Transcript – Dentology Podcast recording with Andy Acton & Chris Strevens
Episode release date – Monday 29 May 2023
Andy & Chris:
So one of the most common questions we’re asked is about EBITDA, reconstituted net profit and what it all means. Because I think sometimes in our world it’s easy just to kind of ban these phrases around because we deal with it all the time. And I think it’s probably worth just stripping it back to basics, explaining what EBITDA is, but importantly what reconstituted net profit is. So So EBITDA, let me start with that and then I’ll leave you to unravel reconstituted net profit. It’s just a bunch of letters, but it’s one of those interesting ones, isn’t it, that as you say, people sort of focus on it, but I’m not really too sure they understand what it is. No, so EBITDA, the E is the earnings, which is the profitability that sits down the bottom. So that’s the money that you’ve earned as a result of your business. It’s an interesting one, isn’t it, a coin net, like an N. Yeah, but I suppose it’d then be a nubider. It wouldn’t work with it. But no, that’s interesting. The B is probably the least important and interesting part of the mnemonic, which is before. So then what you’ve got, you’ve got your earnings and then what you’re adding back to it. So the before bit is the I is interest. So any um… leasing interest, bank interest, that will get added back. The T is the tax. So if you’ve paid any tax that’s due, which should be due on your profitability, that gets added back. So limited companies really only on that one. Corporation tax, exactly. Because yeah, because as an individual, you wouldn’t have tax because you would take your drawing, because that would go on your personal tax return when you pay personal tax, income tax. So yeah, the T is the tax. The D is depreciation. So that’s the allowable accountancy deduction, which would typically be applied to your equipment fixtures and fittings as a typical deduction. And then the A is amortization, which is in the accountancy world, instead of causing it depreciation, they call it amortization, which effectively is the depreciation of the goodwill element. So you’ve got your earnings profit before. interest, tax, depreciation and amortization. And the idea is that that gives you a stable position to be able to compare business to business. And for lots of businesses, that does work because dentistry is slightly different. And the slightly different bit is many of them are not as lifestyle businesses, but there are benefits as a dental practice owner where you can incur costs that don’t directly relate to the efficient running of a dental practice. And that’s why we believe that the reconstituted net profit is really important because for an independent owner taking that practice over that’s a much more reliable number of what the profitability is in that business so yes that’s the EBITDA bit so what’s reconstituted net profit how does that differ? So I think the way I’ve tried to explain to some people is a bit like EBITDA on steroids because as you say that most of our Businesses one are still sold traders so you can sort of discount the tax bit anyway Yeah, but the reality of what we want to do and what we’ve done is if a Normal if there’s such thing as a normal dentist was to take over this practice What would it look like because basically? It’s a bit like I suppose. There’s no point buying a two seater MX5 if you actually want a family saloon because it’s just not fit for purpose, is it? So if you’ve got someone who wants to buy a dental practice who is a general dentist, who wants to buy an implant practice, it’s a four door saloon instead of a Mazda. So what we try to do is effectively reconstitute the profit for a purpose buyer to fit that practice. So you’ve got your EBITDA, which as we know is a start point. But then we look at those other things. So what are the most obvious ones? And feel free to chip in. The most obvious ones, I think, are when you’ve got a principle who is working. three days a week because they wanted to work three days a week. It’s not that there’s no business, it’s just the fact they wanted to play golf, they wanted to stay home, they wanted to sit and watch TV. One of the choices as a business owner, you can do as much or as little as you want in terms of hands-on. They might have worked for 30 years or they might work for 10 years but they only want to work three days a week. So to provide the cover to generate the other income they employ an associate. So the most obvious one there is when you buy this practice, are you going to work three days a week? And I think we can genuinely say from our experience, most people want to buy a dental practice to work in it. Most of them will take a pretty chunky old loan on it. and most of them will want to generate as much revenue as they can and remain sane and not get divorced. And it might be that they go through that cycle of in the early days working perhaps four, four and a half, possibly even five clinical days a week, but they might become the dentist in 10 years time that’s doing three days a week. Yeah, exactly. So it’s just where you are in your life stage. So what we then do is we look at it and say, right, well, you’re paying, you know, let’s say you’re paying £100,000 to an associate. Reduced by a hundred thousand. So so just to keep it simple. Let’s say your your profit was on your accounts 200,000 pounds, but you’ve paid a hundred thousand pounds to an associate Because the associate is doing two days a week so you would might come in and say well actually I’m going to take over those two days a week so are you going to have to pay that associate? No. No so therefore. So that 100 000 can be added back. Yeah so your 200 has become 300 so suddenly it’s way more profitable so that’s an obvious one. I think some of the others I’ve seen would be whereby the wife is the dentist. The husband is the, this is a podcast, so you can’t really see me doing inverted commas, is the practice manager who’s on 75,000 pounds a year. So the reality of a sale is one, would you keep the husband of the… Selling dentist on as your practice manager and the answers I don’t think so And if you wanted a practice manager, would you pay them 75,000 pounds? again, unlikely. So that’s an item that can be added or broken going. So let’s say 35 grand for a practice manager, that’s 40,000 pounds that you can add to your bottom line. So those are two. So if that scenario was in that practice, we’ve just added 140,000 pounds profit. What other ones can you think of? I’ve seen quite often courses and travel. Yes, definitely. So, you know, very reasonably for CPD reasons, you know, dentists do need to attend courses, need to stay up to date with the profession and latest techniques. However, you may or may not need to go on a course that’s in Germany or Croatia or New York. Or in the case of the guy that I met whilst on holiday in Sun City, South Africa, where he was doing an implant course. And I don’t doubt, courses are a very high quality, but from a running a dental practice point of view, that’s kind of more personal development for you and doesn’t necessarily want the investment of money for that practice. And like with travel, again, people may travel around to get to different, to get different events. And again, that’s a cost that would have been incurred by the practice, which doesn’t necessarily motor. I’ve seen motor expenses appearing in accounts before. And again, when you’re only traveling. in terms from your place of work and it’s your dental practice, arguably that’s not something that would feature for somebody going forward. And I guess all these small items, they add up, don’t they? Yeah, and I think that’s the thing, isn’t it? I know we quite often get questioned about the reconstituted profit number and where did we get it from? And it’s almost sometimes as if the buyers think we just sort of like… Right, we’ve taken a number we’ve made it up and then we just added it back to make it look better. But I think we all say don’t we ask us the question because we can tell you where those numbers come from You know that I think the other one that we’ve seen as well is the the surplus calculation I know that sometimes people get be confused over that don’t they? So do you want to talk us through the surplus? Yeah So in essence and it’s it’s been really relevant in the past few years because of what’s happened post-COVID. But the surplus calculation effectively factors in. But by the very nature of financial accounts, they’re historic. So at the moment, we’re now in May 2023. We’re looking at accounts for 2022 at the latest. In some cases, 2021, if people are a bit behind their admin. So what it means is that the dental practice in the last nine, 12, 18 months, the numbers have changed. And where you see an increasing profile, the fees are going up, with those fees going up, there will be an associative profitability. So what we do is we do a calculation that says, okay, so in your last set of accounts, you turned over 700,000 pounds, but your last 12 months figures show that you’re producing revenue of 850,000 pounds. In that difference of 150,000 pounds, there’s going to be a profit surplus. So we will do a calculation to establish what we believe that profit surplus to be after deducting labs, materials, associates costs, hygienists, whatever it might be. similar to the last set of financial accounts to try and get and it is you know it’s an informed guess it’s not a pure guess but it is an informed guess and what that will do is that will give us a surplus for the last 12 months that again would add to the profitability because because accounts are always so far out of date you’re always working a year to 18 months behind and so one um because it can go one of two ways Yeah, in a declining position, we want to make sure that exactly we want to make sure we can present the most current position possible. The reality is that for most in the last two years, the numbers have gone up. And so quite rightly, the seller would expect to for that to be factored into their valuation. But also the buyer is buying a business that’s performing a higher level than he’s shown on the accounts. I think it’s reassuring for those listeners to understand that we’re not. trying to fleece them with a value because we don’t just take the income and then say well we’ll take your labs and mats so you made like an extra hundred grand profit we do say well someone else is going to have to generate those numbers unless the principal’s got the capacity which in most cases they don’t so there’s an associate cost and I think the one that they they probably don’t know that we do because be honest we probably don’t articulate it in our calculation because we just show a number but the answer is ask us is the fact that we do look at the current staff as opposed to those historical staff especially in the current environment where it makes a difference doesn’t it? Oh well if you think that it’s been you know well covered in the press there’s been strikes of people striking for more money lots of dental practice have increased the pay rates to their and what they’re paid and we then cross reference that to the staff costs in the last set of accounts and look at what the difference is and factor that into the valuation and just to be clear, obviously we’re directors of Frank Town Associates, what we’re talking about applies to any valuation. You should be able to go to any organisation that’s providing a valuation and ask questions like this to understand how that valuation has been created. Any decent valuer should be able to defend and explain how they got to their number. sort of like thinking my birthday times by two and add 10% or something. I must admit I think the reconstituted profit figure is that one that EBITDA is great and obviously for multiples they you know as in sorry associate led buyers they will probably use EBITDA more than our reconstituted profit figure. But the two apply. I tell you one thing that might be worthwhile you mentioned the time is the difference between when people are down the pub or in the cafe or a dental show probably more appropriately where you’ve got some guy saying I sold for eight times EBITDA and another bloke says well I sold for five times EBITDA but they’re sort of almost the same practice in the same locality. And somehow the bloke or the pledge, the bloke who sell for five, feels that he’s been hard done by. So I know that we’ve, we’ve had the discussion with loads of people, but it might be worthwhile you explaining that as to, to why that sort of looks a bit old. So let’s just try and keep the numbers really simple. So we have a dental practice that produces a profit of 200,000 pounds and that’s the the profit is with the principal working in the business, right? Okay, so that business would attract a multiple of five times I can profit of 200 multiple of five is worth a million million pounds That’s with a dentist working in in that practice. So she own a manager exactly most of practices still own a manager Million pounds. Yeah, okay So these numbers don’t quite work But but it will just make the point was being run on an associate-led model. So it’s owned by a corporate. They’re completely reliant on associates to deliver the dentistry. Let’s just say that profitability dropped to 100,000 pounds. There’s no longer 200,000 pounds, it’s 100,000 pounds. Because you’re paying everyone to deliver the work. Because they’ve increased associate costs. And that practice is now gonna have a multiple of 10 times. So the other one only had a multiple of five times. And now you’re getting a 10 times multiple, which is amazing news. Which is high. It’s brilliant. It is high and it’s amazing. 10 times 100,000 is a million pounds. So same value. So a 200,000 pounds profit with a five times multiple is a million pounds and a 10 times multiple, but it’s only applied to 100,000 profit is a million pounds. It’s still a million pounds. So the value doesn’t change. And it’s important to mention that in evaluation, there’s two numbers that are really important. Everybody obsesses about the multiple. When you’re down the pub, everyone says, oh, what a multiple is that? What a multiple is that? And a multiple, by virtue of the word multiple, has to be multiplied by something. The something it’s multiplied by is critical because that’s the underlying profitability. And as that moves, your value moves. And if a practice is gonna be worth the same, regardless of who buys that practice, the profit changes, so the multiple changes. So a multiple is a really interesting number. only in the context of what’s it being multiplied by, a multiple on its own. is meaning this. There’s no context. There’s no context. It’s because it’s isn’t it. It’s the you know we’ve done this for a very long time. And I think you know Frank and Sandra was it longest oldest well established whatever in 1988 you know that when we first bought the business in 2000 the question we were always asked was what’s the percentage what’s the percentage of turnover goodwill. What’s the percentage that was it. That’s what people ask now they say. What’s the multiple? But the principle is still the same. You know, what percentage, well, what you multiply, what you apply the percentage to, the multiple, well, what are you applying it to? And if you don’t go to the second question, which is, well, what’s it multiplied by, the multiple means nothing. From a vanity point of view, you know, I got 10 times. It sounds brilliant. But you might be better only getting a lower multiple because it’s been applied to a higher profit. This is all about delivering. pound notes into the bank account. It’s not an ego or vanity game. It’s about getting a robust valuation that stands up, but the underlying profitability is applied to a multiple that works. trying to do the reconstituted profit we try to do it as a as a general dentist taking over so people who are under grossing but have the potential as in someone else is grossing that will be factored in but also it when someone’s a supergrocer that has to be factored in as well yeah yeah but the idea is that as value as every value as Andy says as you said man is the fact of it should be on you know what yes what’s the repeatability yeah not necessarily what it is now absolutely good we enjoyed excellent we will get it absolutely
