Inflation has eased recently after reaching a four-decade high, but it continues to drive economic uncertainty. Persistent high inflation along with geopolitical instability has many economists predicting a recession this year, which has influenced market behavior and contributed to anxiety in the dental industry about what the future holds.
If you’re a dentist who is contemplating a practice transition in the near or medium term, you may be concerned about how inflation will affect the industry overall and your practice value specifically. Here are five things to know about how inflation affects the industry, investor behavior, and practice value plus how you can roll with the punches.
- The dental industry is remarkably stable. One encouraging fact to keep in mind is that the dental industry has proved to be incredibly resilient over time. Practice transactions didn’t grind to a halt when inflation surpassed 13% in 1979, and the dental industry kept growing when the debt market crashed in 2008. More recently, many dentists posted their best revenue numbers ever in 2021 after the sector was roiled by pandemic shutdowns in 2020. So if there’s one thing we know about the dental industry’s resiliency, it’s that it will likely power through today’s economic uncertainty.
- Dental practices are undervalued. Another thing to know is that dental practices are undervalued, which means that inflation is less likely to have a significant impact on practice value during a transition. What does this mean? Say a practice that is valued at $1 million was making a monthly payment of $10,100 on an $800,000 equity loan in 2020. Payments may have risen to $11,300 when rates rose in 2021, but even if payments increase to $12,400 because rates go up even more, the cash flow change is only approximately 7%, so it won’t make a huge difference in the practice’s cash position or valuation.
- Private equity is keeping the dental practice market in bull territory. A generation ago, the health of the dental practice market depended on the balance between the number of dentists looking to sell practices and those wanting to purchase one. If that were still the case, we’d be in a bear market situation now, since baby boomers are exiting the industry in large numbers and Generation X and millennial dentists often have too much student debt to make buying a practice feasible. But private equity investors have filled the gap, keeping the market in bull territory.
- Most dental practices aren’t fully leveraged. Speaking of private equity investors, from their point of view, debt is a major focus, and they establish earnings before interest, taxes, depreciation, and amortization (EBITDA) targets to justify cash flow in debt covenants. In most private equity debt covenants, EBITDA targets aren’t levered as aggressively as they could be, so there’s still room to lever up to keep transactions on track in most cases. However, debt covenants where EBITDA is levered against aggressively could potentially affect the valuation in some cases.
- Practice revenue will catch up with the cost curve. Many dentists are understandably concerned that costs for supplies, equipment, and staff are going through the roof while revenue remains relatively flat. Keep in mind that it will take a while for revenue to catch up with the cost curve, but that will probably happen in a matter of months rather than a year or more. That said, if you haven’t raised prices for your services lately, this is a good time to do so. This action will help on the revenue front as you deal with a steeper cost curve.
Kyle Francis.
On the subject of costs, it’s a good idea to raise fees a modest amount twice yearly, regardless of the wider economic picture, because even when inflation is low, costs tend to go up year over year. Patients usually won’t notice a small increase, whereas raising prices by 10% may generate complaints.
Also, if you see patients through a preferred provider organization arrangement, make sure you’re billing the maximum amount allowed, which may have increased -- insurers won’t necessarily tell you.
If you’re thinking about selling your practice, you have a couple of options in a high-inflation economy: You can either wait until the revenue-cost equilibrium sorts itself out or put your business on the market now and consider offers. A professional team that knows the dental industry can help you explore transition scenarios, including earn-ups, which are provisions that enable a sale now while reserving the option for you to achieve a higher sale price if profits increase.
For now, it’s important to understand that negative rumblings in the marketplace are driven more by fear of a downturn than any action in the dental practice market. Keep these five factors in mind as you think about how inflation will affect your practice, and carefully consider your prospects for a practice transition in the year ahead. Economic conditions justify caution, but fear isn’t helpful.
Kyle Francis has worked in the dental and medical field since 2005, consulting for practices, medical device companies, and groups of practitioners. He has used this knowledge to consult with more than 50 startup companies and dental practices, as well as to help build over 100 dental and medical practices across the U.S. He has owned all or part of more than 20 practices and has been an investor in multiple dental service organization concepts. Learn more about his company, Professional Transition Strategies.
The comments and observations expressed herein do not necessarily reflect the opinions of DrBicuspid.com, nor should they be construed as an endorsement or admonishment of any particular idea, vendor, or organization.
