, the initial public offering (IPO) markets effectively closed, the average price of the IPO 2021 share having fallen by more than 40% from June 1, 2022. IPOs carried out in the first quarter of 2022 decreased by 72% in number of transactions and net proceeds from IPOs decreased by 95% compared to in the first quarter of 2021.
Fortunately, dental consolidation is still in its infancy and is a very lucrative business. Due to the large number of enthusiastic bidders for good practices, current values are still 20% or more above 2019 levels. But now may be the time to understand the value of your practice in an IDSO transaction before before the impending storm comes to your shore.
Editor’s note: This article originally appeared in the September 2022 print edition of Dental economy magazine. Dentists in North America can take advantage of a free print subscription. Register here.