Using readily available accounting software programs, such as QuickBooks, Peachtree, Microsoft Money and others, it's very easy to keep multiple sets of books. With only a few mouse clicks and a calculator, an unscrupulous seller could easily design and show you a healthy looking profit and loss statement that, in reality, represents a very sick practice. As President Reagan once said, "Trust but verify." In this case, that means to verify entries on a profit and loss (P&L) statement with bank statements, cancelled checks, signed tax returns, etc.

While I've written before about the pitfalls of published benchmarks, this is one time they can be helpful. For example, if the seller wanted to inflate his net, he would need to add extra, false income from somewhere else. Let's say he decreased his cost-of-goods-sold (COGS) in order to do this. COGS can vary widely between practices, but they are typically in the 20% to 40% range. If you see a practice net of 50% and a corresponding COGS of 10%, skullduggery is probably brewing in those books.

Another practice-selling trick to watch out for: Some sellers may artificially decrease labor costs as a way to artificially inflate their net, and they dismiss this action by saying, "I paid some people off the books with cash." This may not only speak to the integrity of the seller, but it also makes assessing the relationship between labor, net and sale price much more difficult.

Altered or hidden leases

I've commonly seen sellers not disclose outstanding equipment leases or other loans. Some of these were not visible on profit and loss statements because they were paid (sporadically at best) from another, undisclosed bank account. To avoid getting stung by this, make sure your purchase agreement acknowledges that any undisclosed outstanding bills, loans, leases or similar items are the responsibility of the seller.

No matter how well you plan for it, buying a practice is stressful. I can't stress enough the importance of taking your time and working with experts to avoid not only buyer's remorse, but financial disaster. Make absolutely sure to have a qualified, experienced appraiser examine the practice. And finally, be aware that many who proclaim themselves as appraisers are not, and using their services may put you at even higher risk. For example, a practice broker who represents the seller may have done the appraisal. The broker has a financial incentive to inflate the appraisal price. Overpaying for a practice is a sure way to get off to a bad start, as cash flow will be markedly reduced — or in some cases — non-existent. In fact, many lenders are now requesting that only appraisals done by certified appraisers be submitted when applying for financing for the practice purchase.