What is My Practice Worth?
While there are several “rules of thumb” that we typically use to help our 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.
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.
Dental Practice Appraisal Methodologies
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 and directly parallels the process that dental lenders employ to evaluate practices during the underwriting process.
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.
Keys to Maximizing Practice Value
As practice transition consultants, we are frequently contacted by dentists who have an immediate need to sell their practices due to retirement, disability, etc. After meeting with the doctor and reviewing the practice financials, we often find that practice revenue and profitability have declined over the past few years due to various reasons such as the dentist cutting back his work schedule to pursue other interests, not actively marketing the practice or pursuing new patients, or referring out more procedures. We also often find that the selling doctor has not updated the office appearance or equipment in 10-20 years. Unfortunately, the decline in revenue/profitability and dated décor and equipment typically results in a substantial decrease in the value and marketability of the practice that could have been avoided with prior planning. To prevent this mistake, it is imperative for dentists to understand the keys to maximizing practice value:
- Start planning your practice transition 3-5 years in advance:
By planning in advance, you can choose a transition strategy that best meets your individual situation, make changes to enhance practice value, and avoid mistakes that can reduce practice value and marketability.
- Maintain/Increase Revenue:
Practice value is heavily influenced by the most recent year’s revenue level, so it is crucial to maintain or increase practice production in the years leading up to the sale. Regardless of the explanation, declining or erratic revenue trends will cause concern for buyers and their lenders regarding the future viability of your office. Therefore, you should do everything possible to maintain or increase revenue in your final years as the practice owner. If you are considering cutting back your work schedule, hire a part-time associate to maintain production or consider selling the practice and working as an associate following the sale.
- Control/Reduce Overhead:
Profit is a prerequisite for value … Most buyers are looking for offices that generate sufficient cash flow to cover practice overhead expenses (including the debt service associated with the practice loan) and their personal living expense needs. Therefore, ensuring that your major expense categories such as staff salaries, dental supplies, and lab fees are within industry standards will ensure that your practice is an attractive option for potential buyers. Additionally, the ability for a buyer to obtain financing for the practice purchase is heavily tied to the historical cash flow of the practice.
- Increase # of Active Patients and New Patient Flow:
Active patient count and new patient flow are extremely important to buyers in evaluating the health and goodwill of a practice. We have often heard that, on average, patients switch dentists every seven years. Therefore, an easy way to determine if your patient base is growing or declining is to divide your number of active patients (seen in the past 24 months) by seven and compare the result to the number of new patients you have seen in the past year. If the number of active patients leaving your practice each year is larger than the number of annual new patients, then your patient base is shrinking and may be cause for concern. We recommend conducting a periodic analysis of your active and new patient counts to evaluate the health of your practice and identify trends that may need to be corrected. Enhancing the patient experience and maintaining an effective recall system can ensure maximize patient retention while implementing an internal marketing strategy (asking for referrals from existing patients) and an effective external marketing strategy (such as online marketing or direct mail) can improve new patient flow.
- Consider updating office equipment & decor equipment: Most buyers prefer to utilize newer equipment and digital technologies in their practices. Therefore, practices that have digital radiography and chair-side computers tend to sell quicker and at a higher price than their counterparts. Also, first impressions are important, so practices that do not have a positive “curb appeal” when buyers walk in the door for the first time can lose value and take longer to sell. It is imperative to have a long-term plan for keeping your equipment and facility up to date. The more time you have until the practice sale, the easier it will be to garner a sufficient return on investment from purchasing new equipment and updating office decor. We recommend that you upgrade your equipment and decor 3 to 5 years prior to selling your practice. Keep in mind that you don’t have to do a complete overhaul of the office but simply make investments in the practice to keep it up to date. Your local equipment sales representative can assist you with an assessment of your office and offer advice regarding equipment and facility upgrades.
- Work with a local, reputable practice broker:
Dentists who work with a practice broker can expect to receive a higher value for their office, have a more amicable relationship with the buyer following the sale, and experience much less stress and anxiety during the transition process than their counterparts who attempt to sell a practice on their own. It is also important to work with a broker who has a good reputation, is involved in the local dental community, and is solely representing your interest in the sale.
- Evaluate and raise your fee schedule as needed:
We often work with sellers who have realized consistent annual revenue over the years leading up to the sale but experienced a decline in profitability over the same period of time. In some cases, this can be attributed to the fact that their fee schedule has not been increased in years, resulting in a reduction in net income. Considering that practice value is most heavily influenced by revenue level and cash flow, practice owners should evaluate their fee schedule on an annual basis and make increases to keep up with inflation and rising overhead costs.
- Clean up accounts receivable & credit balances:
It is relatively common to see practices with high > 90 days accounts receivable balances due to the fact that the practice owner has not written off uncollectable accounts in years. While this may be an easy explanation, buyers and lenders may relate a high accounts receivable balance to an issue with the office’s collection rates/policy. Therefore, it is a smart move to clean up accounts receivable prior to beginning the transition process to alleviate any undue concern from potential buyers. It is also important to mention that the seller is commonly required to refund any credit balances or write a check to the buyer for the amount of the credit balances at closing, so these balances should also be cleaned up prior to a practice sale.
- Reduce discretionary write-offs on practice tax returns:
As we previously discussed, cash flow is one of the primary components of practice value. Since buyers and their advisors will utilize your practice financials to evaluate the cash flow of your office, you will want to make it as easy as possible for them to dial in on the true overhead expenses of your practice. While buyers understand that you may be writing off personal or discretionary expenses such as travel, country club memberships, and meals and entertainment through your business, it is wise to minimize these write-offs in the years leading up to a practice transition. If you choose not to do so, be prepared to provide potential buyers and lenders with documentation regarding any personal or discretionary expenses that are being run through the practice.
- Have a contingency plan for death & disability:
Practice value can deteriorate rapidly upon the death or disability of the practice owner. Therefore, it is crucial to have a contingency plan in place should an unfortunate event occur. First and foremost, contact an estate attorney to draft a will. Secondly, notify your spouse, heirs, and/or attorney of the time sensitivity associated with a practice sale initiated by your death or disability. Third, ensure your family knows who to contact to facilitate the sale of the practice. Lastly, make sure that all practice financials and management reports are easily accessible.
By planning ahead and focusing on these key factors, you can rest easy knowing that you will be in the position to maximize the price you receive when it’s time to sell one of your most valuable assets.
McLerran & Associates has the experience and expertise to determine the market value of your practice by completing a comprehensive dental practice appraisal or a short form valuation known as an “Opinion of Value”. Should you have any questions about the valuation process or be interested in ordering a practice appraisal, please don’t hesitate to contact us.