Assessing Whether a Private Equity Offer Supports Your Financial Plan

We help dental practice owners assess the financial reward of a private equity offer by looking at the deal in three different scenarios: the best case, base case and the worst case. The best case means that all the cash flow will be realized at the optimistic assumptions. The worst case incorporates only the deal elements that are guaranteed. If the deal offer supports your financial plan in the worst-case scenario, you can be confident it will work in the best-case scenario.

Let’s explore this with the elements of a hypothetical private equity deal offer for an orthodontist’s practice. The profitability of the practice is approximately $1 million per year on $4 million of collections, which is very steady. The private equity group offers a deal valued at around $9.4 million, or approximately 10x the practice’s earnings before interest, taxes, depreciation, and amortization (EBITDA). By comparison, a common multiple is 3x for a traditional sale (a sale and walk away). Based on a conservative multiple valuation of 3x EBITDA for a sale and walk away, or $3 million, the private equity deal offer looks incredibly appealing.

The private equity deal elements are as follows:

• Cash at closing: $3 million
• Rollover equity: $1.3 million (assumed in year five at four times the initial equity roll)
• Salary: $275,000 (for five years)
• Bonus: $150,000 annually if a 7% profit increase is realized

Based on these elements, there are three scenarios:

Best-case scenario: This scenario assumes the practice owner would hit their bonus threshold each year for the next five years and that the dental support organization (DSO) second sale would be 4x the original equity roll. In that case, the total value of the deal has the potential to be worth $9.4 million. When testing this amount against the owner’s financial plan, the result is a 98% likelihood of meeting their personal financial goals.

Base-case scenario: This scenario assumes there would not be a DSO sale. Instead, the practice owner would stay with the practice for the next five years and then complete a sale and walk away to an individual clinician. The owner would retain the practice profitability of approximately $1 million annually and sell the practice after year five for $2.8 million, which would net the owner approximately $8 million. When testing this amount against the owner’s financial plan, the result is a 93% likelihood of meeting their personal financial goals.

Worst-case scenario: This scenario assumes the practice owner would only receive the $3 million cash at closing and $1.3 million on salaried income, or $4.5 million. When testing this amount against the owner’s financial plan, the result is an 83% likelihood of meeting their financial goals.

By testing these three scenarios within the practice owner's financial plan, we could gain insight into the owner’s ability to accept a worst-case scenario with the opportunity of capturing the upside of the best-case scenario. Ultimately, the owner is positioned to accept the risk of not fully realizing the best-case outcome without a significant financial disruption to their personal financial plan.

Overall, in this hypothetical scenario, we discovered that the practice owner could assume the risk of a private equity deal based on the financial life established. Private equity deals can be a great opportunity to secure your financial plan and invest in the deal for a possible larger future return. As with any other transition model, dental practice owners should seek a deal that aligns with their clinical desires, financial plan, and risks and opportunities they are comfortable taking.

This blog is the third in a three-part series intended to educate medical and dental practice owners about private equity transactions. The first explores the basics of a private equity sale and explains the key terms you need to know. The second gives an overview of the different types of risks associated with a private equity sale. The third explains how to assess if the deal fits into your financial plan with a hypothetical example. This blog series is for informational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Individuals should speak with qualified professionals based upon their own circumstances. The scenario mentioned above is for illustrative purposes only and does not reflect actual client experience. R-23-4483