Dental Practice Valuations

Dental practice valuations offer more than ‘just a number’ used to buy or sell a dental practice.

A good valuation helps dentists know what they’ve got. Because many dentists seriously misjudge practice values, knowing what they’ve got is the starting point for transactions, retirement planning, estate planning, and even for profit enhancement.

The valuation process starts with understanding that buyers of a dental practice seek a future stream of income. The more income they believe the practice will put in their pocket in the future, the more they will be willing to pay right now.

The single most important factor, therefore, to the valuator performing a dental practice valuation is how much cash flow remains after paying all costs such as salaries, rent, insurance, et cetera.

The higher the cash flow, the more valuable the practice becomes. And the more certain and stable the revenues are, the higher the multiple the purchaser will feel comfortable paying.

A prospective buyer will wonder whether and if so, how the loss of one or more staff members would affect the practice’s cash flows.

While free cash flows are the primary value driver, several other factors also affect the valuator’s conclusions:

Key Factors in the Value of a Dental Practices

• Number of professionals: Each additional dentist in the practice should bring a proportionate increase in revenue. A sole practitioner has autonomy but limited growth potential. A large practice with many dentists may be constrained by underperforming partners or significant institutional overhead.
• General versus Specialized Practice: The nature of the dental services provided is an important factor in dental practice valuations. When the success of the practice depends on the talents of a specific individual, the practice is more difficult to sell and therefore is worth less than an otherwise identical practice with less dependence on any one person.

  A specialized practice tends to rely on referrals from other professionals who base their referrals on the reputation of the specialist. Another dentist, therefore, cannot merely take over the specialist’s practice and expect the referrals to continue uninterrupted. A general dentistry practice will probably have less reliance on a particular professional than (say) a practice specializing in endodontics.

• Limited pool of buyers: Only trained and licensed professionals may practice dentistry, so the pool of buyers of a dental practice is limited.
• Payment (managed care vs. private insurance): If a practice relies heavily on managed care or third-party pay, volume may be high but average collections may be lower. Fee-for-service practices are generally more valuable but may find trouble if their customers limit discretionary procedures. Adjustments to Medicare and Medicaid add another layer of complication as 15% of the US population has dental coverage through one of these programs.¹
• Technology: Advancements in dental technology have risen tremendously in recent years. New machines and devices make work much easier, but come with high price tags. Keeping up with the most progressive dental offices may require significant capital investment, but also creates a tall barrier to entry for potential new competitors.
• Demographics: Dental businesses are tied closely to demographic statistics: adolescents and elderly clients make up a large portion of a practice’s clientele and tend to need more complicated and expensive procedures than typical adults. Dental offices in areas with favorable demographics will be more appealing to potential purchasers.
• Geography: Dental practices tend to be very regional as few patients are willing to travel long distances for routine appointments. Firms located in affluent neighborhoods generally attract wealthier customers who may be more willing to pay for elective cosmetic procedures.

A sound dental practice valuation requires the valuation analyst to consider, analyze and quantify these factors from the perspective of a third-party buyer.

Experienced valuators of dental practices will employ one, two or all three valuation methods to determine the fair market value of a practice. Because each practice is unique, an approach suitably used to value one practice may be completely inappropriate to use valuing another practice across the street.

Dental Practice Valuation Approaches

These are the three primary methods or approaches used for a valuation:

1. The Income Approach: Common among professional practices, this method assesses the income-producing capability of the practice and quantifies it in today’s dollar terms (present value).
2. The Asset Approach: For practices (usually specialty) with very unique or valuable equipment, the assets themselves may comprise the bulk of the company’s value.
3. The Market Approach: A very practical and accurate method because it examines recent sales of similar practices. However, comparable data can be hard to compile, particularly in suburban or rural areas.

Upon review of your financial statements and conversations with management, any competent appraiser should be able to explain to you why each methodology would or would not apply to your own practice.

Dental Practice Goodwill

Apart from the physical assets of a practice, professional firms derive much of their value through intangible assets, or goodwill, which can have a significant impact on dental practice valuations.

Let’s imagine two dental practices in your town which happen to sit right across from each other on Main Street. They both happen to have the exact same décor, equipment, number of staff, computer systems.

The only difference is the owner: Dr. John Smith has been in business for twenty years, is well respected in the community, and has a very loyal client base. Dr. Frank Jones just emerged from dental school – eager and knowledgeable but inexperienced and no book of clients yet.

Which practice would appeal more to a purchaser? Almost universally purchasers would prefer Dr. Smith’s practice.

While the companies have the exact same physical assets, Dr. Smith has something Dr. Jones won’t have until many years have passed.

Professional practices by their very nature build up intangible value over time with every client interaction. Goodwill quantifies the difference in value that can’t be found by comparing the two companies’ balance sheets.

However, take note that the goodwill of a practice can be divided into two distinct categories.

A portion of the total value of the practice is due to the personal reputation or skill of the owner(s) and may not be easily transferable to a buyer. This is known as professional goodwill. In certain cases professional goodwill has no value to a buyer.

Practice goodwill, on the other hand, results from the practice’s successful operation apart from the individual talents of the owner and should continue even if the practice changes ownership.

Practice goodwill is a component found in most valuation estimates.

Dental Practice Valuation Rules of Thumb

When an owner tries to get a ballpark range of value for his or her business, industry ‘rules of thumb’ can provide a guideline.

Rules of thumb are popular because they are simple to use, and cost nothing. But they invariably end up misvaluing the practice, usually by orders of magnitude.

Why?

Because they assume the dental practice is exactly like every other dental practice (except for the variable being tracked, such as sales). We all know that is an absurd assumption – every practice is unique.

Consider two practices, both with $1 million in gross annual sales. Practice #1 is located in an affluent, growing market with two dentists working 60 hours a week. The practice has posted steady annual growth between 20%-30%. This practice has very bright prospects for future growth.

Practice #2, on the other hand, is in a rural location and has a dentist in the twilight of his career. He’s gradually dwindling down his number of patients and not bothering to make capital investments to keep the business current. The practice’s revenues have been falling for years, and last year fell 20%. The trend line is definitely ominous.

Yet this particular year, both practices have exactly the same gross annual sales: $1 million. A revenue-based rule of thumb (like ‘60% of gross annual sales’) would suggest both practices have equal value.

But which would you rather own?

Still, rules of thumb can serve as good reference points for industry comparison. Drawing from the Business Reference Guide, written and compiled by Tom West, industry multiples include:

• 60 to 65 percent of gross annual sales (includes inventory)
• 2 times seller’s discretionary earnings; add fixtures, equipment and inventory; may require earnout
• 2.5 to 3 times EBITDA

Next Steps

Whether you’re thinking about valuing your dental practice to determine a sale price, update a buy-sell agreement, establish a price for a management buyout, or to plan your retirement, this is a great opportunity to speak with someone who can understand your situation and explain the options that lay before you.

Sign up for a free consultation call, where you can tell us all about your practice and we’ll give you the best advice we can offer. Or call (800) 895-4100 – one of our Value Advisors will speak with you now.

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¹ IBISWorld Industry Report 62121, Dentists in the U.S., November 2010