Beware, the due diligence iceberg is bigger than it seems By Gareth Thompson. January 20, 2017.
It’s rare, but the CQC sometimes shuts dental practices down. The first time was in 2012 when it found a kitchen being used to sterilise dental instruments in Dudley. If you’re a practice owner and you’re thinking about due diligence then you’re probably — and quite rightly — thinking along these kind of red lines. Obviously they are fundamental and non-negotiable, but they are just the visible part of the due diligence killer iceberg. The other part is a lot bigger and it sees a lot more people come a cropper. I’m talking about getting your paperwork in order when you are buying, selling or starting a practice.
Unfortunately what a lot of people do is rush in and make a bid, or accept a bid, and then let their lawyer handle the byzantine paperwork around everything to do with the property, goodwill valuation, stock, employment contracts, and fixtures and fittings. Or they try and muddle through themselves.
Both are really bad ideas — I recently spoke to a dentist who was buying who said it took three months out of his life.
That’s three months not earning because he was doing all the liaising between the seller and his own lawyers, and it took more than a year to get all the information together for the sale to proceed.
The problem with lawyers (and it takes one to know one) is they operate in silos. If you ask the lawyers handling your acquisition to look at the employment contracts you will be inheriting, the work will be sent to an employment lawyer in the firm, just as someone else will be handed the commercial aspects of the sale and someone else will handle the property. If this was a project, you’ve just let the lawyers build three walls to impede communications, increase workload and saddle the project with delays.
If you were starting any other project, at the outset, at the very least, you’d want a delivery date. Hardly anyone expects a realistic delivery date in dental real estate because everyone knows no one has control.
Try asking your lawyers for a delivery date and they will say “it depends”.
There’s no control or consistency in the way sales are processed because the due diligence stuff isn’t handled when it should be — early. When it is you save time and money, and if you are selling it does wonders for your marketability and valuation. If you’re buying it protects you from expensive oversights and can minimise your tax liabilities in the future.
You can transform a transaction by being ready.
It affects the speed, confidence and trust, and speaks volumes about the way you run your business. Without wishing to bore you, let’s look at a few specifics to show you what I’m talking about — and be warned, this list isn’t even close to being exhaustive. If you don’t have time, just skip to the bottom to find out how we can give you back control and stop your project being hijacked by infuriating lawyers…
Property due diligence
If you want to sell your property, grant a lease or obtain the freehold, the first question is are you actually entitled to do so? You might not be. Have you got any running disputes with anyone adjoining your property? That could become a nightmare. Are there any statutory notices that are likely to impose a hideous financial liability on you to avoid you getting shut down? Things really do lurk out of the woodwork: someone might crop up and say, “I’ve always had permission to use your electricity because that’s the agreement I had with the last owner…”
So do you really have the right to hand over the keys, or are there any sub-agreements with suppliers, associates or anyone else that give them a right to use a bit of the building?
This sort of issue arises quite frequently and if it happens late in the game (when you’re close to exchange) you’re in a corner against a wall. You really don’t want to end up cul-de-sac’d like this, blackmailed into getting your cheque book out.
Whoever’s acting for you is going to have to give a report to the bank saying that you have planning permission to use the whole building as a dental practice. So are the dates right, or has the permission been breached historically? There could be a prospect for enforcement action there retrospectively. Have any of the buildings been altered? If so have all the relevant permissions and building regs been obtained? What kind of state is the property in? Are there any dry rot or structural defects? Is the property served by all the relevant services? You should have all of this sorted beforehand.
Every property now needs an energy performance certificate and from April 2018 if it’s below a D you can face enforcement action and a fine and have to take whatever steps are necessary to make it right.
Likewise if you want to sell a property or acquire it you need to confirm whether there’s asbestos and if so take action to manage or remove it. And what about fire safety regulations? Is there a current full fire safety compliance and risk assessment and are all the statutory records kept?
There are a plethora of hidden risks here, but the most striking thing is they were always there; avoiding them now only means they will come back to bite you later, at a more critical moment. Do you want to have your ducks in a row for a speedy sale or do you want all the back and forth, delay, stress and expense that is the norm in this industry? If you are buying you will need to be asking all the same questions and if the vendor can’t answer them you will know it’s not a wise purchase.
I have barely started; there are so many more complications… As Gilbert wrote in 1878:
Things are seldom what they seem,
Skim milk masquerades as cream;
Highlows pass as patent leathers;
Jackdaws strut in peacock’s feathers.
Fixtures and fittings due diligence
Are there any solar panels on your building? If they are leased, whoever wants to acquire them has to take over the lease (the panels will be owned by the solar panel provider), and the terms might not be attractive.
Have you ever gutted the property you are selling? If you’ve spent money on items for which you could claim capital allowances, anyone acquiring it will want to see the history of any allowances including, for example, electrical work and air con ducts — anything that’s been woven into the fabric of the building and qualifies for relief. If you’ve already got all the information and you can make it available it will add to the attractiveness of your sale. Otherwise you can find yourself embroiled in a process of catch up and the surveys required can be expensive. Any prudent buyer will at least want a promise that any time up to two years after sale you will cooperate to pass on relevant information.
Does the practice have an amalgam separator machine in accordance with the 2006 Department of Health rules? Does it comply with health and safety, environmental and data protection statutory requirements? If not, what’s been done about it? Have the statutory decontamination requirements been complied with and can that be evidenced?
Dental equipment due diligence
If you are buying a property, be sure that what you see is what you get when it comes to kit. Here are some questions to ask: does the vendor own it, is it leased, has it replaced something else that was leased, or has it all been rolled into one lease package (which could be hideously expensive)? Have lots of payments been loaded into the back end? Have all the payments been made? What happens when the lease expires? How easy would it be to take over the lease?
Are there copies of any maintenance agreements for everything from the burglar alarms to the practice software? Now we’re on the subject, if you dived into the IT system in the practice you’re buying, is it robust? What’s the practice continuity plan in the case of a breach or power cut, and where’s all the data backed up? In other words is the practice being run in a professional, efficient and compliant way? This can all inspire the confidence for you to crank up the price if you’re selling…
With leases you can’t transfer the benefits or the burdens unless the lessor agrees — transferring liability’s a three way process not a two way process. You’ll want a copy of every hire purchase or lease agreement to find out what the terms were for anything that’s going to be left on the premises you’re buying. You need to know whose name they are in, who owns them and who is entitled to use them. With electrical equipment, autoclaves and scanning equipment you’ll need to know if it’s all currently compliant and certificated.
Stock due diligence
You need to know whether all the stock is going to be removed upon sale or whether some will be left. How much is obsolete and how much is valid?
Apologies in advance for how boring this is. Can you imagine doing all this yourself? Incredibly, many practice owners don’t need to imagine because they try to muddle through themselves, wasting time, energy and money.
What we’re talking about here is the inside leg and buckle cavity measurements of the practice.
Imagine you want to stay on as a consultant; if the buyer discovered there were problems with the practice you won’t become a marketable commodity.
Practice operation and structure due diligence
Is the practice a limited company or unincorporated or a mix of both? If it’s a mixture then different rules and processes will apply to transferring each, which means extra costs.
Is the NHS contract in the name of the dentist and the private side of the practice in the name of company? Are there appropriate expense sharing arrangements and employee contracts? If not this may breach the NHS contract terms, which may affect its transferability and NHS pension benefits. Is or will the company side of the practice be subject to a transfer of control clause or an efficiency review by NHSE? If so this may affect the practice’s transferability as well as its value.
Compliance due diligence
Any new dental entity must be registered with the CQC. In a sole trading practice that will mean jointly registering the existing practitioner (seller) and the new practitioner (buyer) and then the new practitioner alone. The downside time wise being that the CQC may take three months to process each application. Who will manage that aspect of the transfer to avoid the project completion date being scuppered?
Goodwill due diligence
Depending on its size and structure the practice’s goodwill value could be a multiplier of EBITDA (accountant speak for net profit) or a percentage of the gross fee income of the practice or the going local market rate. High profits will favour an EBITDA valuation and low profits a gross fee income one. If the practice is within the M25 then throw the accountancy slide rule away as the goodwill could be worth whatever someone will pay for it (ie a lot more).
If the practice is not incorporated and its assets are being sold, has the value of its goodwill and equipment as well as the property been separately assessed? There can be significant tax differences in terms of how these are treated depending on whether you’re selling or acquiring. If you are acquiring a practice you want a high equipment value. If you are selling you want the equipment value to be as low as possible.
Most people leave the nitty gritty about how to split the value between stock, goodwill, property and equipment to the lawyers who then pass the buck on to the accountants.
That’s the worst idea, not least because most lawyers won’t offer advice on this stuff. You need to lead this conversation and set out your stall first.
If you’re selling, can you supply trading accounts for the past two years? If all or part of your practice operates as a company are there management accounts to cover the period since the last registered accounts? If not how is the practice going to be accurately valued?
Employment due diligence
You need copies of all contracts but especially employment contracts. Then check whether they’re all compliant, up to date and regularly reviewed. What will happen if you want to sell, will the employees stay or go? Are any dental associates’ contracts BDC and DPA approved? Has HMRC ever challenged their self-employed status?
Practice liability due diligence
Where do you advertise your services? Do you have marketing contracts, and can they be taken over? Who are your suppliers for dental supplies and lab work, and what are the contractual commitments there? Have there been any GDC enquiries in the past three years in relation to any of your clinicians? Have you, the seller, had any disciplinary action taken against you? Have there been any punch ups (figurative or literal) with any third parties? Has anyone threatened to sue you or the practice?
Anybody approaching a practice disposal or acquisition has to think of it as a project.
It needs an end date. That’s critical — you need it to make sense of everything. Without it you can’t plan your life or your business.
You can go from shop window to transfer of ownership in three to six months if everything’s transparent and tickety-boo. Otherwise expect six months to a year, or more. So why wait?
At Fine Co we understand the compliance side, the accounting side and, crucially, the property side. Our site finding service means you can avoid wasting time on poorly run businesses from the outset because they won’t stand a chance of making it into your shortlist.
So how does it work, and how much does it cost?
If you’re selling, the fees are a function of how dysfunctional or otherwise the practice is. If it’s already in pristine good order this can make the difference between a week’s and a month’s work. However, we do a pre-due diligence audit check on the practice to see how it stacks up. That enables us to calculate the number of days a due diligence project will take. Then you’ll get a report showing the danger areas and what we think you will need, with an estimate of time required for the project and with it a reliable idea of cost.
And wouldn’t it be helpful if the due diligence work just happened to be done by the same lawyer who does all the legal work — surely that should reduce costs and increase the speed of the project?
Yes, yes and yes, and that’s what we do at Fine Company. As head of due diligence here I bring decades of experience in legal work across a wide range of professional property, commercial and employment matters. I’m also an ex-litigator so a bit of a poacher-turned-gamekeeper and I therefore know this patch quite well.
The other really good thing about Fine Company is that we have leading experts in dental software, marketing, accounting and site finding in one place, so your project is coordinated and seamless because the transfer of relevant knowledge happens automatically. That means we get to set the terms of the project (meaning big things like the end date) on your behalf.
No one gets to hijack it. You get control.
Sound like a better approach? Give me a call if you’d like to know more.
“The problem is most lawyers work in silos”
due diligence director