Due diligence is critical when purchasing a dental practice. This requires a detailed examination of all aspects of the vendor’s practice. The starting point of due diligence is the practice appraisal. In the vast majority of cases the vendor will have his or her practice appraised by a licensed valuator. The appraisal determines a fair market value of the practice and is an extremely helpful document to both vendors and purchasers.
The appraisal is typically quite lengthy and contains all sorts of information about the dental practice. It details the value of all the equipment, furnishings, leasehold improvements, inventory, supplies and the goodwill. It will contain financial information including billings, the number of active recall patients, staff information, premises lease, and many other items.
Appraisals are usually based on asset valuations. However, for tax reasons, many purchases and sales of dental practices are by way of share sale, not assets. There are important differences between sales of shares versus sales of assets, including tax treatment for both sellers and purchasers. Therefore, whether selling or purchasing a dental practice, it is critical to speak with your tax advisors to determine the best approach to the transaction. The appraisal is only a starting point. The valuation will allocate the value of the practice among the various assets. In negotiating the purchase price of the practice a purchaser may wish to change that allocation, where appropriate, to make the tax treatment more acceptable.
The vendor will provide the appraisal to the purchaser for review. The purchaser needs to consider the following questions: Is the appraisal current? Did an experienced valuator of dental practices prepare the appraisal? Does that valuator have a reputation for valuing conservatively or aggressively?
If a vendor hires a valuator to prepare an appraisal, then that appraisal was prepared solely for the vendor’s benefit. This is an important fact that purchasers often overlook. The valuator’s responsibility and legal liability is to the vendor, not to the purchaser. A purchaser must review the appraisal with caution, keeping in mind that it was prepared for the vendor and was based primarily on information given to the valuator by the vendor. Even though the valuator may know the appraisal is being prepared in anticipation of a practice sale, the valuator has no direct legal obligation to a purchaser.
Therefore a purchaser cannot rely on the vendor’s appraisal and must make his or her own due diligence investigation of the dental practice. As part of this process, it is imperative the purchaser complete a detailed patient chart audit to determine the number and quality of the active patient charts.
The legally binding document between vendor and purchaser is the purchase and sale agreement. If there is important information to a purchaser in the appraisal that a purchaser wishes to rely on, that information must be included in the purchase and sale agreement. That agreement should contain the condition in the purchaser’s favour that the purchaser (and the purchaser’s professional advisors) may conduct the due diligence examination of the practice, including an audit of the patient charts and fees, review of the financial information and to confirm the dental equipment, computer hardware and software and other assets function correctly.
It is essential the purchaser complete a thorough due diligence review early in the process of purchasing a practice. Provided the purchase and sale agreement contains the due diligence condition, if the results of the due diligence investigation are not satisfactory to the purchaser prior to expiry time of the condition, then the purchaser can terminate the purchase agreement and transaction.
Purchasers who do not conduct appropriate due diligence of a practice are putting their investment at risk. The ancient Latin phrase ‘Caveat Emptor’ translates to ‘Let the Buyer Beware’. This maxim of Roman law is part of the British tradition common law and still applies in Canada in the 21st century. To paraphrase a Supreme Court of Canada case:
The doctrine of Caveat Emptor operates as between purchaser and vendor and instructs the potential purchaser to rely upon his own investigations, inspections and inquiries. The concept of buyer beware tells the potential purchaser that if it seeks greater protection than its own investigations, inspections and inquiries provide, it should seek appropriate warranties from the vendor.
Therefore, the best advice is proceed with caution and careful due diligence. And to assist you in conducting proper due diligence, retain independent professional advisors who focus on advising dentists regarding the purchase and sale of dental practices.