While there are several “rules of thumb” that practice brokers typically use to help their clients gain a general understanding of the fair market value of their practices, a formal dental practice valuation can serve as a valuable tool in planning for a practice transition and negotiating with potential buyers. In this article we will exam the different appraisal methodologies that are utilized in determining the market value of a dental practice.
According to the IRS, which is the primary theoretician in the business valuation world, a proper dental practice appraisal should consider three approaches: Income, Asset, and Market. The conclusion or calculation of value for the business does not necessarily need to include all three approaches – but each approach should be considered by the professional conducting the analysis.
The true monetary value of being a practice owner is derived from the additional personal income the doctor realizes above and beyond what he would be paid to produce the same amount of dentistry working as an associate. Therefore, the Income Approach examines the cash flow to the practice owner after paying all overhead expenses including doctor compensation (we include a doctor compensation rate of 30% of annual doctor production). Once the net cash flow amount has been determined, the appraiser then “capitalizes” that income based on a “capitalization rate”, which is built from a combination of Treasury bond rates and specific industry risk rates (capitalization rates typically range from 20-35% in dental practice appraisals). This approach to valuation is extremely valuable in analyzing the monetary benefit of owning a practice.
The Asset Approach focuses on the appraised value of tangible assets (equipment, supplies, etc.) combined with intangible asset value (goodwill). This approach can be very useful when attempting to sell a dental practice where the owner has recently purchased a significant amount of new equipment or when the practice has been operating for only a short amount of time prior to a sale and the value of the goodwill is difficult to determine. Of the three approaches to valuation, the Asset Approach typically has the least impact on the appraised value of an established dental practice.
The Market Approach is conducted by comparing the subject practice to comparable sales of dental practices with similar revenue levels and practice attributes. Ideally, the comparable sales will be fairly recent, although business databases such as the IBA (Institute of Business Appraisers) Market Database have shown that dental practice valuations have remained fairly steady over time. Experienced practice brokers should also have their own database of completed sales to use in the analysis. The Market Approach typically has a substantial impact on the appraised practice value and is the most frequently utilized method for determining an asking price for a dental practice.
At McLerran & Associates, we feel that it is crucial for practice owners to understand the factors that influence value and complete a dental practice appraisal well in advance of a practice transition. Not only will this knowledge allow practice owners to effectively plan for their financial and professional future, but it can also provide them with the ability to make changes to enhance value and avoid mistakes that negatively impact value leading up to a practice sale.