Financial Due Diligence
Financial analysis is the foundation of practice due diligence. You need to verify that the practice actually generates the income the seller claims and understand the true cost structure that will transfer to you as the new owner.
Financial Documents To Request
- Three years of federal and state tax returns (practice entity returns)
- Three years of profit and loss statements (monthly preferred)
- Year to date financial statements for current year
- Balance sheets for the past three years
- Bank statements for the past 12 to 24 months
- Accounts receivable aging report (current)
- Accounts payable aging report (current)
- Production reports by provider for the past three years
- Collections reports for the past three years
- Adjustment and write off reports
- Current fee schedule
- Payroll records and employee compensation details
- All debt documentation (loans, equipment financing, lines of credit)
- Vendor contracts and recurring expenses
Key Financial Metrics To Analyze
Raw numbers only tell part of the story. You need to understand the trends and what drives the financial performance.
Collections Trend
Are collections growing, stable, or declining? A practice with declining collections over multiple years presents significantly more risk than one with stable or growing revenue.
Collection Rate
What percentage of production is actually collected? Healthy practices collect 95% or more. Lower rates may indicate fee schedule issues, insurance problems, or patient collection challenges.
Overhead Ratio
What percentage of collections goes to expenses? Typical dental practice overhead runs 55% to 65%. Higher overhead reduces your profitability and may indicate inefficiencies.
Owner Compensation
What does the owner actually take from the practice? Normalize for owner salary, benefits, personal expenses run through the practice, and any family members on payroll.
Critical insight: Tax returns often understate practice income because owners run personal expenses through the business. Your CPA should help you identify add backs and calculate the true owner benefit you can expect post acquisition. Learn more about how practices are valued.
Patient Base Analysis
The patient base is what you are really buying. A practice is only as valuable as its ability to retain patients and generate ongoing revenue after the ownership transition.
Patient Data To Request
- Total active patient count (patients seen within 18 to 24 months)
- New patient counts by month for the past three years
- Patient attrition rate (percentage leaving annually)
- Patient demographic breakdown (age, geography)
- Insurance payor mix breakdown (percentage by payor)
- Hygiene recall percentage and reappointment rates
- Average production per patient
- Patient source analysis (referrals, marketing, insurance directories)
- Unscheduled treatment report (pending treatment acceptance)
What The Numbers Tell You
Active patient count determines the practice's capacity and growth potential. A practice with 1,500 active patients has a different value proposition than one with 800 patients, even if current collections are similar.
New patient flow indicates the practice's ability to replace natural attrition and grow. Practices need 20 to 40 new patients per month depending on size to maintain stable patient counts. If new patient numbers have declined, understand why before assuming you can reverse the trend.
Payor mix affects both profitability and practice value. A practice with 70% PPO patients has different economics than one with 50% fee for service patients. Heavy Medicaid dependence presents reimbursement and patient demographic considerations.
Patient Concentration Risk
If a significant percentage of revenue comes from a small number of patients (common in specialty practices) or a single large employer group, losing those patients post sale could dramatically impact your returns. Identify any concentration risks and factor them into your valuation and transition planning.
Equipment And Technology Review
Equipment condition directly affects your capital requirements after closing. Outdated or failing equipment means you will need to invest significant capital beyond the purchase price.
Equipment Due Diligence
- Complete equipment inventory with ages and model numbers
- Maintenance records for major equipment
- Service contracts currently in place
- Recent repair history and costs
- Digital radiography system age and condition
- Practice management software and licensing status
- Imaging equipment (panoramic, CBCT, intraoral cameras)
- Sterilization equipment condition and compliance
- Operatory equipment age and functionality
- HVAC, plumbing, and building systems condition
- IT infrastructure and cybersecurity status
- Any equipment under lease or financing (verify transfer terms)
Consider hiring a dental equipment specialist to inspect major systems if you have concerns. The cost of an inspection is minimal compared to discovering after closing that the compressor needs replacement or the panoramic unit is failing.
Operatory Age
Dental chairs and delivery systems typically last 15 to 20 years with proper maintenance. Units approaching or exceeding this age may need replacement within your first few years of ownership.
Technology Currency
Is the practice using current technology (digital x-rays, electronic records) or will you need to invest in modernization? Factor upgrade costs into your total acquisition budget.
Staff And HR Review
Staff continuity significantly affects transition success. Patients often have stronger relationships with hygienists and front desk staff than with the owner dentist. Losing key staff during transition can trigger patient attrition.
Staff Information To Request
- Organization chart with all positions
- Employee roster with tenure, roles, and compensation
- Benefits summary (health insurance, retirement, PTO)
- Employment agreements or offer letters
- Any noncompete or confidentiality agreements
- Personnel files (with appropriate privacy protections)
- Payroll tax compliance documentation
- Workers compensation history and claims
- Employee handbook and policies
- Credential verification for licensed staff
- Training and certification records
- Any pending HR issues or disputes
Key Staff Considerations
Tenure and stability. Long tenured staff generally indicates a healthy work environment and provides continuity for patients. High turnover may signal management issues or compensation problems.
Compensation benchmarking. Are staff paid at, above, or below market rates? Underpaid staff may leave after the sale for better opportunities. Overpaid staff may expect you to maintain above market compensation.
Key person dependency. Is there a hygienist or office manager whose departure would significantly impact operations? Identify key personnel and develop retention strategies.
Seller's role. How involved is the seller in day to day operations? If the seller handles all patient relationships and clinical decisions, the transition risk is higher than if capable staff manage most operations independently.
Legal And Compliance Review
Legal due diligence identifies liabilities that could transfer to you as the new owner and compliance issues that could create problems post closing.
Legal Documents To Review
- Entity formation documents (articles, operating agreement, bylaws)
- Business licenses and permits
- DEA registration and controlled substance logs
- State dental board licenses for all providers
- Malpractice insurance policies (current and historical)
- Any pending or threatened litigation
- Any dental board complaints or investigations
- HIPAA compliance documentation and policies
- OSHA compliance records
- Insurance contracts and credentialing status
- Vendor and supplier contracts
- Equipment leases and financing agreements
- Any liens, judgments, or encumbrances
- Corporate minute books and resolutions
Litigation And Board Complaints
Any pending malpractice claims, dental board complaints, or litigation must be thoroughly investigated. Understand the nature of the claims, insurance coverage, and potential outcomes. In asset purchases, most liabilities stay with the seller, but reputation damage and ongoing regulatory issues can affect the practice you acquire.
Insurance Credentialing
If the practice participates in insurance networks, verify the credentialing status and understand the process for transferring or obtaining new credentials. Some insurance contracts are assignable while others require you to apply as a new provider. Gaps in credentialing can significantly impact revenue during the transition period.
Need Help With Due Diligence?
A systematic due diligence process protects your investment. Get guidance on what to look for and how to structure your investigation.
Schedule ConsultationReal Estate Evaluation
Whether the practice owns or leases its space, real estate is a critical component of the transaction. Location affects patient access, and lease terms can significantly impact practice economics.
Leased Space Due Diligence
- Current lease agreement (complete document with all amendments)
- Remaining lease term and renewal options
- Current rent and escalation provisions
- CAM charges and other additional rent
- Assignment and sublease provisions
- Landlord consent requirements for sale
- Personal guarantee requirements
- Exclusive use provisions (dental only)
- Tenant improvement ownership
- Maintenance and repair obligations
- Insurance requirements
- Default and termination provisions
For leased practices, the lease is often the most critical document in the transaction. An unfavorable lease can destroy practice economics, and a lease that cannot be assigned or renewed can make the acquisition worthless. Review our guide on commercial lease negotiation for dentists for more detail.
Owned Real Estate
If the practice owns its building or condo unit, real estate due diligence expands significantly. You may purchase the real estate as part of the transaction, lease it from the seller, or negotiate a separate arrangement. Key considerations include property condition inspection, title search and insurance, environmental assessment if warranted, zoning and use compliance, and property tax history.
Many buyers prefer to lease from the seller initially rather than purchasing real estate. This reduces upfront capital requirements and lets you evaluate the practice before committing to the property. See our lease vs buy analysis for more guidance.
Red Flags To Watch For
Certain findings during due diligence should trigger heightened scrutiny or potentially cause you to walk away from the deal.
Declining Collections
Multiple years of revenue decline suggests fundamental problems with patient retention, competition, or practice management that may not reverse with new ownership.
High Owner Production
If the owner produces 80%+ of revenue with minimal associate or hygiene production, transferring that production to you post sale is high risk.
Staff Turnover
Frequent staff changes, especially in key positions, may indicate management problems, compensation issues, or a toxic work environment.
Lease Problems
Short remaining term, unfavorable renewal options, or landlord unwillingness to consent to assignment can make the acquisition impractical.
Pending Litigation
Active malpractice suits or board complaints create uncertainty and potential liability, even in asset purchases where liabilities theoretically remain with seller.
Deferred Maintenance
Aging equipment, deferred repairs, and outdated technology mean significant capital investment beyond the purchase price.
Financial Irregularities
Inconsistencies between tax returns, financial statements, and production reports suggest either poor record keeping or intentional misrepresentation.
Seller Reluctance
Delayed document production, incomplete responses, or unwillingness to provide reasonable information access may indicate hidden problems.
Remember: Finding problems during due diligence is not necessarily a reason to terminate the deal. Many issues can be addressed through price adjustments, seller representations and warranties, escrow holdbacks, or specific contractual protections. The key is identifying issues before closing so you can make informed decisions and negotiate appropriate protections.
Due Diligence Timeline
Organize your due diligence process to ensure thorough investigation within the timeframe specified in your LOI or purchase agreement.
Typical 45 Day Due Diligence Timeline
Build buffer time into your timeline. Document requests often take longer than expected, and issues that arise require time to investigate and resolve. If your LOI provides 30 days for due diligence, you may need to request an extension if significant issues emerge late in the process.
