This is one of the most common questions we receive at Integrity Practice Sales. And it makes sense – you’ve devoted a huge part of your life to your practice! If you’re thinking about selling your dental practice, understanding practice value is key.
The first thing to note regarding practice value is that, just like the value of anything else, the basic rule of supply and demand applies. A glass of water isn’t worth much. I can get a cold water bottle for 25 cents at Costco – and I can turn on the tap in the office and get one for very close to free. So water isn’t worth much…until you’re lost in the desert. With the sun beating down on your parched skin, a single drop of water may be worth a fortune.
Our goal as practice brokers is to find that one buyer to whom your practice is worth the most. We do this by keeping a large and up-to-date record of buyers looking for practices. We pay attention to their specific criteria and overall circumstances, and we also widely advertising the practice to other prospective buyers for whom we may not have detailed information.
When we go to set a listing price for a dental practice, we are aiming to determine what a willing buyer would offer our seller. From there, we discuss strategies for pricing that depend on the seller’s requirements (financial, timeline, etc.) as well as the local market conditions.
There’s both an art and a science to arrive at the opinion of value for a dental practice. On the science side, there are several guidelines that can be fairly easily applied. You can plug the numbers in and…voila! The application of some industry-standard multiples to your top line collection figure or your bottom line profit figure give us a foundation from which we can begin valuing your dental practice.
Determining the profit figure can be a challenge for anyone looking to value a dental practice. Small business owners (dentists included) are economically incentivized to reduce their tax burden. The job of the CPA is, in part, to help the small business owner limit their tax liability through a set of perfectly normal and legal strategies. These strategies are designed to reduce the ‘profit’ that the business shows on paper without reducing the actual discretionary income available to the seller. When we look at the financial records of any selling doctor, we always consider these strategies and work to “re-cast” the financials as if none of these tax strategies were employed. There are many cases where the profit on a tax return may only be $20,000, but the total cash flow actually available to the seller is more like $250,000 or more.
The application of basic multiples, however, is not all there is to it. The art side of the equation is where things get tricky. Below, I’ll give examples of the formulas, and then show how these formulas can get more complicated.
What do you mean by ‘multiples’? Multiples are ratios that are calculated by dividing the value of an asset by some dental-practice specific financial variable. For example, if we know that practices collecting $1,000,000 per year are selling for an average of $850,000, then the multiple we can use is 0.85. We can then take this multiple and apply it to other practices.
Where do you get these multiples? Since there is no reliable and statistically significant data publicly available for recent transactions of dental practices, these multiples are derived from industry standards and our own private data sources. Additionally, they are regularly confirmed by dental practice finance lenders, who maintain some of the best privately-held data available.
How do you choose the right multiple? Initially, we apply a multiple that is based on location and practice size. However, the final multiple will be a function of location, goodwill, profitability, tenant improvements, equipment and technology, insurance accepted, and other factors.
The basis of this multiples approach is the economic principle of substitution, which says that one would not purchase a business asset for more than one could acquire an equivalent substitute asset. Basically, a buyer would probably not purchase a practice – even if the investment risk was relatively low and the projected reward was high – if that buyer could acquire a similar practice for less.
Valuing Dental Practices:
Simple Example: One of the simplest ways to come up with a value is to apply a multiple to your last year’s collections. For this example, I’ll use 80% – but, as I said above, this number depends on a number of market conditions. So if you collected $1,200,000 last year, this quick rule of thumb would value your practice at $960,000. How easy!
Why this doesn’t work: Not so fast. Imagine that there are two practices, Practice A and Practice B. In both practices, the total collection from last year was $800,000. So they’re both worth $640,000, right?
Let’s take a closer look. In Practice A, the overhead is at 50% of collections, which means that Doctor A takes home a profit of $400,000. Dr. B’s overhead, on the other hand, runs high at about 80%. Dr. B takes home a profit of $150,000. A practice where a doctor makes $400,000 every year is more valuable than a practice where the doctor makes $150,000. The percentage of collections method is helpful, but it does not always give you the whole picture.
Multiple Multiples: We always apply these multiples to both top-line (collections) and bottom line (profit or doctor income). Both of these aspects must be balanced to provide the most accurate value, but at the end of the day, the doctor’s take-home income is what provides a very substantial part of the value for a potential buyer. At the same time, you cannot rely on any single multiple alone. Remember Drs. A and B from the example above? Is Practice A really worth $800,000 and Practice B only worth $300,000? That’s a serious discrepancy in value when compared to the percentage of collection method.
Additional Considerations: In our experience, practice value is influenced by many different, dental-specific factors. These include curb appeal, location (city, neighborhood, professional complex vs shopping center, etc.), the age of the practice and resultant value of the goodwill, the age and condition of equipment, the level of technology in the practice, and the recent income trends of the practice (up or down). This is why it is so important to work with an experienced dental practice broker.
What does it really boil down to?
At the end of the day, cash flow is king. It only makes sense to buy a dental practice if you can make enough money in the practice to pay the overhead, pay the bank, and still generate a reasonable income for yourself and your family. If a practice is valued correctly, it will support the buyer.
Balancing these different valuation methods takes an experienced hand. At Integrity Practice Sales, we look at everything to make sure your practice or any practice you are looking to purchase is correctly valued. Click on the link below to get a free preliminary opinion of value for your practice to assist with your financial planning today.
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