When people talk about the valuation of dental practices, there is a lot of jargon thrown around. As is generally the case, the jargon makes it sound harder than it is. Simply stated, dental practice valuation is a determination of the value of your practice. The valuation is important because of what it communicates to parties either interested in or involved in a dental practice transition. Before you can start selling a dental practice, you need an idea of what it’s worth.
The fact is, you want to get as much as you can out of your dental practice. You can set the price as high as you’d like, but, more realistically, you need to find that point at which you are getting the most for your practice within the range of what a buyer in willing to pay. Valuation methods are simply a means to get, as much as is possible, an “objective” value in order to begin negotiations with a buyer for the final sale price and terms.
To help you along, we’re going to answer a few questions about practice valuation. A little general knowledge can go a long way toward understanding what your accountant, business valuation consultant, and practice transition specialist will tell you about the value of your practice.
Why You Need a Dental Practice Valuation
People tend to overvalue their own assets. Not out of any kind of bad intent, but simply because our estimates are based on the value of the asset to us: what we paid for it, what we’ve put into it, what it means to us psychologically, the role the asset has played in our lives. All of these things affect how we see it. By having a third-party business valuation consultant assess and value your dental practice, you are starting with a value that has a greater degree of objectivity. Meaning that the value is one that outside parties can agree on, based on factors that matter more universally and less subjectively.
Having a more objective sense of the value of your dental practice can be useful for a number of reasons. It can give you a sense of what you can expect out of the deal. Meaning that you can project how much money you will walk away with and can determine whether your practice is really ready to sell. If the valuation comes in at or higher than what you expected, that’s great. If it comes in lower, you have the opportunity to consult with your advisors about investments to boost value before you put your dental office for sale.
When you are selling a dental practice, the outside valuation gives you an asking price. The buyer, however, also benefits from the valuation. The buyer is looking to balance a fair price with a strong investment. The valuation can either be simply accepted by the buyer as the baseline for negotiation. Or if the buyer wants to use their own business valuation consultant, the consultant will be verifying the accuracy of the valuation that is already done. In either instance, the valuation you provide is the starting point.
The methods for practice valuation is the same whether you have a general dentistry practice or a specialist practice. The difference, however, is in the risks associated with each of the different practice types— the number of patient cases, the stability of your referral base, etc. Because of this, you want to be sure your financial advisors and business valuation consultant has dental industry experience, so they know how to assess these factors.
How to Determine the Value of a Dental Practice
While the real work of valuation will be done by an accountant, it can be helpful to have an understanding of the methods and theories of dental practice valuation before you get too far down the road of selling a dental practice. Valuation relies on a combination of the following accounting methods:
Capitalization of earnings: this method takes the last three to five years of earnings, averages them, and divides that number by the capitalization rate. Earnings is typically defined as collections (not production but what you are actually paid) less overhead. This is basically the rate of return. It also identifies the risk to a buyer. The capitalization rate will be influenced by factors including A/R, patient flow, treatment planning, and staffing, so, again, you really need someone with a deep understanding of the dental industry and practice management in order to get a reliable number.
Discounted future cash flows: this method estimates your practice’s future cash flow, indicating to the buyer whether it’s really a good investment or not. The value is found by determining the annualized earnings (this is the actual income and expenditures of the practice for a particular period multiplied by the ratio of 12 to the number of months in the period; for example, if annualizing the income for the period January 1 through May 31, multiply the income for the period by 12 divided by 5, or 2.4), subtract the average individual tax rate, and then divide by the discount rate. Then, five years of future earnings are projected at a set growth rate (which is usually the baseline inflationary rate based on current trends) and averaged.
Comparable sales method: in a very basic sense, this method simply considers the sale of similar practices. This is similar to how residential homes are valued. With dental practices, this method considers a percentage of the revenue, perhaps a three-year weighted average, and multiplies it by 55-75%, depending on factors unique to the dental practice.
Summation of assets method: this method is simply determining the value of the tangible assets (equipment, furniture, building or lease, materials, etc.) and adding it to the intangible asset of goodwill.
A dental practice business valuator may take the numbers from each of these methods and combine them using a weighted system. How they are weighted will depend on an assessment of the actual practice and the informed opinion of the business valuation expert. Again, it is essential that your consultants have dental industry specific information or you risk the valuation being unreliable.
Note that what is not considered in any of these methods is past performance of your dental practice. A business valuation expert is not simply going to look at the history of your profit and loss statements and pick a number in line with those. They are more interested in performance trends overall, along with other factors not reflected on a balance sheet, such as the age of the practice and its assets, overhead percentage, and accounts receivable.
What Happens After Valuation?
When selling a dental practice, valuation is merely the starting point, not an end unto itself. The valuation gives the seller of a dental practice the information they need to set a listing price and begin marketing the practice. For the buyer, the valuation gives them the information they need to decide whether to pursue purchasing the practice at that price, to begin negotiations on price, or to look for another practice to purchase. Often, the value of a practice as determined by the business valuation expert is not the price it sells for. The terms of the deal, including seller carryback, contingent part of the sales price, and a split of price to determine long- and short-term capital gains, can influence the practice’s price.
How to Choose a Dental Practice Valuation Expert
Any accountant can look over your financial and tax records and stick a price tag on your practice. For that number to be reliable, however, you need a CPA who really understands the dental industry and all of the factors that make dental practices run. Specifically, you need a CPA with a specialization in dental practices. In addition to valuing the practice, a dental-specific CPA can offer additional assistance in areas such as structuring the transaction in the most advantageous format, obtaining financing, and minimizing tax exposure. If you are selling a dental practice and don’t already have an accountant with this level of expertise, ask your dental practice transition specialist for a referral.
Selling a Dental Practice? DDSmatch Southwest Can Help!
As part of our process, we consult with you about your goals for your practice transition, the local dental practice transition market, establish the best transition options for you, and advise on improvement and investments that can boost your practices value. If you are considering transitioning your practice in the next five years, we’ll provide a free, no-obligation Practice Transition Assessment address each of those issues. Contact us today and find out what we can do for you.
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Your practice can benefit greatly from adding an associate at the right time. Remember that by adding an associate you are redirecting some of your revenue stream, which may impact your take-home pay. Matt explains “there’s a lot of variables at play here, typically we like to see over a million dollar collection practice, in general, that way that there’s plenty of room from associate to come in and inherit some of that revenue stream.” (See the full webinar below on this page.) Dentists who want to scale back their hours or take care of patient backlog before it becomes a customer service issue should consider adding a dental associate to keep their revenue steady and grow the practice. An associate can fill in the gaps and allow the owner to either take a step back or focus on other parts of the practice. Meet with a professional dental CPA and a dental broker to talk over your specific numbers and decide if you and your practice will benefit from an associate.
How an Associate Figures Into Retirement
As a solo practitioner, you have spent years building your practice and should be able to sell it for an amount that reflects that work. When retirement is five or more years away, adding a dental associate can be a right decision. According to Matt Howard, “A decreasing revenue stream in the valuation world is not exactly ideal. What we like to see is [the practice] either consistently growing by inflation or at least steady in the collection perspective.” This means growing your practice in the years before retirement is a good strategy and will allow you to sell your practice for a higher price. But what if you want to ease out of practice and into retirement by cutting back on your hours now? That is where adding an associate can benefit you. Your associate can keep up with current patients and even bring in new business while you scale back. Another option we often see is to bring in a new doctor as an associate a few years before you plan to sell the practice to them. Dental Economics posted an article explaining that these few years will provide “time to increase the associate doctor’s productivity and practice management skills necessary for a successful transition.” If you are nearing retirement, especially if it is five or more years away, talk to a DDSmatch Southwest broker now so you can decide which path to choose and start planning now.
How Much Will an Associate Cost?
It goes without saying that bringing in an associate will redirect your revenue stream. As a business owner, you need to decide where that will come from. Matt Howard suggests collections of over $1 million, so you have plenty of revenue to work with before hiring an associate. Compensation can vary, but Matt explains that commonly, “[the associate] might get some sort of guarantee the first year [then] move into some sort of production or collection-based compensation after the first couple of months or even maybe after a year at the most.” A dental CPA can help you look at your practice’s finances and decide if you are ready to add an associate and what type of compensation deal is right.
Adding a Dental Associate for Customer Service
Dentists who have built a thriving practice and as a result have patients booked out months in advance should consider the customer service implications of how long a patient has to wait for their appointment. If your practice is booked for weeks or months, your patients might not be willing to wait around and instead will choose another practice. According to Matt, “if you’re booked two to three months out that’s not very good patient service quality for your patient, so you need to come up with a constructive way to service them quicker” which will result in a better experience. An associate can help address a backlog of patients and shorten wait time for new patients wanting to make their first appointment.
How to Find an Associate
If you’re thinking about adding a dental associate, whether you need to address the backlog, reduce your hours, or are preparing for retirement, talk to the professional dental brokers at DDSmatch Southwest. We can help you decide what is the best path forward for your specific needs and wants. When you’re ready to add someone to your practice, we will find you the perfect match and ensure a smooth transition. DDSmatch Southwest specializes in dental practice transitions including buying, selling, and adding an associate, so schedule your consultation today.
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RK: Randy Kinnison with DDSmatch Southwest, just wanted to thank you for being with us today and answering a few questions that we’d like to share with our potential clients and customers. If you would just please introduce yourself and kind of describe the relationship that DDSmatch has with Blue & Co. and the business valuations that you guys prepare for us.
MH: Good morning Randy, and thank you for the time. I’m Matt Howard with Blue & Co. I lead our business valuation team. We do approximately over a hundred dental evaluations a year for DDSmatch and other dental needs. We’ve just really carved out a nice niche in it and have a lot of fun with it. I am a dental CPA and also an accredited business valuator and a certified valuation analyst. So, I have certain credentials that are specific to valuation. Our relationship with DDSmatch Southwest is, we are the third-party, non-biased valuator that comes in and gives you a true market test for what your practice is worth at the date of our valuation. We’ll be looking at the practice from an industry perspective trying to help both seller and buyer know what a true fair market value price is for the practice.
RK: Thank You, Matt. Just describe a little bit about the BV [business valuation] and what it entails. I know the first part of the business valuation always has the historical numbers of the practice as well as the performance. So, if you would just tell us a little bit more about the BV and what it entails.
MH: Certainly. With any small business or personal service company, the biggest noise in the practice would be the owner’s noise. What I mean by that is anything that’s inside the practice that is not necessarily operational or is basically something that the owner has decided to do at the practice that doesn’t exactly reflect the operations of the practice. A lot of times a seller will own the building, and in owning the building, they’ll pay themselves a lease rate for that building. Sometimes, that isn’t a market rate. And sometimes, it’s a little bit above; sometimes, it’s a little bit lower. Our job in this process is to really work through the practice to make sure it shows the historical financial statements. Basically, we help sanitize or normalize the numbers as we see them and as the true operations of the practice are reflected. So, our part in the valuation process is we will collect data. We’ll go through the data. We’ll enter it into our models. We’ll ask very specific questions about that data about maybe aberrations and the financial performance over time. Sometimes, a dental supply category jumps ten percent over a year. We want to really understand everything that’s going on inside the practice. Then as we go through it, we would release a draft document for discussion with the seller. That document would be completely … a conversation piece to talk about the variables that we took into consideration, the market effects that impacted the valuation price to really just helped you understand exactly how we came up with that number. And then after that conversation, with any input from the seller, we’ll move it to a final, and then that will be the piece to share with any potential buyers as they consider the practice.
AE: That’s great, Matt. Hey Matt, Andy Edmister here jumping on the call with you. I have a few more questions. Thanks for joining us today. Matt, when would you recommend a dentist start preparing for a sale? And, why would you recommend him at that time?
MH: Yeah, a great question. I wish it’s a question that a lot more sellers kind of investigated not the year before they’re considering the sale. So, some things to take into consideration is knowing yourself and knowing what your aspirations or your goals are for the practice transition. What I mean by that is, a lot of dentists will wait until they’ve slowed down some, and we have something called a decreasing revenue stream, that’s where the collections slowly over time have started to decrease. That’s just basically reflective of the seller or the owner wanting to start to slow down. There’s nothing wrong with that if that’s an intentional decision you want to make. Unfortunately, when we see that in an evaluation, and even when banks see that in our evaluations as they consider financing this for a buyer, it does have to be taken into consideration. So, a decreasing revenue stream in the valuation world is not exactly ideal. More of what we like to see is if they’re an immature practice that’s either consistently growing by inflation or at least steady in the collection perspective. So, as you understand who you are and what your goals are, I do think it’s an important thing to consider when to sell and maybe selling before we start decreasing your output or decreasing your hours. That’s the first key. I would say anywhere from five, maybe even a little bit over five years, would be a good time to meet with your DDSmatch Southwest broker and start discussing what you want to do in the future and what does that look like in your mind from an ideal perspective taking all the different desires that you have into consideration. They’ll be able to help you walk through when may be a good time to even bring in an associate; or maybe when it’s a good time to think about something; maybe a couple of years before you thought you would; just so that we don’t run into that decreasing revenue stream which would impact the valuation price.
AE: Okay, that’s great advice. Basically, to sum it up, keep your foot on the gas until you get through the evaluation and the transition of the practice to maximize the value of the dentist’s practice.
MH: Precisely, I couldn’t have said it better myself. Yes, trying not to minimize the fact that yes, you want to slow down; however, you also want a good price for your practice. Obviously, those two things go hand in hand.
AE: Okay, well, thank you. I’m gonna move on to another question. The question pertains to purchasing in a practice or doing a de novo or startup practice on your own. What do you see is the benefits of each or the cons of each; and what would you recommend to a new dentist client of yours.
MH: A great question. And, a question that comes up quite often. As a person coming out of school, the ideal part of buying a practice is the fact that you’re walking into cash flow day-one. What I mean by that is, you are paying a fair market value price for the practice; and then, you’re making money. You’re walking into, hopefully, a three hundred, four hundred, five hundred, and up thousand dollar collection practice which helps pay your bills day-one. That’s an obvious benefit of buying a practice. The problem with starting a practice is this: it’s a three to sometimes seven-year journey to maturity or average collections of a de novo. So basically, the first year you’re probably going to feed the business as in bring money to the table to keep it going as you build up that collection stream. The second year, you might break even or maybe pay yourself a little bit but definitely not up to industry standards. The third year, between the second and third years, during these startups is where we see you making some progress towards paying yourself a reasonable wage. Still probably not what you could get out being an associate at another practice. But you’re on your way. And then, that fourth, fifth, six, maybe up to seven years could get you, hopefully, up to average. An average is somewhere around nine hundred thousand dollars of collections, hopefully, dropping somewhere about to two hundred and fifty to three hundred thousand dollars bottom line. These are all guesses. Every marketplace is a little bit different. Every geography is a little bit different, but that’s just in general.
AE: Okay, well, good answer, thank you. I’m sure that will be useful for a lot of people watching. Next question. When would you recommend or what do you think is the best time for a dentist who is where he wants to be, but he’s not sure if he’s ready to bring on a new associate. What would a dentist do to say, “hey am I ready, or am I not ready to bring on the associate.”
MH: Again, a great question enough, and a complicated one sometimes. Every practice has a limited amount of resources, of ops, of time for the staff to not hit over time. So, there’s a lot of variables that play here. Typically, we like to see over a 1.2 million dollar collection practice, in general, that way there’s plenty of room for an associate to come in, inherit some of that revenue stream as the seller wants to back off a bit and transfer some of their patient-base over to the associate. Let’s just look at this from both angles. A seller wants to have an associate for the benefit of growing and continuing to serve the patient-base well. If you’re booked two to three months out, that’s not a very good patient-service quality for your patient. So, you need to come up with a constructive way to service them quicker and have a better overall experience for your patients. A lot of times that’s where an associate will come in. Therefore, you can help address the backlog and give to the associates. From the other angle, the associate has the ability to make money day one, not build up a new business inside of a practice. They might get some sort of guarantee the first year, but you’re gonna move them to some sort of production or collection-based compensation after the first couple of months or even maybe after a year at the most. It’s important that it’s a formula that doesn’t only work for the seller, but it also makes economic sense to the buyer. Typically, buyers these days have quite a bit of student loans that they need to address, so they need to make a certain amount inside the practice. Associateships work great if there are enough collections and the seller wants to slow down a little bit and maybe back off a day, and open up some collections to the associate. And then obviously, there’s a lot of other variables, but those are just some general thoughts.
AE: Okay, well that’s great. What kind of tools could you offer as part of DDSmatch Southwest? What could you provide to help dentists decide if they are ready for an associate or not on an analytical side just on the numbers besides a gut feeling and wanting to slow down.
MH: Yeah, that’s also something that we’ve seen over and over again coming up is, “am I a good candidate for an associateship? Does it make sense for my practice to do this?” So, what we’ve come up with is an associate IQ or quotient that helps walk you systematically through the practice with about ten different areas that we look at to make sure that it makes sense for the practice to bring this on. Does it make sense from the owner side? Does it make sense from the associate side? Some things we’ll look at is if you only have three ops, and you want to bring in two dentists a day, that does not make a lot of sense. After looking at a bunch of these different variables and intricacies of the practice, we will come up with a quotient of how you rate on a scale of 0-100 for being a good candidate for how many associates. We’ll walk you through the entire process. Does that answer your question, Andy?
AE: Yeah, I think that’s great, in that way, they can make an educated decision on where they’re at currently and if their business can support another dentist. But also, it shows them what they would need to do to grow to get to that point.
MH: Exactly, the last thing that anybody wants, and we run into this occasionally as well because people jump into associateships, is after a year the associate goes away. We’re stuck holding the bag here–of all the attorney fees and the professional fees to get that to happen, and then have that asset, have that partner walk away. That’s really tough for a practice, especially, if you’ve grown it significantly and can’t keep up with all the work coming in the door. It’s very important that an owner of a practice considers all the variables in play as they consider this major decision that can affect the valuation of the practice and can affect your stress levels as well.
RK: Very good Matt, thank You. Randy again. We have another question. We get a lot from dentists that are preparing to sell their practice, and even if they are a few years out, they ask a question, “should I invest in any major equipment purchases? Or, what should I do to make the practice more attractive to a buyer?” What does that do, normally, to evaluation? Does that help evaluation or not?
MH: Yeah, you’re absolutely right. That question comes up quite often. I’ll use a house as an illustration here. There’s a couple of different types of upgrades for remodeling that we can take into consideration. When you’re buying a house, you fully expect the roof to be leak proof. That’s just part of the standard price of the house. It doesn’t add anything if you find out the roof has all sorts of problems that need to be replaced before I pay you the price that you quoted. So, with that kind of consideration inside of a dental practice, certain things like x-ray heads, chairs, and normal standard-of-care type assets at the practice, you absolutely need. If you redo them a year before selling the practice, it’s not really gonna make a significant difference in the value of the practice. Some things that would make a significant difference in the practice, let’s say two months before you sell your practice, is adding a cerec machine or something that’s not been in the practice previously that hasn’t affected the income or the collections of the practice. There’s a couple of different things to consider, to remodel the practice. If you still have shag carpet in the practice, it probably needs to go before you start marketing it. So, those types of considerations and things that will bring it up to a higher standard-of-care could make it more valuable. However, you’re probably not going to get a one-for-one pay back on your investment. I guess my end-all be-all recommendation is five years before the practice sale, unless you’re really making your practice digital or doing something that’s bringing it up to standard-of-care, any other significant remodels at that point would probably not be a complete one-for-one return on your money. Does that make sense?
RK: Yes, that makes great sense. Thank you for that clarification and answer. One other question we’d like to ask you, Matt, once we get down the road matching a buyer and seller together and negotiating the asset purchase agreement, there’s always the question of asset allocation which plays a pretty important part for both sides. Do you mind touching on that a little bit?
MH: Yes, so what we’re talking about here is let’s say we come up with a price, and the price is one million dollars for the practice. The practice price is set, and we’ve negotiated that. At the end of the day though for both parties at play, really even more acutely to the seller is, it’s not just the price, it’s the overall deal that makes it a good or bad deal for you. What I mean by that is this, the million dollar price is great; however, it’s not about what the price is. It’s about what you keep. Obviously, what I’m referring to here is taxation. As you come up with the purchase price, and it’s an asset sale, inside that sale you would have two different buckets to place things in that the IRS expects you to fill out on a certain form. How much of the price is going to be assets? And, how much of the price is going to be goodwill? Those two buckets are very important. For the goodwill side on the seller’s side, amount that is going to be potentially subject to capital gains. Capital gains is a big deal because the difference between that and ordinary income can be significant. We can talk about over ten percent difference here. That’s a big deal for a million dollar price. Ten percent is a hundred thousand dollars. It could be that important. The asset side is anything that’s called an asset in the sale. That would be more advantageous to the buyer. That means they can depreciate those assets quicker than goodwill. Goodwill they can amortize over fifteen years as under current law. To the seller, goodwill is important. To the buyer, assets are important. It’s a little bit more important to a seller though. To a seller, that difference between capital gains and ordinary income can be quite significant. To the buyer, it’s a difference of when can I depreciate something; when do I get the tax write-off for this asset or goodwill. It’s the difference between five years to 15 years. They still get it. It’s just a question of when. For a seller, it’s a one-time deal. It’s either goodwill or it’s either assets. The more that’s goodwill, the better for the seller. And really, that is just subject to negotiations. It’s not really mandated by the IRS in any way. It’s based on what are the negotiated rates allocated to each bucket.
AE: What would you advise a young dentist in an associate for a couple of years, or two to five years out of school, paying off debt? They came to you saying, “I think I’m ready to look at purchasing my first practice.” What would you review with that dentist and how would you prepare him to be ready to engage with Randy and myself to find him a practice?
MH: Some of the first things here is have you spent the time clinically to get your hand speed up, to make sure, that whatever you’re looking at buying, you can actually do or can you document that you can do that in the that new practice? Something else or the bank will be looking at is have they been able to produce at the levels of the practice that they’re buying. That’s one important element. The second important element is taking a look at what does their world look like. Have they gotten in a couple years out of school. Have they been able to create some sort of emergency fund? Do they have some sort of margin in their life? That sounds very logical but a lot of times a buyer is not a good candidate because they don’t have any kind of safety net in their life. So, the third thing that I would talk about is do you know what you’re looking for? Do you know a geography? Have you really studied what area you want to be in and what that practice might look like? Having a clear direction and intentionality about the practice that you’re buying I think is an important thing for a dentist to address to a broker at DDSmatch Southwest because they really need to know that you’re fully vested in buying in a certain area, for a specific purpose, with a certain clinical skill set. Does that answer your question?
AE: Yeah, Absolutely I think that’s great. There’s a lot of young dentists out there that are just kind of on the edge, “am I ready?” It’s scary to start your own business.
MH: No doubt about it. I walk through maybe twenty buyers a year. and Some of the same elements that you’re just discussing here come up often. It can be a terrifying thing. You just need a really good board of directors to walk you through. I mean a great CPA like myself and a great attorney to help you understand the logistics of the transaction and how to structure it. Beyond that, if you have the right people on your team as advisors, we’ve been through this a hundred plus times just helping you through that is part of what we do.
AE: Well, thank you very much, and again we appreciate you taking the time today. You’ve been a huge partner and a huge help not only for us but especially for our clients, so thank you, very much, Matt.
MH: I think that this has been a great conversation and great questions. I think these are key elements to any transaction as these will come up at some point in the process. It’s nice to have a heads up for your sellers or even the buyers out there to understand the dynamics at play. Again, DDSmatch Southwest is a great brokerage. They really walk their clients through everything. It’s an open process. They invite your advisors in to help you through it. I’m a big fan.
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