Dental literature often quotes this formula — The value of a dental practice is 60% to 70% of annual collections. Why, then, should dentists pay to have comprehensive, professionally done appraisals of their practices?
No dentist I know would pay a half million dollars for a home built on a foundation of sand. They know the foundation is key to the long-term stability of any building. The money spent digging a deep, solid foundation and using concrete blocks and pilings ensures the overall value of the wood, brick, and mortar built on top of the foundation.
With a typical dental practice selling for $500,000, taking any shortcuts when transitioning this valuable asset can cost a lot of money. This is why I have been paid to do more than 1,500 practice appraisals during the past 20 years. My clients know accurate, comprehensive appraisals are vital to their successful practice transitions.
Why do they know this secret to success, when many of their colleagues do not?
The answer lies in the details. Almost every time the 60% to 70% of annual collections value is quoted, the complete picture is not given. Just as you can’t see the foundation of a home, most dentists do not know that more than two-thirds of dental practices actually sell for 40% to 80% of annual collections.
This means that the actual sale price of a typical practice collecting $800,000 per year can range from $320,000 to $640,000. This is a swing of up to $200,000 from the value determined by the Rule of Thumb method. My clients know that there is no such thing as a typical practice — every one is unique and needs to be valued in that manner.
What are the elements of a comprehensive, professionally done appraisal?
• A thorough analysis of goodwill factors
• An accurate Fair Market Value for individual items of equipment, furniture, and other tangible assets
• Personal inspection of the practice, location, and an in-depth interview with the dentist
• The utilization of both the Market Data Comparison and the Capitalization of
Earnings methods of appraisal techniques
• References to market transaction databases
• A proven track record of values vs. actual sale prices
In my Dental Economics® (January 2007) article titled “Maintaining Practice Income and Value,” I compared two similar practices that each had annual collections of $1.7 million. One practice had an appraised value of $1.2 million; the other $956,000. The higher-valued practice was appraised at 71% of collections; the lower one at 56% of collections; thus a swing of $253,000. Did you notice that both practice values fell outside of the Rule of Thumb valuation technique? Why did this happen?
You probably think that the higher-valued practice had all brand new equipment and a newly remodeled facility. Wrong. The value of the tangible assets for this practice was actually only $206,000, vs. $477,000 for the lesser-valued practice. The key element was the overhead of the practices.
One had an operating income (cash flow profit) of $782,000, the other $476,000. Thus, the owner of the high-valued practice had more than $300,000 of extra cash flow due to the practice’s lower overhead. The value of goodwill accounted for the increase in value for the higher-valued practice.
If a practice appraisal is accurate, it can help the dentist in many ways:
• Accurately valuing a practice decreases the time it takes to sell
• Seller confidence in total retirement assets is enhanced
• The chance for a practice transition failure is greatly diminished
• Obtaining 100% financing is much easier
For example, based on my 400 practice transitions, my appraisals average 98% of the actual sale price. My philosophy is to value a practice at its true value, not an inflated real estate type of value that a buyer is expected to lowball. This facilitates the transition process since buyer/seller negotiations are much more transparent and trustworthy. It also simplifies the allocation of the sale proceeds, thus minimizing
the contentious atmosphere among buyer/seller CPAs and attorneys that can occur when accuracy is questionable.
Remember, the key to a successful transition is a comprehensive, accurate practice appraisal. Build your successful transition on a foundation of facts, not guesses. The financial payoff can be incredible.