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!
“I would literally tell anyone, call those guys up. Follow exactly what they say to do, and just let them do it. There was zero effort on my part to do this.”
Mitch Conditt, DDS
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.