Lowering the transaction cost of credit card utilization, bank interest rates and fees, and the proportion or percentage of total sales devoted to any particular expense activity is a long-standing best practices method of managing dental entities whether in a solo or a group practice setting. Only recently has the same argument applied to the time point when the owner decides to exit and sell his or her practice or group. 1
The reason for the slow recognition of the taking of earned value from a selling dentist is vested interest. George Bernard Shaw expressed this well with his observation: "All professions are a conspiracy against the laity." Here the "laity" translates as the selling dentist, and the professions conspiring against the selling dentists are those in the accounting and legal professions who also house transition agents in their firms. The conflict of interest of marketing the same practice that you account for or prepare legal opinions is overlooked in the pursuit of the high sales commission rate charged to selling dentists. The transition industry whose role is to sell practices lapses in professional conduct by construing sales price from boiler plate adjustments and rule-of-thumb and outdated methods of valuation. Transition agents assume compilation statements as fact when, in truth, only after the exercising of a financial audit may this claim be made. Without an audit, the truth and accuracy of the EBITDA or net income on which market value is determined cannot be verified.
Were dentists to read the cover letters accompanying their year-end financial statements, they would bear witness to one of the greater acts of deception perpetuated on gullible clients. A public accountant writing on his or her own firm’s letterhead earning a fee for denying any responsibility for producing the material which earned them this fee. How you move from a financial statement without assurance to a sales price without an audit is one of the magic tricks of the transition industry.2
In a sample $1,000,000 sale of a dental practice, the transaction costs add up to a considerable amount. First, there is no sale without at least a CPA compiled financial statement which will cost the selling dentist $15,000 to have prepared, a transaction fee of 1.5 percent.
Second, there is no sale without an attorney drafting a purchase and sales agreement for another $15,000, another 1.5 percent transaction fee. Third, there are escrow fees and other closing costs which round off to a third set of $15,000 charges, or, once again, a 1.5 percent transaction fee. Fourth, there is usually a closing fee based on points for bank financing but this is not the responsibility of the seller. Fifth, the bonanza -- transition brokers charging the selling dentist a $100,000 commission on the sale, a 10 percent transaction fee. Together, the transaction costs to the selling dentist of a simple dental practice sale are 14.5 percent, taking $145,000 from the pocket of the selling dentist. The fact that there are also transaction costs against the buyer demonstrates how out of control transaction costs have become in the otherwise straightforward sale of a dental practice.
Imagine removing the biggest transaction cost of them all by eliminating the broker’s transaction fee! This action immediately changes the transaction cost scenario from 14.5 percent to 4.5 percent, reducing the transaction costs to the selling dentist from $145,000 to $45,000.
While the positive microeconomic effect of this imagined scenario for a single selling dentist is obvious, the significance of the reduction in transaction costs is felt to an even greater extent on the macroeconomic level. Transaction fees move into the pockets of CPA, legal, banking, brokerage, and escrow companies as sales revenues, but find their way back into the economy as net income, a number significantly less than the amount taken from the selling dentist. The selling dentist, on the other hand, has available the full amount as a capital sum, and, as a capital sum, is an investment whose effect is felt on the economy as a whole through a multiplier.
For example, if the net income on $145,000 of fees is 6 percent, then only $8,700 moves into the economy as an investment to be applied against a multiplier. At 5,000 practice sales a year (each at the same $1 million sales price) that’s $43.5 million of money flowing through the economy. Contrasted, since the selling dentist has the entire $100,000 of extra money available for investment, at 5,000 practice sales (each at the $1 million sales price), that's $500 million of money flowing through the economy. Using a conservative seven-year treasury yield curve rate dated January 2, 2015 or 1.92 percent as the multiplier, the net benefit of the reduced transaction costs to selling dentists adds $1.6 billion into our economy. This amount goes missing with high transaction costs.
Loss or lessening of investment income into the economy is a corollary argument to the one made in the seminal paper on the subject of social cost published by Ronald Coase, where he speaks of transactions costs being "extremely costly, sufficiently costly at any rate to prevent many transaction that would be carried out in a world in which the pricing system worked without cost."3
While I ponder the loss or lessening of investment income into the economy with high transaction costs, Coase ponders the loss of this investment income altogether owing to high transaction costs preventing an economic event from happening in the first place.
Lower transaction costs are better at both the microeconomic and macroeconomic levels. It is time for someone in the dental industry to address high transaction costs and help selling dentists to avoid them.
Not surprisingly, it is an economist who is beginning the process of reducing transaction costs to selling dentists! The advertisement (reproduced below) appears below the masthead in today's Becker’s Dental Review. It is also appearing on the Home Page of DrBicuspid.com for the entire month of May 2015, as well as in the Classified Section of the June 2015 issue of Dental Economics.
The fee (higher of $20,000 or 2 percent of total sales price) I am paid by the buyer in matching the criteria for purchase – geographic, demographic, private pay vs. Medicaid, number of operatories, sales volume, et.al. – against available practices is not a transaction cost, either to the buyer or seller. Because I perform an audit to verify the accuracy of the financial statements, my fee is a due diligence expense on the part of the buyer and is expensed accordingly. Do not confuse the contingency of "2% of total sales price" with the 10 percent commission charged by transition brokers. Unlike a brokerage fee, the contingency in my remuneration formula is there to address the extra work involved in an audit with a sales volume greater than $1,000,000 or for a group practice.
I expect the nuts and bolts to come off the swing door gates of the transition industry when this advertisement begins to circulate in the dental community. Comparisons to Judas and Benedict Arnold, if not Marx and Lenin, are going to be made from those currently housing transition sales people in CPA offices and law firms as well as from dental brokerage companies. The day of their gouging selling dentists to the favor of their own pockets is coming to its rightful end.
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1 In 45 “non-corporate” states and D.C. the owner must be a state licensed DDS or DMD; the 6 “corporate” states where the owner does not have to be a state licensed dentist are Arizona, Mississippi, North Dakota, New Mexico, Ohio, and Utah. Jim Moriarty and Martin J. Siegel, Survey of State Laws Governing the Corporate Practice of Dentistry, © 2012 Moriarty Leyendecker, available at: http://oversight.house.gov/wp-content/uploads/2012/04/4-25-12-Survey-of-State-Laws-Governing-the-Corporate-Practice-of-Dentistry.pdf. A useful sidebar identifying the non-corporate states is in: Thomas Climo, “How DPMs are sold in corporate vs. non-corporate states,” DrBicuspid.com, May 8, 2013.
2 For a definition of the three different assurances of CPA-prepared financial statements – none, limited, and positive -- see: Thomas Climo, “Internal audit provides inexpensive financial assurance,” DrBicuspid.com, October 8, 2013.
3 R.H. Coase, “The Problem of Social Cost,” Journal of Law and Economics, Vol. 3 (Oct., 1960), p. 15.