January 28, 2021
Guide to Dental Practice Valuation
No matter your plan for your dental practice, it is always advised to understand the health of your dental practice. While many doctors believe they can determine their dental practice valuation by taking 70% of your last three years’ collections, or 1.5 times your net income, there is a lot more than goes into establishing the value of a practice. There are multiple methods used to give fair market value to dental practices, but the methods that are most appropriate are market and earnings (capitalized income). Any valuation will ultimately use one of these approaches but using combinations of approaches will form a more reliable indicator of value. We want to help with our guide to dental practice valuation.
Fair market value, according to I.R.S. Rev. Ruling 59-60, 1959-1 C.B., is defined as “the price at which a property would change hands between a willing buyer and a willing seller when the buyer is not under any compulsion to buy and the seller is not under any compulsion to sell, with both parties having reasonable knowledge of the relevant facts.”
There are many factors used in calculating the value of your practice. At Professional Transition Strategies (PTS), we use the most effective method of calculating your practice’s worth by looking at both attributes and challenges and how they have impacted the success of the practice.
“Erroneous assumptions can be disastrous.” – Peter F. Drucker, U.S. management guru
Factors used in determining value of a dental practice:
- The practice’s location, visibility and population of city or town.
- Type of medicine or dentistry, revenue sources and active patient base.
- Growth potential.
- Patient attraction and retention rates.
- Reason for sale of practice.
- Projected patient and revenue retention after the sale.
- Condition and age of medical and dental equipment based on wear and tear, as well as technical advancement.
- Office decor and condition.
- Long-term trends of the practice’s revenue and profit margin.
This price includes the going concern value of the practice, including dental and office equipment and furnishings, instruments and supplies, its patient records, current location and telephone numbers assigned to the practice. It assumes a smooth transition of ownership, including letters of introduction to all active patients and/or referring sources, the seller’s best efforts in assisting in the transfer of the practice, a noncompete agreement and all other tangible and intangible assets of the practice.
This price will not include the accounts receivable (A/R) of the practice, cash on hand and any other bank or cash accounts, as well as the practice owner’s belongings, marketable securities, real estate or vehicles, if any.
The typical information collected to create a dental practice appraisal includes:
- Three years of profit-and-loss statements.
- Three years of tax returns.
- Current balance sheet.
- Production broken down by provider.
- Production broken down by procedure type.
- Total active patients.
- New patients per month for the past 12 months.
- A/R aging report.
- Copy of current lease (if applicable).
- Employee roster with hire dates and hourly wages and benefits.
- Bio of selling dentist.
- Physical observation of office with pictures of equipment (typically performed by PTS staff).
- Lists of insurances on plan.
- Office hours.
Please note nearly all information can be run by your practice management or accounting software, as well as your certified public accountant (CPA).
While hard assets located within the dental office tend to be included within a prospectus, it is important to know the equipment value will not reflect the insured value or purchase price. It will represent only the current market value. For example, the value of equipment included in the prospectus is comparable to what one would pay if purchased on eBay or Atlas Resell Management.
Even though the patient overview does not necessarily affect the value of the practice, it is still wise to understand how your patient base is broken up, especially in cases when you may be looking to sell. This is one of the reasons it is important to know not only your patient demographics, but also have accurate records of active patients and patients in recall. In addition, the insurance plans your dental practice accepts, as well as the percentage of patients on said plans, may not factor into the value, unless it is a heavily Medicaid practice. Having the basic knowledge of the breakdown is important to having a deeper understanding of your patient base.
It is also smart to be aware of the type of dentistry performed based on the composition of the production. For instance, is the practice hygiene heavy, is it a bread-and-butter practice, is there a lot of specialty work performed in the practice, or is it primarily referred out?
One component included in evaluating a practice is the adjusted earnings before interest, tax, depreciation and amortization (EBITDA). Put simply, EBITDA measures the practice’s operating performance. Adjustment to doctor’s compensation, adjustments and net income of the practice are added together to achieve Adjusted EBITDA.
One thing that is not included within a prospectus is A/R. The A/R can be sold separately or not at all. The reason A/R is not incorporated into the value is that they can change by the day, hour or even minute. Therefore, the value of accounts receivables will be determined the day of closing.
The reasons one seeks a practice appraisal can vary. A dentist could be considering selling their practice or bring on a partner or associate into the practice. One could be trying to determine their own personal net worth. In this same regard, it is common for a dentist to need an appraisal prior to marriage or prenuptial agreements, or possibly due to an upcoming divorce. It is also advised to have a valuation completed to establish a baseline for future business endeavors, as well as simply having a deep understanding of the health of your practice. Other common reasons include allowing for fair disposition of assets for your estate or simply for disability purposes. Lastly, it is advised to know the value of your dental practice for retirement and estate planning.
Should you be seeking a prospectus for your dental practice because you plan on selling all or a portion of your practice, it is important to note that while the previous three year’s financials are included, the most recent year is weighed the heaviest. This is one of the many reasons it is advised to consider a transition during a peak in your production rather than after you’ve slowed down and decreased the value of your practice.
Just as there are different transition types, there are also different types of buyers. To ensure you have all the information you need to decide the right strategy for you and your dental practice, it is advised to understand the difference in value from an individual receiving a bank loan compared to a larger dental service organization (DSO) with private equity backing.
Unfortunately, unlike basic real estate, there is not a multiple listing service (MLS) or a centralized database of dental practices previously sold. This is one of the several reasons you should a professional complete the appraisal for your practice. As noted business magnate and philanthropist Warren Buffett says, “Managers and investors alike must understand that accounting numbers are the beginning, not the end, of business valuation.” (1)
While many companies and individuals claim they can determine the value, it is important to go with a company that has significant experience valuating dental practices. This ensures they can provide adequate comparisons and experience to help determine what the marketplace will bear in addition to what lenders will loan.
Another factor to consider is the desirability of the area the practice is located. Two identical practices with four operatories in a medical plaza collecting $800,000 will be valued significantly differently if one is in rural Kansas and the other is in San Diego, California.
Should you be seeking a prospectus to potentially put your practice on the market, you should know what a buyer’s return on investment (ROI) would be. To calculate the annual or monthly return, you will take into consideration the doctor’s payroll plus adjustments and net income distributions less any new debt service for the most recent year. Typically, debt service assumptions are 100% of purchase price/10-year loan/5% interest rate.
Whether you own or rent your real estate will not affect the value of your practice. However, it is important for any potential buyer to know the real estate situation, which is why it is incorporated into a prospectus. Not only are they interested in the square footage of the dental office, as well as if the practice is in a retail space or a medical complex, but they also want to know if you owe the space and if it is for sale along with the practice. Of course, just because you may own the real estate does not mean that you must sell it, as well, you can also retain the office as an investment and lease the space out to the new buyer. In addition, if you don’t own the real estate and simply lease it, it is important to know leases can be transferred, as well as negotiated when the new tenant signs on.
To determine the value of your practice, no matter the reason, contact team at Professional Transition Strategies.