31 May 2023
Warning to dentists selling practices
Corporate closing partially owned practices and leaving dentists holding premises lease obligations
A number of dentists who sold majority equity in their practices have subsequently experienced the closure of the practices but have been left holding the lease obligations to practice landlords!
It is vital that if selling all or a majority stake in a dental practice that all leasing and financial obligations be transferred with the transaction in “even dated” contracts signed simultaneously. Do not trust a corporate to complete subsequent lease assignments or other outstanding matters.
Many dentists have accountants and solicitors who simply are not a match for corporate tricksters who buy up a series of practices, but at a sign of weak trading close some of them and walk away from premises leases and other obligations. This leaves contractual lease obligations with the dentist who sold the practice or a majority stake in the practice to them. Be very careful who you deal with!
Some corporates cannot be trusted to cement handshake deals into contracts and leases are not assigned making it easier for the corporate to walk away at a sign of weakness in trading.
Beware lawyers and accountants with negligible experience of dental contracts
Regrettably many dentists have accountants who are not aware of the pitfalls or family solicitors with nil or insufficient expertise in dental contracts with corporates. Most family solicitors survive on house conveyancing and administering wills. Others in larger firms which have differing client bases pretend that they understand dental clients but cause multiple delays while they learn about dental structures and dental contractual pitfalls on the job. Their dental clients have to pay for their delays and suffer their negative impact on buy/sell transactions. While I am under no obligation to recommend any solicitor or other professional adviser, a solicitor who has advised a multitude of dentists and veterinary practice owners known to me is Clair Whitehead 0421 338 0262.
Practice brokers be careful
Persons known to dentists for past activities are able to reinvent themselves as dental practice brokers but may be too closely associated with dental corporates. They may be able to get dentists what appears to be a good sale to a corporate but be insufficiently concerned at contractual oversights. Many dentists are naïve in these matters, most only ever being involved in a single practice sale transaction.
The Smiles Inclusive Ltd disaster demonstrated the pitfalls of practice owners selling a majority share of their practices and retaining a minority interest. As Smiles Inclusive traded at a loss, the minority shareholders never received an income related to their minority equity nor were they paid for its capital value and suffered the most as Smiles fell into inevitable insolvency.
Don’t assume that all dental corporates have significant financial backing! Nor that they are well managed.
Be aware that some practice brokers have backgrounds as significant figures in dental corporates. They may view their quickest path to a sale commission as introducing a buying opportunity to a corporate mate, if a sale turns out badly they blame the dentist’s solicitor or accountant who had scant understanding of the risks involved.
Some corporates have insufficiently robust finances and as history demonstrates poor management. Some have been far too optimistic concerning dental aggregation only to realize too late that running a large number of practices profitably has proven far more difficult than they realized. Decline into unprofitability leads to drastic actions to close some practices. Practice closure is easiest where they are able to walk away from lease obligations. A lease to the corporate with a long period to run until a renewal point offers protection as it will likely to be well down the list of practices at risk of closure.
Jon Adgemis’ roll up of off-Broadway pubs and hostels under crushing debt burden
According to the Australian Financial Review of 22 May 2023 Jon Adgemis/Public Hospitality Group (Public) pub and hospitality aggregation is being crushed by over $500 million of mostly short-term debt taken on from non-bank sources at usurious interest rates. The amounts of borrowing and detail of the information disclosed in the AFR article is striking. The most likely explanation is that somebody very close to Public/Adgemis has done a great deal of research and spilled the information to the AFR’s Rear Window journalist, who in turn has done sufficient examination of the evidence in the form of mortgage searches to verify it. This might be a lender who has discovered that the value of their security is a great deal less than the amount that they have loaned? Or that the financial situation of the borrower is much worse than they thought, or somebody with some other motive to call out Public such as applying additional pressure in a negotiated loan work-out situation.
According to the figures in the AFR article, Public’s identified debt is over $500 million, much of it at interest rates of 20 percent, and some at 30 percent—followed by an increase to 45 percent! It paid only $280 million for the twenty properties in the portfolio, sixteen of which were purchased between 2020 and 2022. The Group has spent or has indicated that it is spending $125 million on renovations.
$280 million of acquisitions and, perhaps, $125 million of renovations adds up to $405 million. The group also admits to having racked up $95 million of interest payments, far more than possible rental income. According to the AFR, Public has over $500 million of debt registered against the titles of its properties! This is in addition to $15 million of convertible notes held by Thorney Investment Group and Gleneagle! It strains the imagination as to how the enterprise could possibly have any net equity in the properties. Its claimed valuations which total $750 million raise questions as to the competence of some of the valuers, the veracity of tenancies proffered to valuers and the gullibility of greedy investors lending on the basis of Information Memorandums (IMs) produced by irregular lenders who are loan syndicators to those classified as professional investors. The IMs are not subject to the regulatory rigors of prospectus’s and indeed some prospectus’s have been found wanting.
Public financed various purchases using valuations vastly higher than purchase prices to borrow huge sums of money from secondary financiers who in turn raise their funds from professional investors via IMs. This investment avenue is open to ‘professional investors’ who forgo the normal prospectus protections when seeking extremely high interest yields on money invested. Professional investors are classified as such by the magnitude of their wealth or their annual income as specified by their accountants. They seek returns of 20 percent or greater, but can only achieve those interest rates by lending to borrowers who cannot obtain finance from the normal banking system. This lending is at high risk of failure—hence the huge interest rates.
According to the AFR, of Public’s twenty properties fifteen are mortgaged twice and three have triple mortgages! In each case it would be normal for the holder of a registered first mortgage to have first call on the asset in a ‘mortgagee in possession’ situation. Given the magnitude of debt and the impact of rising interest rates the ability to on-sell the properties at sufficient price to cover all debts is challenging, particularly as interest payments of around $7.5 million per month are mounting. When markets realize that assets are debt distressed, potential buyers become tough negotiators and sometimes assets pass into the ownership of mortgage holders at bargain basement prices.
What drove Public to this position?
Sometimes a string of like businesses—or in this case hotels/hostels—have a higher collective value than the sum of the parts, particularly if a group is large enough to contemplate a stock market listing. Australia’s hotel barons have long since captured the hotel/pub crown jewels across Australia. What was left were properties they would not consider worthy of investing in. It was also necessary to spend substantial sums on refurbishment. Mainstream lenders have conservative lending criteria and insist on valuations done by valuers on their approved lists. That apparently drove Public to the secondary lending market, taking loans at enormous interest cost. Possibly some of the valuers used were not on banks approved lists. It is likely that Public expected to rapidly refurbish the group’s properties and on sell as a substantial portfolio but has been caught out by changing economic circumstances.
Courageous valuations and internal leases!
Some of the valuations of Public properties defy logic. Valuer Egan signed off a valuation of $58 million for a ‘shabby’ apartment block in Sydney’s Darlinghurst three weeks before Public purchased the property for $23 million! The Egan valuation was based on two companies, both owned by Public! Signing leases to pay an extraordinary $2.7 million in annual rent before refurbishment— i.e. Public was tendering leases to itself as a basis for a valuation $35 million above what it was paying. Such valuations tended to secondary lenders for quotation in their information memorandums to professional investors appear to have been greatly optimistic and would not withstand a searching analysis! This is not the only transaction of this nature.
Now that so many adverse facts have been reported, potential buyers of properties owned by Public will be doing detailed due diligence of the owners of corporate tenants in the properties and their financial standing. Publicity in the AFR and on the internet are likely to have blown the chance of Public on-selling recently acquired properties at elevated prices and caused lending sources to evaporate.
A possible scenario
Secondary mortgage holders have been known to buy out the security of a primary mortgage holding lender in order to gain control of the mortgagee in possession process. In such cases they may then choose to let their interest accrue at extremely high interest rates until it matches the realizable value of the property and any additional amount that they judge that they can squeeze before foreclosure. It is likely that various secondary mortgage holders are contemplating actions to preserve as much as possible of their capital after milking their interest payments to where they perceive is the critical point. This scenario is, of course, conjecture on my part. Nor do we know who all the primary mortgage holders are nor all of the secondary and tertiary mortgage holders. As so many details have been discovered by the AFR a possible explanation is that one, or more than one lender, acting together, have determined that it is in their financial best interest to spill the story thereby pressuring those in the lending chains to take actions to rescue as much of their loans as is possible. Some lenders finance will have been used paying operating expenses including interest payments to other lenders. Each separate mortgage holder will be assessing its amount of money at risk relative to others. A resulting rush not to be the last lender left standing with least security might see some or all of the properties passing to mortgagees in possession and Public Hospitality Group wound up. It will be interesting to observe from afar whether Mr Adgemis can pull off a massive financial rescue of the group. Given the leaking of the overall financial exposure of the group a financial rescue appears to be extremely difficult! The relative strength and bargaining leverage will vary among lenders.
Another scenario is that an outside party wishes to acquire particular properties and intends forcing their sale by increasing the financial stress. The amount of publicity will have significantly eroded the ability of Mr Adgemis to engineer an overall financial rescue of Public.
Remember how the Bond empire was destroyed!
I am reminded of the historical example of the debt laden corporate empire of 1980s entrepreneur Alan Bond being placed under enormous pressure by African-born British entrepreneur Tiny Rowland. Rowland in an act of revenge hired a team of corporate accountants to review the Bond empire’s accounts from top to bottom. Their report, distributed to every financial journalist in Australia, exposed the group as being insolvent and set a series of events in motion as lenders forced sales at distressed market values leading to the implosion of the Bond Group.
We may never know who the largest losers among lenders to Public turn out to be. The quickest and most ruthless among them will lose least and may even escape without loss. Some “professional investors” who loaned large sums are at risk of large losses but may be unlikely to expose their naivety to the public. Losses may trigger secondary legal actions against some of the loan aggregators and valuers, if indeed any can be found with significant unprotected assets.
For general interest only. I definitely would not go near those involved, but have commented because of the substantial lessons it provides to investors.
Financial Success for Dentists
Financial Success for Dentists: Rules for How to Approach Your Dental Career sets out the key strategies which make dentists successful. It is specifically written for those dentists and dental specialists owning their own practices and for those aspiring to own practices. Among the topics included:
Understand key practice valuation criteria.
Learn how some dentists inadvertently reduce the value of their practice by $500,000
Avoid long term errors when purchasing your practice.
There are many accountants, financial advisers, marketing consultants, web site designers and practice advisers who give advice from their particular disciplinary experience, but very few have the wider breadth of experience to define for their clients the key rules to follow to optimize their practice and their long-term financial outcomes. An otherwise competent financial adviser may have little understanding of what makes one practice much more successful than another. Many accountants have detailed knowledge of the taxation rules but cannot identify if a dental client has broached invisible barriers to practice growth or a threat to practice goodwill value.
I spent 33 years examining dental practice financial outcomes and reviewing the key strategies and decisions which separated successful Australian dental practices and practice owners from the less successful and this led to relevant conclusions and advice to dental practice owners.
A complete and comprehensive career guide for mature and aspiring dentists. Based on real life situations and a lifetime of dealing with dental practice ownership outcomes this book is worthy of Text Book status for every dental teaching school.
—Merv Saultry, Founder Dental Innovations Network
To Obtain a Copy:
Go to the Delany Foundation website at http://www.delanyfoundation.org.au
Click on the Donations tab and make a donation of minimum $60. This is easiest by Mastercard or Visa.
Email graham.george.middleton@gmail.com confirming that your donation has been made, as well as your name and mail address
A copy of the book will be mailed directly to you
All production costs and mail costs are met by me personally, so all money donated goes to the Delany Foundation which contributes toward the running of schools in Ghana, Kenya and Papua New Guinea. Naturally donations above $60 are welcome.
The donation to obtain this publication will be the most cost-effective practice advice most dentists will ever receive.
Please Pass On
If you like these newsletters, please pass them on to colleagues. Past newsletters and articles in Australasian Dental magazine on business issues are at grahammiddleton.com. I can be contacted directly at graham.george.middleton@gmail.com
Independence And Disclosure
I am not a representative of any accounting practice, financial planning firm, business or marketing consultancy. I spent 33 years as a business and financial adviser to mainly dental, medical and veterinary specialist and general practitioners. Since I retired as a director of a financial services group, of which I had been a founder, on 30 June 2020, I am no longer licensed as an investment adviser. Readers should treat the above as general advice and take professional advice as required.
General Advice
The above is ‘general advice’ and individuals are urged to undertake considerable personal research of companies in which they are investing as well as demanding of their advisers that they tailor advice toward their best outcome after demonstrating an understanding of their position in detail. Be cautious about accepting advice unless you are certain that your adviser has a thorough knowledge of your situation. If in doubt the best decision is often to make no investment changes.
I sold my interest in a financial services and accounting group on 30 June 2020 and have no intention of starting another financial services business. I own, via my family superannuation fund and investment portfolio, some of the stocks mentioned in this newsletter. My website is now available at grahammiddleton.com.
Those who find my newsletters of value to them are asked to consider making a donation to the Delany Foundation, a registered charity which assists schools in Papua New Guinea, Ghana and Kenya. Delany Foundation c/- Holy Cross College, 517 Victoria Road Ryde NSW 2112.
Best wishes to all readers
Graham Middleton
