An understanding of the value of a dental practice is essential not just for those considering a transition, but for any dentists attempting to accumulate wealth for their retirement. All dental practice owners need to understand the true investment earnings (EBITDA-earnings before interest, taxes, depreciation, and amortization) of what is often their single largest investment asset: their practice. If this asset is under-performing, addressing the issues that are causing any less-than-desirable results is the single greatest wealth-building strategy available to a private practice owner.
EBITDA is a hybrid market/income approach to valuation used in the investment community. It is a measure of expected cash flow that is available to investors before taking into consideration debt and capital expenditures. In recent years, dentistry has become an attractive target for financial investors, private equity funds, and corporate roll-ups that are searching for dividend-paying (cash flow) investments greater than the traditional debt and equity markets. EBITDA is the primary yardstick these investors use to determine the market value of dental practices.
The first step in calculating EBITDA is to differentiate between what the owner/dentist earns for tax and personal reasons as opposed to what an investor can actually do. The income and expenses of the subject practice must be carefully examined. Revenues and expenses are “normalized” to exclude non-cash expenses, elective expenses, creative expenses, unusual items, and items not necessary to operate a dental practice (i.e., depreciation, interest, personal insurance, automobile expenses, etc.). After making these necessary adjustments, the result is a revised true net profit for the subject practice.
The second step is to determine the investment earnings of the subject practice. Practice owners receive compensation not only for producing dentistry, but also as a return on their investment. The only expense not yet covered in the above calculation is the expense to provide the dentistry. The owner of a practice must be compensated a “fair salary” for services provided to patients. A figure of 30% to 35% of collected revenues for services provided to patients is typically a fair and comparable salary for a general dentist. Specialists tend to command a higher percentage and/or a per diem.
From the normalized net profit determined in the first step, subtract the compensation for the services rendered by the owner in the practice to determine the investment income to the owners of the practice. This is EBITDA.
If EBITDA is negative, this means the practice owner is taking home less income owning the practice than if he or she were an associate without any of the risks and/or investment of time, money, and energy. Positive EBITDA is the free cash flow that is a marketable asset and which holds significant value to the owner, investors, and other dentists.
In a solo practice, EBITDA can range from a negative number to hundreds of thousands of dollars annually. EBITDA is the financial engine that provides the capital to fund retirement contributions, acquire other assets, and build true wealth. By reviewing EBITDA on your own or with a financial professional, you will have a better handle not only on the value of your practice, but you’ll also be able to address the issues that might be reducing EBITDA.