Do’s and Don’ts of Borrowing Money to Start a Dental Practice
By: Zach Obront
Tags: Dentistry, Dental Care, Entrepreneurship, Dentist, Dental Practice

The following is adapted from DSO Secrets by Emmet Scott.

The banking industry is traditional. The dental industry is not. It has moved away from individual mom-and-pop cottage-industry dental practices. No one thought about dentists having more than one location and certainly not enterprise-level numbers of up to thirty locations! Including bankers. Their banking system and process is not made for the DSO world.

If you have one or two locations, you’re still considered a mom-and-pop shop. What the banks figured out long ago is that you, as a dentist, have the means and the skills to work your way out of any loan, so with little to no experience, you can get a loan and start buying or building a practice.

More Practices Owned = More Scrutiny From the Bank

By practice three or sometimes a few more, you’re no longer the owner of an individual practice but a business owner. You need management skills for your multilocation practices, and the money you need is probably a couple million instead of just the half million you needed when you didn’t have to budget in such things as IT systems, sophisticated marketing, and HR departments. The investment and risk, in a banker’s mind, are higher.

The checklist the traditional bankers have established for your type of business doesn’t fit our transitioning industry anymore. They have boxes to tick and federal guidelines to follow. They have a maximum range they’re comfortable loaning to an individual dentist with the full knowledge that it’s a personally guaranteed loan. If your practice falls apart, then the bank knows you can just go work for someone else and pay back your debt. What a bank is initially doing is underwriting your ability to make personal income and use that income to pay the debt.

But as you start to grow bigger, your ability to use your wages to pay back the loan dwindles. That’s the heart of the problem. As you get more successful, banks are no longer looking at your clinical skills but instead scrutinizing your business skills. While the bank trusts that you can pay back a single loan or two with the skills you learned in dental school, scaling puts you in uncharted territory. This takes you from business owner banking to corporate finance.

Financial Mistakes in Acquisitions

It’s important to know how the banks determine their loans so you can avoid a mistake that most dentists — and even banks — make. Most banks make initial dental practice loans based on top-line revenue. Top-line revenue, or a percentage of it, is essentially where banks determine their own risk. Assuming your practice is doing $1 million and your loan is 80 percent, your practice loan would be $800,000.

Now let’s look at your bottom line. We’re still talking about a $1 million practice. But let’s subtract an appropriate wage for an associate once you get that additional practice. And what wage would you or do you draw now as an associate clinician? After you pay yourself, what’s left at the bottom?

Let’s say $250,000 annually is paid to the associate and $100,000 will be left at the bottom to pay back the $800,000 loan. Using this math (and no interest rate, to keep it simple), and assuming all bottom-line income was used to pay down the loan, it would take you eight years to pay back the loan (800,000/100,000 = 8). What if the bottom line is $50,000? It will now take sixteen years to pay back the loan, or, more than likely, it will require you to eat into the associate’s or owner’s income to pay back the loan on time and not lose the practice.

The problem with stopping at top-line revenue when calculating practice value arises when you consider paying back an $800,000 loan. Early on, the banker does the math a little differently than you do. The banker thinks, Oh, their wage is $250,000. I’m fine with that. It will only take this dentist four years to pay back the loan in the worst-case scenario.

With a bottom line of $50,000 or $100,000, the ramifications are that fulfilling the bank’s expectations means using your actual wages to pay the loan. That won’t work if you actually want to eat, pay for your house, and travel.

Plan Ahead When Seeking Additional Loans

As a business owner, when considering financing a practice, start looking at your net income and ask yourself, How long am I willing to spend paying back this loan that I want the bank to give me? This will help you calculate a clearer value of the practice.

Use this math when buying your second location and beyond. You won’t have the luxury of taking the associate’s wage to pay down the loan, so if there’s no net income coming out of the practice, stay away from the purchase.