As everyone knows, we have had a horrible virus around for over a year now, and while it certainly impacted practice transitions for some time between say March and June 2020, since June 2020 buyers are back in full force looking for a practice to call their own.
Almost immediately buyers and potential buyers started asking if practice values should be decreasing due to Covid. My response has been consistent throughout this past year….in most cases, NO! Although many disagree with my response, I suspect it’s because they are simply looking for the so-called “Covid Discount”. This simply means that because nearly every practice had to close for a period of time due to Covid, practice collections for 2020 for many practices will be less and therefore practice values should be less.
However, my argument against that notion is this – for the vast majority of practices that had to close, it’s not like these practices lost any patients. EVERY practice was closed, and many localities mandated that their residents stay at home. These patients were not leaving the practices looking for another practice, they simply were not going to see their dentist unless it was an emergency.
You see, from a valuation perspective, one of our tasks when valuing ANY business is to normalize the cash flow. Now, in the dental world, many people are aware of some of the typical normalization adjustments like adjusting for family members on payroll, eliminating owners’ perks (like meals and travel expenses), or adjusting owner-occupied space to fair market rent and removing interest and depreciation.
These are not the ONLY normalization adjustments that a valuation professional needs to consider. We have to consider other “events” that may have occurred that are more “one-time” events that will likely not happen again. Occasionally, we have needed to make adjustments for the disability of a provider, maybe a short-term closure (like a week to several weeks) for a flood or fire, or maybe a longer period closure for a hurricane. All these are potential issues that could be a once-in-a-practice life occurrence and issues that should likely be normalized within a set of annual cash flows.
Covid is no different in my opinion. Here we are in 2021 and we are going to be assessing many practices for our buyers that include the year 2020 and many of those 2020 years will likely show a very different cash flow than the previous years. We will see lower production, lower collections, maybe lower wages for staff members who were allowed to collect unemployment, many other expenses will be lower due to less production OR vendors providing non-payment options while these practices were closed due to Covid. Then there are potentially more expenses for PPE and even additional closures due to an office staff member Covid infection that required the practice to close another week or two during the year.
What does this mean for valuation professionals? What it should mean is IF we are going to use 2020 practice profit & losses in our analysis to determine value then we need to normalize the 2020 numbers. We will need to know the number of weeks a practice was closed due to Covid, we will need to know the number of weeks staff were not paid due to unemployment, we will also need to know if there were any expenses that were forgiven by a vendor out of courtesy and even which additional expenses or PPEs that may not be repeated. Based on all this information we will then have to “re-cast” the 2020 cash flow to what it SHOULD have looked like as though it were a normal year. That is called normalization.
So you see, if one takes the necessary steps to normalize the 2020 year, you will likely come to the conclusion that 2020 would have been very similar in terms of profitability to the previous years and maybe even moreso, which means the notion of a “Covid discount” likely will not apply in many cases.
Now, all that said, we will see some practices that took the opportunity in 2020 to change their model and therefore potentially changing the cash flow outlook for 2020 and into the future compared to previous years and it’s these practices we need to watch out for.
I recently had such an example – An OMS practice with two locations and two providers lost one of their providers in December of 2019 and decided to close one of their locations in May of 2020, mainly due to the loss of a provider, however, also due to Covid. This caused the revenue to drop even more severely in 2020 so even after normalizing for Covid related closures this practice will still look very different in 2021 and beyond compared to 2019 and earlier years.
Unfortunately, the seller had their sights set on historical numbers from 2019 and earlier and wanted an asking price that would have been reasonable had they not made some drastic changes in the practice model. They substantially changed the financial performance of the practice in 2020 and therefore, altered the value of the practice compared to earlier years.
Buyers will still have to beware, however, they should also be educated to understand that Covid alone should have very little, if any impact on practice values…in my opinion.
About Tim Lott
Tim Lott, CPA, CVA, has decades of experience working with dentists at all stages of their careers. He is a regular speaker at study clubs, societies, and dental schools. Tim is a frequent participant and a moderator of Dentaltown.com. You can reach Tim at firstname.lastname@example.org or any of the other dental partners/principals at (800)772-1065 or email@example.com