February 6, 2023
How Does Inflation Affect Your Dental Practice Valuation?
Last year, inflation in the United States rose to its highest level in 40 years. “It appears to be stabilizing, but many economists believe inflation and other economic pressures will trigger a recession,” Professional Transition Strategies Founder and President Kyle Francis recently wrote in an article for Dental Review. So what does this mean for dentists thinking about a practice transition? While the answer depends on individual circumstances, we provide insight into how inflation affects the value of dental practices and private equity interest in the dental industry.
How have industry fundamentals evolved?
“Inflation rises and falls, but rates were low in the decade before the recent spike, so sticker shock comes into play,” Francis wrote. “As context, remember that even with double-digit inflation from 1979 to 1981 — far worse than what we’re seeing now — there were still plenty of practice transitions.” Francis reminds us dental practice market also weathered a challenging time during the 2008–09 debt market crash, in addition to the pandemic that shut down dental practices deemed nonessential services. In both instances, dental practices bounced back better than ever. Today, with baby boomers retiring and the next generation of dentists graduating with a much heavier student debt load, the emergence of private equity groups has kept practice valuations and transaction volumes higher than they would otherwise be.
What do current conditions mean for your dental practice?
Generally speaking, dental practices tend to be an undervalued asset. “Rising interest rates affect cash flow, which in turn affects valuation, but because dental practices are undervalued, the overall effect is unlikely to be significant,” Francis wrote. Where private equity is concerned, debt covenants aim for specific earnings before interest, taxes, depreciation and amortization (EBITDA) to justify cash flow. Only a small subset use aggressive tactics to lever up to eight times EBITDA in higher-end practices; the vast majority don’t lever up the maximum amount so there’s wiggle room remaining to execute transactions. “At this point, fear is driving more action than inflation,” Francis wrote.
What do you need to know about making a dental practice transition in uncertain times?
“Inflation exists, and dentists need to be concerned about cash flow and prepared for a possible downturn,” Francis wrote. Costs have risen, and revenue hasn’t caught up yet, but there are steps you can take to close the gap, including if you’re a PPO dentist or operate on a fee-for-service basis. The same can be said for dentists considering a practice transition: “If you’ve experienced a margin decrease due to higher staff and supply costs, you can either see what the market will bear now or wait six to eight months until revenue catches up with the cost curve,” Francis wrote.
“Your best bet is to discuss your options with a professional team that understands the market and can explore various scenarios with you,” Francis wrote. “But remember that you’re in an extremely resilient industry and that fear is driving more negativity than inflation at the moment, so don’t panic.” Contact the experts at Professional Transition Strategies to get the conversation started.