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Thursday, December 5th, 2013 | by ADS - Practice Transitions Made Perfect (TM)

When Is an Appraisal Not an Appraisal?

Why you need to know the difference

by Paul Rang, DMD, JD, and Greg Auerbach, MBA

The question, “Do I need an appraisal?” often comes up when working with sellers, buyers, or even clients entering into partnerships, litigation, or estate planning.

It is important to define the term appraisal. An appraisal is a formal opinion of value based on all the pertinent information available about the subject (a dental practice). There are many components, including gross and net income, fee schedule, staff information, insurance participation, active and new patient count, procedure mix, demographics, and market issues. Appraisals can be oral or written, but they must be based on all relevant practice information.

Some brokers and consultants offer a “free appraisal” of a practice when seeking to represent a seller, but more often than not, this is an “opinion of value” based on a “rule of thumb,” not an “appraisal.” So what’s the difference?

Using a “rule of thumb”

A rule of thumb uses limited practice information and applies an arbitrary multiplier to arrive at a value. The most common examples are: practices worth “70% of collections” or “one times net income.” Neither of these are an accurate representation of practice value.

Why? Consider two practices, each collecting $1,000,000, one with 50% overhead, the other with 80%. Applying the “70% of collections” rule, both practices should be worth $700,000, but in reality, the practice with the 50% overhead is significantly more valuable (larger profit). Similarly, if one practice is state-of-the-art and a second is old and out-of-date, the first is worth more.

Formal appraisal

This includes reviewing all the pertinent practice information and providing a written report. The report can be comprehensive (50 to 70+ pages plus supporting documentation), or a short report (two to four pages plus supporting documentation). Both reports use the same data analysis, but the comprehensive report contains significantly more discussion beyond a simple summary. Both formal reports must be signed and dated by the appraiser.

So why is this important when choosing a transition specialist?

Unfortunately, there are specialists who will tell a seller what he or she wants to hear in order to engage them as a client. If the seller thinks the practice is worth $500,000, but an official appraisal suggests $350,000, the seller will be more inclined to engage the broker who suggests $500,000, even if the broker knows the practice will end up selling for $350,000. And, the broker has a contractual period, usually a year, where the seller is obligated to work with that broker.

An honest broker will tell you what the market is for your practice and, by doing a proper analysis, give you a realistic selling price. The appraisal does not have to be in the form of a written report, but the analysis that the broker performs should include all of the pertinent information that would go into a formal written report.

In all, since your practice is one of your most valuable assets, doesn’t it make sense that you would want to know its true value? We encourage all dentists to periodically have their practices appraised as an element of their net worth, for their exit strategy planning, and for estate planning purposes. Besides a value, the process can turn over rocks and open shades on your practice that could allow you to be more effective, efficient, and profitable, now and in the future. Not only does this help you in the short term and allow you to sleep better at night, but it could also be a long-term plus for you, your family, and your retirement.

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