Beware the Numbers Game

Here are a few key components of what I’ve been seeing recently in the private equity space, particularly in real estate and dental practice sales.

The Game Private Equity is Playing

Private equity thrives on promises: high valuations, enticing upfront payments, and projections of future profits. However, what looks like a win-win on paper often conceals risks that could erode your long-term financial stability.

Here’s a typical scenario:

1. The Offer: A private equity firm offers to buy your practice or building at a seemingly generous valuation, often above what the private market would pay. For example, I recently spoke with a doctor who was offered $1 million for their dental practice previously valued at ~$700,000.
2. The Catch: Instead of paying the full amount upfront, a portion of the payment (sometimes 50% or more) is deferred and placed in their “fund” with the promise of high returns or a payback after they’ve refinanced in a couple of years.
3. The Leaseback: When the real estate of your practice is involved, like in this scenario, you may be required to lease the property back at higher-than-market rates, locking you into a long-term financial commitment.

While these deals are pitched as lucrative, they are often structured to benefit the buyer more than the seller.

The Risks You Must Consider Before Selling

1. Overstated Valuations

Private equity often inflates the stated value of assets, such as your practice or building. They may offer $1 million for a $700,000 building but only provide $500,000 upfront, with the rest tied to speculative fund performance.

The actual sale is less favorable when accounting for high rent obligations and limited control over deferred equity.

Actionable Advice: Compare their valuation to independent appraisals. Consult a commercial real estate broker to ensure the offer aligns with true market value.

2. Leaseback Traps

A common strategy involves purchasing your property and leasing it back to you. While this might free up capital, the lease terms may include:

• Above-market rents. In the example above, the doctor was told it would be $8,000 per month when the market rate was only around $4,000.
• Triple net leases (NNN), where you bear all additional costs, such as property taxes, insurance, and maintenance.
• Escalators tied to inflation indexes increase your financial burden over time.

Over a 10-year lease, you could end up paying more than the total purchase price of the building.

Actionable Advice: Compare the lease terms to local market rates. Factor in long-term costs before accepting any sale-and-leaseback arrangement.

3. Deferred Payments and Retained Equity

Private equity often defers part of the payment into a pooled fund, promising higher returns in the future. However, returns are uncertain, particularly in today’s high interest rate and inflationary environment. 

You also lose control of the asset while remaining tied to their performance metrics.

Actionable Advice: Ask yourself, “What will I do with the upfront cash? Can I earn a better return on my own?” Be skeptical of long-term promises and ensure any deferred payment is clearly outlined and guaranteed.

Key Questions to Ask Before Accepting Any Deal

1. What is the true market value of my asset?
2. What are the lease terms, and how do they compare to market rates?
3. How secure are the promised returns on deferred payments or retained equity?
4. What will I do with the upfront cash, and can it outperform my current asset’s value?
5. How will the deal impact my long-term financial health and cash flow?

Playing the Long Game Requires a Team

Private equity firms are masters at structuring deals to their advantage. Their success hinges on your willingness to accept valuations and terms at face value. The key takeaway, however, is not to avoid private equity entirely or have a negative view of them. It’s to approach any deal with a critical eye, reading into the paperwork, the numbers, and the impact of your decisions on your future.

There’s a saying that goes, “If you want to go fast, go alone. If you want to go far, go together.” Private equity is playing the long game. That’s why they have an army of attorneys and number crunchers.

Where is your team? You don’t need an army. You just need a trusted few. Consult professionals—commercial real estate brokers, CPAs, attorneys, and mentors—who can help you navigate the numbers game.

Doing this ensures any deal you enter truly aligns with your long-term goals. Remember, the smarter money is always playing the long game. So should you.

Stay vigilant, ask the hard questions, and protect your assets.