Understanding practice value
There are many reasons why dentists might want to have their practices appraised.
There are many reasons why dentists might want to have their practices appraised. Some of these reasons include:
1)Sale or purchase
5) Death or disability
No matter what the reason for the sale, it’s important to understand the term “value.” There are three values for most dental practices:
The purpose of this article is not to provide formulas for determining these values, but to discuss their meaning.
Seller’s value is what most sellers apply to their practice. Whether it is relative or not will depend on the seller. Some sellers underestimate the value of their practice because they don’t have a clear idea of its true value. They know there is value in the tangible assets, but they often look at the replacement value, which is clearly not the value of existing equipment in any practice.
They then add value for goodwill, which is realistic. What is not realistic is adding value for the “blood, sweat, and tears” a dentist has put into his or her practice. Also unrealistic is adding an additional value for “building out” a new facility. Although there is value in the owner’s time and energy, it is not something a typical buyer is willing to pay for when purchasing a practice.
In most situations, the seller’s opinion of value will be the highest and most unrealistic assessment.
It would stand to reason that the economic value of the practice would reflect the most reliable value. This number is arrived at when a dental practice appraiser, who thoroughly and objectively reviews practices, is hired to determine value. The major components making up this value are the tangible assets (dental equipment, furniture, fixtures, and office equipment) and intangible assets (goodwill).
When assigning value to tangible assets, appraisers consider the age and useful life of the equipment. Tangible assets fall between depreciated book value and replacement value and an economic useful life, to which a representative value is applied. Intangible value is determined by goodwill, which is comprised of location, active patients, staff, cash flow, and other factors.
The ultimate economic value of the practice is based primarily on the metrics generated - active patients, gross receipts, and most importantly, adjusted net income or cash flow. Once these factors are reviewed, the appraiser will render his or her opinion regarding the value of the practice.
From a pure numbers standpoint - and viewing the practice as an isolated asset - this opinion of value may be accurate, but unrealistic.
Two practices with nearly identical financial numbers, equipment, physical characteristics, and staff may have similar values, but may not generate the same selling or purchase price. The market factor or market value will have a dramatic impact on the two practices. As in real estate, the mantra, “location, location, location” is all-important when viewing a practice. This is never more obvious than when practices are located in rural areas verses urban areas, the right side of the tracks versus the wrong side of the tracks, or the run-down area versus the new growth area.
Hiring an appraiser who is familiar with your area and who practices within that locale will help you determine whether you set a realistic value for your practice. The right professional is critical as you attempt to maximize your practice value. Pricing your practice to the market will ensure a fair price for both you and a buyer, and will ensure a timely sale.
The value placed on your practice must pass the “justification test.” After expenses, will it pay the debt service, provide adequate cash flow to the buyer, and withstand the need for future new equipment, as well as fluctuations in business cycles? Adequate cash flow is always relative to any buyer, but it has to be more than a buyer would earn as an associate to justify the risks that are part of any sale or purchase.
John M. Cahill, MBA, of John M. Cahill Associates, has more than 30 years of experience in the dental industry, including all aspects of appraisal, sales, purchases, and buy-ins in connection with dental transitions. Cahill is a member of American Dental Sales, Inc. He can be reached at (510) 844-0330, or by e-mail at email@example.com. See the classified ads for names and addresses of ADS members in your area.