Articles & E-Books

 

What’s your dental practice worth? How to go beyond the ‘rules of thumb.’

May 22, 2022

By Brandon Christopherson

The need to establish a value for your dental practice becomes clear when you’re devising your retirement plan, contemplating on selling your practice or selling a portion of your practice to an associate.

For practitioners steeped in the precision and clarity of the day-to-day work of dentistry, it may be eye-opening to understand the multitude of assumptions and considerations that are assessed in the valuation process of a dental practice. The valuation process involves as much art as science.

The downsides of the percentage of revenue rule of thumb

There simply is no “going rate” for establishing the monetary value of your practice with so many quantifiable variables, from patient load and staff size to business overhead and location. It may also be tempting to rely on the convenient and popular “rule of thumb,” which dictates that your practice is worth 70-100% of your average gross revenue. That could be highly misleading as there are many reasons why a practice should be valued on the low end of the range and others justifying the top end.

To be sure, using a percentage of gross receipts may be a reasonable starting point, but much more is involved in the process of obtaining an accurate and reliable valuation when you are about to enter into negotiations around the sale of your practice.

Here’s one example illustrating how two practices with identical annual collections of $1 million can have significantly different valuations. If you use 70% of revenue, both practices would be valued at $700,000. However, if Practice A has overhead of 80% and $200,000 of net income, and Practice B has 60% overhead and $400,000 of net income, then Practice B would appear to be much more valuable because it has double the earnings.

But then it gets more complicated: The lower overhead might not be transferable to a new buyer, and the selling dentist may be more cost-conscious in their spending than the buyer, which would change the results. There is no guarantee the buyer would replicate the same $1 million in revenue. Patients could exit along with the selling dentist, and the skills of the incoming dentist might differ from those of the seller.

In addition, the assets and liabilities included in the sale are not always the same. One may own their building while another leases space; one may have brand-new x-ray equipment and another’s may be very old. Each of these scenarios has an impact on the value of a practice that is not factored into the percentage of revenue formula.  

Three approaches to dental practice valuations

In the valuation of any business, an appraiser will look at three approaches to value:  Market, Income, and cost. Determining the valuation of a practice may involve a combination of all three. And taking all three methods into account can lead to the most accurate results.

1. Market-based valuation

This method compares a practice’s performance to transaction data available from close peers. For example, an appraiser may analyze performance metrics from similar or comparable dental practices. They will look at practices of a similar size operating in similar areas (urban, suburban or rural) and with similar overhead percentages, for example.

The ultimate outcome is to assess the value of a subject practice by applying multiples derived from an analysis of recent sales of comparable practices to the subject practice’s appropriate earnings measures.

2. Income-based valuation

Income-based valuations use the practice’s expected future cash flow to determine value. Normalizing the practice’s earnings is a key aspect of this approach and is said to fairly represent future expected cash flows in perpetuity. Determining a reasonable, “normalized” earnings is the key to a reasonable valuation.  

3. Asset-based valuation

The asset-based approach determines a practice’s estimated equity value by subtracting liabilities from assets that have been adjusted to market values. Assets include equipment, supplies, tangible personal property, receivables, and intangible (practice goodwill) assets. However, for a majority of dental practices, most of the practice value is not found in its tangible assets. Intangible assets include the practice’s workforce in place, active patient records and goodwill.

Market data from practice sales where the value of goodwill is broken out can be used in the cost approach to estimate the value of goodwill to be added to the value of the tangible assets to arrive at the value of the practice as a whole. 

Other factors affecting value

In addition to income in a practice, risk factors and future growth potential in net income can have an impact on the multiple buyers will pay. 

Dentists should be aware of actions they can take that may have an impact on risk and future growth and have noteworthy impact on the valuation.

  • Leverage the work of hygienists: The more work you can shift to the hygienist, the more revenue a one-dentist practice can generate which increases the value of a practice. Leaving the cleanings and general work to hygienists frees up time for you to focus on more specialized treatments and see more patients. Because of their expertise, a dentist’s time is more valuable doing more advanced procedures.
  • Offer specialized services: Practices that include cosmetic treatments like veneers or corrective services such as Invisalign can increase the overall value of the practice.
  • Location, location, location: A practice located in a high-traffic area is likely to be valued higher than one in a more remote setting because of the potential for higher revenue.

How Wipfli can help

Buying or selling a dental practice is a major event in a dentist’s life. Wipfli’s valuation team has deep knowledge and understanding of the nuances involved in that decision. Our team can work with you to navigate the complexities to ensure you arrive at a fair price. Contact us to learn more.

Sign up to receive more business valuation content in your inbox or continue reading on: