Dental Practice Valuations and Appraisals
Dental practice valuation is a crucial process for determining the economic worth of a dental practice. This assessment is essential for various reasons, including selling or buying a practice, partnership changes, estate planning, and financial decision-making. Three primary methods are used for valuation: income-based, market-based, and net asset valuation.
Dental Practice Valuations and Appraisals
Dental practice valuation is essential for determining the business health and economic worth of a dental practice.
Dental practice valuation is a crucial process for determining the economic worth of a dental practice.
Factors affecting a practice’s value include financial metrics, operations, market conditions, patient base, and intangible goodwill…to name a few.
Hemmen & Associates then compiles the weighted results of the Capitalized Earnings, Multiple of Gross and Net Revenue methods to arrive at the total fair market value; placing the greatest weight on the Capitalized Earnings method. Many methods may be used to determine a value of a dental practice, however, there are only a few recognized by the ADA.
How the practice owner benefits
The process reviews the practice’s business health; identifying successes and challenges that assist the owner in making improvements. Usually resulting in better efficiencies, happier patients and staff, and ultimately improved cash-flow. The greater the cash-flow, the greater the value. It is recommended that a practice owner have the “valuation” completed every 3 to 4 years to ensure optimum results and good health. Much like scheduling patients every 6 months for an office visit.
Don’t procrastinate, if you’re not certain this is the right move for you reach out for a free consultation. Those that have are pleased they did, those that don’t are disappointed when they realize what could have been. 800-745-1438.
What Are The Reasons for Valuing a Dental Practice?
The reasons for valuing a dental practice are listed below:
Hiring Dental Associates
Valuations can inform compensation structures and potential ownership track agreements for new associates.
Navigating Mergers
When practices are considering merging, valuations of both entities are necessary to structure the deal fairly.
Taking on a Partner
Similar to buy-ins, bringing on a new partner requires an accurate assessment of the practice’s worth.
Estate Planning
For succession planning or in the event of a dentist’s death, having an up-to-date valuation is crucial for estate purposes.
Securing Financing
Banks and lenders often require a professional valuation when considering loans for practice purchases or expansions.
Litigation Purposes
In cases of legal disputes or divorces involving dentists, practice valuations may be necessary.
Annual Financial Planning
Regular valuations can help dentists track the growth and health of their practice over time.
Securing a Letter of Instruction
This relates to estate planning, ensuring clear instructions about the practice’s value and disposition.
Practice Improvement
Valuations can identify areas of strength and weakness in a practice, guiding improvement efforts.
Insurance Purposes
Accurate valuations ensure proper insurance coverage for the practice.
Retirement Planning
Knowing the practice’s value helps dentists plan effectively for retirement.
Tax Planning
Valuations can inform strategies for minimizing tax liabilities in various scenarios.
What Are The Methods To Calculate The Value Of Dental Practice?
To Calculate the value of dental practice, follow these methods:
Determining the worth of a dental practice is crucial for various reasons, including sales, financial planning, and strategic decision-making. This guide explores three primary valuation techniques: income-based, market-based, and net asset valuation. Each method offers unique insights, and combining them can provide a comprehensive understanding of a practice’s value.
1. Income-Based Valuation
This method focuses on the practice’s financial performance, particularly its cash flow. It’s based on the principle that a practice’s value is directly related to its ability to generate income.
Key Concept: EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) EBITDA is a crucial metric in income-based valuation. Typically, a dental practice’s sale price ranges from two to four times its EBITDA figure.
Two main approaches fall under the income-based method:
a) Discounted Cash Flows (DCF)
The DCF method estimates future cash flows and adjusts them to present value. Here’s how it works:
- Project net income for the next decade
- Determine growth rates and expenses for each year
- Apply a discount rate to calculate present value
While DCF can provide valuable insights, its accuracy depends heavily on the reliability of future projections. This can be challenging, especially for newer practices with limited historical data.
b) Capitalized Earnings
This more popular approach examines current net earnings to predict long-term performance. The process involves:
- Calculating net present value
- Dividing by a capitalization rate (typically 15-30%)
Smaller practices often use rates between 20-25%. Like DCF, this method relies on future earnings predictions, which can be difficult to estimate accurately. Thorough research is essential for reliable results.
2. Market-Based Valuation
This method compares the practice to similar ones in the same region that have recently sold. It involves:
- Identifying comparable practices
- Analyzing their sale prices
- Adjusting for differences in factors such as:
- Office size
- Reputation
- Patient load
The market-based approach is most effective when there’s ample data on comparable practice sales. It may be less useful in smaller markets or areas with limited dental practices. Unlike income-based methods, it doesn’t consider future financial performance.
3. Net Asset Valuation
This technique assesses the practice’s total assets, both tangible and intangible.
Tangible assets include:
- Real estate
- Equipment
- Computers
- X-ray machines
Intangible assets encompass:
- Patient lists
- Brand recognition
- Intellectual property
While tangible assets are relatively straightforward to appraise, intangible assets pose more challenges. As a result, this method may be less accurate than others and is often used as a reference point rather than a standalone valuation.
The “Rule of Thumb” in Dental Practice Valuation
Many practices apply a general principle when using the net asset valuation method: approximately 80-85% of a practice’s total value comes from goodwill. Goodwill represents intangible assets such as:
- Patient records
- Staff quality and loyalty
- Doctor’s reputation
These factors significantly impact a practice’s value but are difficult to quantify precisely. When selling a practice, the buyer acquires these intangible assets and their potential for future profit.
How To Choose the Right Valuation Method?
Each valuation technique has its strengths and limitations. To get the most accurate assessment of a dental practice’s worth, consider the following approaches:
- Comprehensive Valuation: Use all three methods and average the results. This provides a well-rounded view of the practice’s value from different perspectives.
- Quick Estimate: If time is limited or you need a rough figure for planning purposes, choose one method that best fits your situation. Consider factors such as data availability, practice size, and market conditions when selecting a method.
- Professional Appraisal: For the most accurate and legally sound valuation, especially for practice sales or major financial decisions, consult a professional appraiser specializing in dental practices. They can apply these methods expertly and consider additional factors specific to your practice and local market.
What Are The Factors Affecting Practice Value?
The factors affecting a practice value are listed below:
1. Financial Metrics
a. Gross Income
The total revenue generated by the practice before any expenses are deducted.
b. Net Income
The practice’s profit after all expenses, taxes, and deductions. This is crucial in income-based valuation methods.
c. Discretionary Expenses
Expenses that are not essential to the practice’s operation and could potentially be reduced or eliminated.
d. Cash Flow
The net value of the practice’s incoming and outgoing payments, which impacts valuation methods like discounted cash flows.
a. Gross Income:
- The total revenue generated by the practice before any expenses are deducted.
2. Operational Factors
a. Equipment Age and Condition
The value and state of dental equipment, technology, and office furnishings. Well-maintained and up-to-date equipment can enhance practice value.
b. Leasehold Improvements
Enhancements made to the office space, such as renovations or upgrades, which can affect the practice’s overall worth.
3. Market Factors
a. Location
The geographical area where the practice operates. Practices in high-cost-of-living (HCOL) areas or those with less competition may have higher values.
b. Competition
The number of other dental practices in the area. High competition can affect patient volume and practice value.
c. Patient Base
The size and demographics of the patient base. A large, loyal patient base can significantly increase a practice’s value.
d. Market Trends
Current trends in the dental industry and regional market conditions. Economic factors and changes in patient preferences can impact value.
4. Patient and Practice Metrics
a. Number of Active Patients
The number of patients who have visited the practice within a certain period (e.g., 18-24 months). A larger active patient base can increase value.
b. Patient Retention and Attraction
The practice’s ability to attract new patients and retain existing ones. High retention rates and successful patient acquisition strategies can enhance value.
c. Specialties and Procedures
The range of services offered and any specialized procedures performed in-house. Practices with unique or high-demand services may be valued higher.
5. Intangible Assets
a. Goodwill
The reputation of the practice, including the quality of patient relationships and the practice’s overall standing in the community. Goodwill is a significant component of practice value.
b. Brand Recognition
The practice’s reputation and brand presence in the local market. A well-recognized brand can add to the overall value.
c. Staff Expertise
The skill level and experience of the practice’s staff. Highly skilled and stable staff can contribute to a higher valuation.
6. Practice Structure and Systems
a. Efficiency and Workflow
The practice’s operational efficiency, including systems for managing patient flow, billing, and appointment scheduling. Streamlined operations can enhance value.
b. Technology and Software
The use of advanced technology and dental software for practice management. Modern, integrated systems can positively affect the practice’s valuation.
7. Legal and Compliance Factors
a. Compliance and Licenses
The practice’s adherence to regulatory requirements and possession of necessary licenses. Ensuring compliance can prevent potential legal issues that might affect value.
b. Contracts and Agreements
Any existing agreements with insurance providers, lease agreements, and other contractual obligations. Favorable terms can positively impact the practice’s value.
Dental Practice Appraisals are a necessary and powerful tool to be used for the following:
Selling your Dental Practice
An experienced dental practice appraiser is needed to determine the Fair Market Value of your business before it is placed on the market. From the appraisal, the correct information is extracted to prepare “Marketing Packets” to provide to prospective buyers. The eventual buyer will provide the lending institution with the practice details to obtain financing.
Financing a Practice
Financial institutions require specific information about the subject practice to determine the feasibility of a loan to the buyer. The information provided must show that the practice will “make the payments.”
Estate Planning
To protect your practice and estate an appraisal is required by your financial advisor/estate planning Attorney. Without this guidance, estate taxes could become a burden and in the event of your death or disability it is very possible your personal advisors would have no idea of the practice’s market value. A delay in determining where to obtain a professional opinion could result in heavy losses to your family/estate.
Divorce
An amicable divorce is typically an oxymoron. Proper preparation, depending up on the home state of the practice, may require a complete Practice Appraisal. Confirm this with your attorney.
Entity Formation/Dissolution
A Practice Appraisal is normally required for each practice. It is impossible to fairly create or effect a merge or partnership of some sort without complete financial and operational details of the parties involved. Obviously, the need for a Practice Appraisal is required for the same reason with a dissolution.
Buy/Sell Agreements
Entity formations require a dental practice appraisal. Opinions of Value are typically used every few years, if not annually, to be assured the Buy/Sell Agreements within an entity are fair and true to market value.
Request an Appraisal
To request a Practice Appraisal, complete the form below or call Hemmen & Associates at (309) 517-3023.