When you are looking to buy or sell a dental practice, there are a number of steps you must take in order to be successful. If you are a dentist who is looking to put up your dental practice for sale, you might want to know what the market is like and what your practice is worth. Alternatively, if you are looking to purchase a dental practice, you might want to evaluate the value of that practice yourself, instead of solely relying on the assertions of the seller. Regardless of which party you are, you will need to be fully armed with the knowledge and understanding of how the evaluation process works. Failure to be informed could lead to a bad deal, sure to be accompanied by buyer’s or seller’s remorse.
There are a number of valuation methods that can be utilized when you are seeking to buy or sell. Primarily, there are income-based valuation methods, market-based valuation methods, and net asset valuation methods, each with their own variations. While every one of these methods has its own specific place and purpose, whichever is the best fit for your practice should be the method that you utilize.
One of the most commonly-utilized methods of evaluation is called income-based valuation. A buyer or seller can use this method to determine the most accurate fair market value of the practice that they are looking to buy or sell. When evaluating using this method, be certain to remember that income is considered to be the amount of cash-flow before taxes are taken out.
Capitalized Earnings Method
When using the capitalized earnings method, the valuation is based on either the net income of the prior year, or on the average net income of the past few years. Once that number has been determined, it should be divided by a cap rate in order to calculate the fair market value of the practice. The typical industry standard for cap rates ranges from 25 – 31%.
Discounted Cash Flows Method
If the discounted cash flows method is used, the net present value of a five- to ten-year projection of net income is calculated. When projecting cash flows, the rates of collections and practice costs are both based on a reasonable amount of growth, followed by a discount of an assumed capital cost and risk premium. That discount rate tends to range from 23 – 31% in the industry.
Choosing to use an income-based valuation, such as the capitalized earnings method or discounted cash flows method, is most useful for practices that can demonstrate robust levels of revenue and growth, along with a steady influx of new patients.
Differing from the income-based form of evaluation, market-based valuations rely on various market data stemming from the area surrounding the practice. Traditionally, using this method of evaluation involves examining the history of practice collections and multiplies that amount by a collections multiplier. The danger of this method is that it only takes into account collections and not profits. As a result, it can often be difficult to truly determine the value of one practice versus another.
This method of valuation involves inventorying both tangible and intangible assets and having them all appraised. Tangible assets include assets that you can touch, such as dental equipment, a building, and office supplies. Intangible assets are assets that are not touchable but are still valuable. This might include any investments or practice goodwill.
One unwritten rule in the industry states that the key to valuating a dental practice is to argue that 80 – 85% of the value of a practice stems from practice goodwill. The issue with this “rule” is, however, that practicing goodwill is a relatively subjective concept. What is considered to be valuable to one person may not be as valuable to another. In order to overcome the problems with this type of valuation, net asset valuation should only be used in concert with another method.
Under any of these valuation methods, it is important to also normalize earnings by adding back non-essential operational expenses which may include automobiles, pension plans and other expenses that are more personal in nature. This will certainly allow for a more accurate analysis of the true profitability of your practice which impacts the value as described above.
Because the valuation processes can seem highly technical and numbers-heavy, consulting with your CPA, wealth management advisor, or dental attorney is highly recommended. In addition, there are a number of forms online that can assist you with calculating and evaluating the various methods of valuation. When making a major life decision such as selling or buying a dental practice, having accurate valuations is absolutely critical. Those calculations can become your leverage during the negotiation process, aiding you in your search for the best deal for your money.
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