When dentists are looking to sell a dental practice to a Dental Service Organization (DSO), one of the most important terms they need to understand is their EBITDA.
What is EBITDA?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is a measure of profitability and is similar to net cash flow. It is a calculation that adds back expenses that are non-recurring or will not need to be paid by a purchasing DSO. This calculation shows how much the DSO could stand to have left over to use as they wish when all of the required expenses are paid.
What do you do with EBITDA?
EBITDA is a tool used when selling to a DSO to create a common standard to compare profitability. [Remember when selling to another private doctor, the seller's discretionary income (SDE) is used. In particular, EBITDA calculations include an add-back for the doctor’s compensation whereas SDE does not.] EBITDA gives DSOs a common language to understand profit - usually for practices selling at an average of $1.5 million or more.
EBITDA shows the earnings before cost of goods / one-time costs of running a business.
How do you calculate your EBITDA?
EBITDA is calculated annually by your CPA or other financial advisor. However, when you are looking to sell a dental practice, EBITDA should be thoroughly reviewed to ensure as much profit as possible is shown. Your Practice Transitions Group (PTG) team will do a thorough forensic analysis of your
- profit and loss (P&L) statements
- balance sheets
- general ledgers, and
- tax returns
to look for anything that may have been missed. Oftentimes, dentists will overlook items such as supply costs in calculating EBITDA, and PTG will be there to look for inconsistencies in financial statements to ensure you get the most accurate EBITDA calculation. This number will then be reviewed and negotiated throughout the sale process.
Who calculates EBITDA?
EBITDA is first calculated by your PTG team who will work with their underwriters to review your financials and get a rough estimate of EBITDA and what the market will support. The buyer’s quality of earnings team will do their own review of EBITDA when negotiating. For example, one area where EBITDA can be impacted in negotiations is in calculating the dentists’ salaries. EBITDA calculations require adding back in the current salary and adjusting for market rate. Sometimes doctors are either over-or underpaying themselves and determining proper market-rate salaries can be negotiated between the buyer and seller.
Why is EBITDA important?
EBITDA is how DSOs make their offer. There are other metrics in play, such as the state of the market and potential competition, but EBITDA is the most important factor. It is a common misperception that top-line revenue is what is important, but for DSOs, what matters is what you, and they, will take home.
EBITDA has become even more important as the supply of practices in the market has increased. Dentists looking to sell a dental practice have increasingly looked at selling to a DSO because they provide predictably, remove the administrative burden of running a dental practice, and help make connections with other dentists.
Bottom Line: If you want to sell a dental practice, get your financials in order. Your practice transitions broker and the buyer's quality of earnings team will need a clean, accurate calculation of EBITDA. The calculation will then determine if a DSO will be interested in your practice, how much they’ll pay, and will have the largest impact on valuation of all other factors.