In this webinar, Virjee Consulting breaks down how to evaluate a dental practice before signing a Letter of Intent (LOI). The goal is to help buyers identify profitability, understand risk, and avoid costly mistakes.
About the Speakers
Omar Virjee, CEO and Founder of Virjee Consulting, launched his first business at 16 and is an active real estate investor. He is part of the Goldman Sachs 10,000 Small Businesses program and works closely with dental practice owners across the country.
Humza, Partner of Advisory Services at Virjee Consulting, specializes in tax strategy for scaling dental practices and leads tax planning for large dental operations, from independent 1099 dentists to franchise builders. Over the past six years, hundreds of dentists have grown tax-efficiently through the firm’s advisory services.
Agenda
This webinar covers:
- The tax impact of deal structure
- Hidden costs in “strong” practices
- Understanding EBITDA correctly
- Real-world red flags from due diligence
- Financing realities
- Reverse engineering the right purchase price
- Entity and ownership structuring
1. The Tax Impact of Deal Structure
When purchasing a dental practice, the Asset Purchase Agreement (APA) is critical. Within that document, the bill of sale is especially important for tax purposes.
The bill of sale breaks down the total purchase price into specific components, similar to an itemized receipt. For example, a $500,000 practice purchase will be divided into:
- Equipment
- Supplies
- Tangible assets
- Goodwill
This breakdown becomes the blueprint for how deductions are calculated.
Tangible Assets vs. Goodwill
Tangible assets are physical items such as:
- Equipment
- Operatories
- Supplies
- Physical improvements
These typically qualify for faster depreciation, including bonus depreciation where applicable.
Goodwill includes:
- Patient records
- Non-compete agreements
- Intangible value of the practice
Goodwill is generally amortized over 15 years.
A common misconception is that buying a $600,000 practice means receiving a $600,000 deduction immediately. In reality, the timing of deductions depends on how the purchase price is allocated between tangible assets and goodwill.
Asset Sale vs. Stock Sale
Most dental transactions are asset purchases.
In an asset purchase:
- The buyer purchases specific assets.
- The seller’s LLC is emptied.
- The buyer forms a new entity with a new EIN.
Stock sales are rare in dentistry. In a stock sale:
- Ownership of the entire entity transfers.
- There are generally no new depreciation write-offs.
- Liability exposure is higher.
For most buyers, the asset purchase model provides more flexibility and tax benefits.
2. Hidden Costs in “Strong” Practices
High production does not automatically mean high profitability.
A practice may show strong production and collections on paper, yet still suffer from:
- Heavy lease costs
- Inefficient payroll
- Poor overhead management
For example, a practice may appear busy with a full schedule, but if collections are weak or overhead is excessive, true profitability may be limited.
Lease Burden
A high lease—such as $8,000 to $10,000 per month—can significantly compress margins. Lease costs are fixed expenses that cannot easily be adjusted.
When buying a practice, evaluate:
- Remaining lease term
- Escalation clauses
- Rent relative to collections
A high lease reduces flexibility and may make resale more difficult.
Equipment and Technology Upgrades
A practice may require:
- Digitization of paper charts
- CBCT or advanced equipment
- Renovations or signage upgrades
These additional investments must be added to the purchase price when evaluating total capital required.
Marketing and Patient Churn
If a practice spends $5,000–$6,000 per month on marketing but revenue remains flat, there may be patient churn.
For example:
- 40 new patients per month
- $72,000+ annual marketing spend
- No top-line growth
This suggests patient leakage, which impacts long-term value.
A strong practice must be evaluated beyond surface-level production numbers.
3. Understanding EBITDA Correctly
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.
It is often used to evaluate profitability, but EBITDA alone can be misleading.
Common Distortions in EBITDA
- Owner compensation may be artificially low.
- A spouse may be underpaid as office manager.
- Non-recurring or discretionary expenses may distort results.
For example:
- If a doctor pays themselves only 20% of production, EBITDA may look inflated.
- If an office manager is paid far below market rate, expenses are understated.
EBITDA is a starting point. It must be normalized to reflect realistic compensation and operational costs.
4. Real-World Red Flags from Due Diligence
Many practices have inaccurate or poorly maintained financial records.
Common red flags include:
- Misclassified expenses
- Poor bookkeeping
- Owner discretionary expenses buried in the P&L
- Shared expenses between multiple offices
For example, if a dentist owns multiple practices and allocates shared costs to one location but not another, one P&L may look artificially strong.
Benchmarking expenses such as:
- Lab fees
- Supplies
- Payroll
- Marketing
helps identify inconsistencies.
Poor bookkeeping can significantly reduce a practice’s valuation.
5. Financing Realities
Bank approval does not automatically mean a practice is a good deal.
Banks evaluate:
- Debt-to-income ratios
- Loan repayment ability
They do not evaluate long-term strategic value.
Lease Risk and Exit Strategy
A practice with a high lease may still qualify for financing, but:
- Resale may be difficult
- Profitability may be constrained
- Flexibility is limited
Unlike wages or marketing, lease costs cannot be easily adjusted.
Creative Structuring When Banks Decline
For smaller practices (e.g., $300,000–$400,000 collections):
- Equipment loans
- Working capital loans
- Strategic tax planning
can sometimes create opportunity.
By combining financing and tax strategy, buyers may build equity in undervalued practices.
However, the total investment—not just purchase price—must be evaluated.
6. Reverse Engineering the Right Purchase Price
Many brokers focus on doctor’s discretionary income.
A better approach is to think like a business owner.
Ask:
If I hired an associate at 32–33% of production and stepped away for several years, would there still be profit?
If replacing the owner eliminates all profit, the buyer is purchasing a job—not a business.
Example Framework
If:
- Reported profit is $200,000
- The owner is underpaying themselves
Adjust compensation to market rate.
If normalized profit drops to $150,000, the valuation should reflect that lower number.
Valuation must be based on realistic post-transition profitability—not discretionary income alone.
7. Entity and Ownership Structuring
An LLC is a legal structure.
An S-Corporation is a tax election.
These are not the same.
A practice is typically formed as an LLC. The IRS then allows the owner to elect tax treatment (S-Corp, partnership, etc.).
Timing Matters
Electing S-Corp status too late can create unintended capital gains consequences.
Example:
- Year 1: Large depreciation and losses taken
- Year 2: S-Corp election made
- Assets: $100,000
- Liabilities: $300,000
Negative equity of $200,000 may trigger phantom income and capital gains taxation.
Proper planning in Year 1 avoids this issue.
Entity structure should align with:
- Long-term goals
- Growth plans
- Risk tolerance
- Exit strategy
There is no universal default. Structure depends on the owner’s broader business objectives.
Key Takeaways
- The bill of sale determines tax strategy and depreciation timing.
- Strong production does not guarantee profitability.
- EBITDA must be normalized before valuation decisions.
- Due diligence requires deeper financial analysis.
- Bank approval is not the same as strategic validation.
- Reverse engineer purchase price using realistic associate compensation.
- Entity structure and S-Corp elections must be timed carefully.
