This week, the ADA Health Policy Institute, the economic research affiliate of the American Dental Association, released their updated forecast for 2021 practice collections. While their forecast of U.S. dental practice collections for 2020 was revised upward to only a 38% decline, the 2021 forecast was less encouraging.
2021 U.S. Dental Practice Collections Projected to be 20% Lower
LPS is not in the business of forecasting collections, but we are in the business of very accurately forecasting practice values. The ADA/HPI projection for 2021 will have an immediate and potentially long-term impact on practice values.
For many years, the primary driver of rising values of larger practices has been the belief by financial investors in the inexorable, recession proof growth of dental practice revenues. While not the sole datapoint that investors will consider, given the forecasts’ ADA provenance, it is an important tool in modeling future risks and returns. If a 20% decline is forecasted in the collections of all U.S. dental practices, the result will not be higher values for any practice, even if they are growing.
The entire industry runs the risk of falling out of favor.
Fortunately, by definition, LPS clients are larger, more resilient and more successful than the average U.S. dental practice. Our client practices are quickly returning to pre-COVID collections levels and ongoing growth will in theory cause little or no practice value reduction in 2020. Note I said 2020, not 2021. However, the overall impact could be more significant if the industry becomes less attractive to the financial sponsors of Invisible Dental Support Organizations.
Example of 2021 Values with 20% Reduction in Collections; Net Sale Proceeds Down 50%
Let’s assume a practice had $5,000,000 in collections in 2019 with an EBITDA of $1,500,000. Its value would be about $9.0 million today. Paying today’s 20% Long Term Capital Gains tax rates, the net proceeds to the doctor would be $7,200,000 after tax. (Assumes a 100% sale)
If that same practice had a reduction in collections in 2021 of 20% to $4,000,000 and a reduction in EBITDA to $1,000,000, its value would decline to $6,000,000 assuming the overall valuation metrics stayed the same and did not decline. With the 2021 expected tax rate of 40%, the net proceeds to the doctor would be $3,600,000, after tax. The net, in pocket change in practice value in 2021 vs. 2020 would be a 50% reduction.
Assuming tax rates are not increased in 2021, the reduction in net proceeds after tax is still $2,400,000 lower than 2020. That is a LOT of risk to take! The polls and the deficit tell us long term gains tax rates are soon to be history no matter who is elected.
Chicken Little Said the Sky is Falling
I have recently been accused of being negative on the future values of practices. This is actually not true. I am exceptionally bullish on the values of practices that complete transactions in 2020. We are in the “Perfect Storm” for practice values. At the moment, it is calm and deals are still closing. In fact, we have now signed $92,000,000 of Letters of Intent between our clients and IDSOs this quarter at 2019 values. We have also signed over $300,000,000 in new clients. LPS will close over $100,000,000 in transactions in the next 60 days, and maybe more!
The key to the current activity is that practice values today are still being calculated on 2019 year end or Feb. 29, 2020 EBITDA numbers.
However, the storm is coming. Once buyers start including the results of Mar/Apr/May in their value calculations, values will go down. When taxes go up, values will go down and net proceeds to sellers will go down by at least 20% from the tax impact alone. This is reality on measurement periods, and I believe a high probability on tax rates. I could be wrong.
But if your collections decline by 20% in 2021, and valuations include the second quarter of 2020, and taxes go up to 40%, your net is dropping in HALF. Why take the risk with your largest single asset which can be monetized, in part, at 2019 values and tax rates TODAY? It makes no sense to me.
But then again, no one except for the $200,000,000 of doctors we sold in 2019 believed me in 2019 when I predicted that we were witnessing the peak, the apogee, the zenith and the tippy top in practice values.
We shall see… But if you want to close a deal in 2020, we are about out of time.
- Practice Partnership Podcast Ep 14: The Surprising Drivers of High-Value Practices - December 11, 2024
- Death, Taxes, & Dental Practices: The power of diversification - December 5, 2024
- Decisions in Dentistry: The Rise of Invisible DSOs - December 4, 2024