Dental Practice Appraisals

Dental Practice Appraisals

General overview of dental practice valuation methods…………… Market approach & rule of thumb

Rules of Thumb

The following methods of dental practice evaluation are the most commonly used and most easily understood.

Rules Of Thumb - Rules of thumb are generalizations of what has been happening in the market, as well as what might be expected to happen in the market. Rules of thumb do not take into account specific elements of the practice being valued, but they provide a broad brush stroke to the dental practice value process.

Because of the lack of specific comparisons, rules of thumb cannot assure an accurate value of a particular practice. The most important consideration in the use of a rule of thumb is the accuracy of the information relied on. Often I hear someone make the statement, "I understand that practices are selling for 70 percent of gross." Or, "I understand that practices are selling for one times net."

The question to ask is, "From where do you understand this information?" The only valid determination of an accurate rule of thumb is to evaluate enough actual market data to begin to see a legitimate trend. Obviously, the data must be germane to your specific dental practice if it is to apply. In other words, if yours is a specialty practice and you are applying a data base generated about general dental practice sales and their relation to dental practice values, you are dealing in apples and oranges.

As you can see, the process of determining the value of a dental practice is much more complex than one might expect and the degree to which an appraiser uses one or more of the methods available usually is a function of the reason for the appraisal. If litigation, estate-planning or the sale of a practice requires an appraisal, it is important to select a qualified party who has the experience and market resources to provide a supportable valuation. If you`re just curious as to what your practice might be worth, use a rule of thumb - probably between 50 percent and 70 percent of gross (on a $600,000 gross revenue value between $300,000 and $420,000. For a swing of $120,000, it`s probably worth getting a legitimate dental practice appraisal).

Much of the "tug of war" that exists in this area can be minimized by staying focused on this reality. (i.e., the Purchaser and his/her representatives always think the appraised price is too high, and the Seller and his/her representatives always think that the price is too low!) If the price of your practice appears to be in line with comparable sales of practices in the general area, and the terms are structured to make it reasonably profitable for the Purchaser, then it's very likely that the price will be considered an equitable one by a prospective Purchaser.

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Market Approach

The Market Approach - Market approach simply compares your dental practice price with other dental practice sales that have recently sold to determine your dental practice value. The theory behind this method is that a ready, willing and able buyer has paid a certain amount of money for a practice and the seller has sold for that amount of money, neither party being under any duress.

MAJOR MARKET FACTORS:

(1) AREA DESIRABILITY: This area-desirability factor also holds true in real estate: location, location, location! Nearly "identical" practices located in different macro-geographic areas (small town vs metropolitan areas) or micro-geographic areas (one particular area of a city or town vs another) will sell for widely different prices. Practices in "high growth" areas generally sell for more than "low growth" areas. In general, practices located in large urban areas are in greater demand than elsewhere and practice values usually decrease proportionately with the distance away from these areas (Some coastal areas are an exception). An increase in Dental practice sale’s price is directly related to areas with higher per capita income

(2) PROJECTED PROFITABILITY: Projected profitability will be based on past and present practice figures. Although it is difficult to sell future practice potential, any "windfall" profitability perceived by the Purchaser will only enhance the potential selling price. Although we are not able to translate potential into a specific dollar value, it can definitely increase the likelihood of a sale at the desired price.

Examples of potential "windfall" profits include situations where specialty procedures such as endo, ortho, perio, implants, pedo, and other procedures are being referred out routinely to specialists rather services as "in house."

(3) SELLER FINANCING: The Seller's willingness to finance a large part of the purchase price can often make a big difference in the final selling price. This financing is preferably at a fixed interest rate and for a longer term than the usual bank financing.

(4) EXISTING EQUIPMENT AGE: Equipment value depreciates rapidly soon after it’s' purchase, and becomes a progressively smaller factor when determining overall practice value, especially in established practices.

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Cap Rate Method

The capitalization rate, or "cap rate," is a percentage that is used to determine the final value of a dental practice and consists of the following formula: earnings/cap rate. The most common method for determining the cap rate relies on an evaluation of different risk factors (see below) that are involved in investing in a dental practice versus other investments.

The cap rate only reflects the return on investment and does not consider the fact that, in most dental practice sales, the new owner works in the practice to contribute to the overall gross collections.

Selecting the cap rate is market driven and reflects current economic and industry conditions, such as interest rates, inflation and the future outlook for the profession and the community.

The range of cap rates used to value dental practices varies from 18 to 35 percent. The lower rate represents less risk, while the higher rate represents greater risk. Risk factors that influence purchaser’s return on investment are directly related to the cap rate. Most appraisers use their knowledge of the market, the demographics of the community and the practice data to select an appropriate cap rate. Selection of the cap rate is the most subjective process in the approach to determining the value of a dental practice.

Summary of Risk Factors

Elements that increase the risk of purchasing a particular practice will decrease its value, and vice versa. If a particular purchaser desires to be in a certain area, and an established practice with sufficient cash flow is near the preferred location, risk factors such as the number of practices in the area or the age/quality of the existing equipment may become negligible factors in the mind of potential buyer.

The biggest dilemma in purchasing an existing dental office is the question of transferability. The value of the practice goodwill to a buyer and the practice numbers should only be considered if transferability is not an issue.

Transferability is dependent upon the seller’s ability to handover the goodwill to the purchaser. The seller’s ability to transfer staff loyalty to the new doctor is, in turn, a risk factor directly related to the transferability of the practice to the purchaser. In addition, the seller’s willingness to slow down and work less in the practice post sale also plays a big role in determining the success of patients and staff shifting their allegiance to the new owner.

Common risk factors to consider when evaluating the cap rate used in the valuation of a dental practice are:

Practice productivity trend
Number of dental offices in a five-mile radius
Transferability
New patient flow
Years in practice in the area/years at location
Overall office appearance
Age/quality of equipment
Existing or future lease and terms
Seller/bank financing
Local economic outlook
Other practices for sale in the area
Staff attitude/turnover/skills
Office systems
Accounts receivable/collections policy
Parking/office access

Most risk factors associated with the purchase of a dental practice versus the purchase of some other type of business are generally low, and the risk tolerance of each individual investor is, to a large extent, a personal matter.

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