Each dental practice is unique, and each has many differentiating factors to consider when determining the true value. Knowing the value of your practice, how that value was arrived at, and how to maximize that value are important value drivers for practice owners.
Arriving at a value for your dental practice is an integral part of your succession and retirement planning. Get a valuation in time to make changes that could impact your sales price.
Valuing a Dental Practice
For a true valuation, there is a purpose, standard, and premise to the value that is assigned. You must understand the purpose of the valuation first before you can arrive at an accurate number.
In the marketplace, there may be misconceptions about the value of a practice if you do not understand the purpose, standard, or premise (i.e., the background) of how that value was calculated.
There are three approaches to valuing a practice:
1. Income Approach
When you value a practice, you can look at the income and cash flow of the entity. This is done under two main methods:
Capitalization of Cash Flow Method
This method converts a company’s income stream into a value by dividing it by a rate of return that is adjusted for growth (capitalization rate). This method is used for a mature practice that expects long-term, stable cash flow into the future.
Discounted Cash Flow Method
This is a multiple period valuation model that converts a future series of benefit streams into value by discounting them to present value at a rate of return that reflects the risk inherent in the benefit stream.
2. Asset Approach
This is a blend of appraisals and an income or market approach. Basically, you're breaking apart all of the assets of the practice and calculating the value of the pieces to get the total value.
3. Market Approach
This approach looks at comparable sales in the marketplace to see at what price other similar practices have sold.
Valuing a practice is also determined by the tangible and intangible assets of the practice. What are the tangible assets in a practice and how can you measure/calculate them?
- Accounts Receivable – There are two ways to calculate accounts receivable as part of the selling price. It can be determined at closing using current receivables as well as the practice’s historic collection percentage. Or there can be an arrangement where the accounts receivable is paid out as they’re collected for a period of time (typically in the 6-to-12-month range) after the sale.
- Supplies – The common method for the supplies of the practice is to look at one or two months of the prior twelve months’ expenses as the value of the inventory on hand.
- Equipment – This is a difficult category to value because you do not know the state of the equipment. Is it brand new? Is it all digital? Is it old equipment and everything is on paper? If there are large pieces of equipment, an appraiser should be brought in. Most often for dental equipment, the straight-line depreciation method is used with a 12-year life. At the end of that time period, the equipment would then be appraised at a salvage value (typically 10% of the historic cost).
- Leasehold Improvements – This category is often valued with a similar methodology as equipment. However, leasehold improvements may have a life of approximately 15 years.
- Building – The building is a non-operating asset so if it’s part of the sale, an appraiser should be brought in to value the building separately. Buildings typically have a very consistent cash flow and they could be valued in different ways (i.e., not at the same multiple as the practice).
What are the intangible assets of a dental practice?
- Goodwill – This is the right to earn income off a block of patients in the future. You’re essentially buying the income stream. Typically, for a general dental practice, the range of goodwill is approximately 1-1.5 times one year's net income before dentist compensation (i.e., the collections of the practice less an adjusted normalized overhead).
- Covenant not to Compete – This is an agreement where one party promises not to compete with the other party in a specified area for a certain period of time.
Determining the Practice Price
What you are selling impacts the value you can receive from your practice. There are two ways to determine the selling price of a dental practice:
- Asset Sale – The practice price can represent all or any combination of the tangible and intangible assets, but it excludes the liabilities.
- Stock Sale – In this method, all assets and all liabilities are included.
The biggest difference between these sales methods is an asset sale will often result in a higher price because only the assets are included, not the liabilities. A stock sale includes everything in the practice – assets, liabilities, and even contingent and past liabilities you may not be aware of.
In general, it is recommended that buyers shy away from a stock sale, unless it is a situation where you are already part of the practice and are comfortable that there are no hidden liabilities.
The seller would prefer a stock sale from the liability standpoint, but it's also a tax issue. When you are selling the assets of the practice, depending on the asset mix, there are different tax rates that go along with the sale.
Ordinary income is a portion of the sale, and it will be taxed at your marginal income tax rate as an individual. Then there will more than likely be capital gains associated with the sale. This results in a blend of ordinary and capital gains rates.
To receive the highest price possible, how do you increase the value of your dental practice? The following value drivers can help:
1. Top-Line Revenue Growth Over Time
Consistent steady growth in top-line revenue is very attractive to a buyer.
2. Healthy and Consistent Level of New Patients
Buyers want to feel the practice is vibrant, you're attracting new patients, and that the infrastructure is in place for those patients to continue to come to the practice after the seller leaves.
3. Services Provided by Seller
Are there services you are currently referring out (i.e., endodontics, periodontics, orthodontics, etc.) that you could be doing in-house? Buyers of dental practices are trained and are doing those services themselves, so they view that as a positive revenue enhancer to your practice, which in turn increases the value of your practice.
Specifically in general dental practices, the relationship between hygienists and patients is vital. So, the longevity of staff can affect the value of a practice.
5. Facility Lease Transferability
If, for example, your practice has a five-year lease in a prime location, a buyer may want to make sure they have the ability to stay in that location and capitalize on it. It’s important to watch your leases and ensure you have a clause to assign your lease to a potential buyer.
The quality of the practice’s equipment and furnishings can impact the value of the practice.
7. Active Patients
Many buyers will want to know the number of active patients seen in the prior eighteen months because it gives a glimpse into patient growth. If, for example, there is a high consistent new level of patients but there is no revenue growth or an increase in active patients, then there may be a potential problem in the practice.
Revenue less overhead is an important component when valuing goodwill, or if using a multiple of the operating profit.
9. Transition Plan of Seller
As a seller, are you willing to stay on to help transition the patient base? Do you plan on leaving immediately? Are there any issues that might prevent you from staying on in the practice and working? Having a clear transition plan can have an impact on the practice valuation.
10. Payer Mix/Contractual Discount Level
If your practice is not in the network and doesn’t accept discounted plans, that may be a negative factor for some buyers if they know they will have to absorb those discounts.
11. Fee Schedule to Market
Make sure your fee schedule is up to date because if it is not to market, you're leaving revenue on the table which can affect top-line revenue growth.
Get Your Practice Ready for Sale
Now that you have an idea of what your practice is worth and how you can increase that value, what should you focus on next? Here is a checklist of what to do three years prior to the sale of your practice:
- Maximize Production and Revenue – This will drive your top-line growth. If you're working off an income multiple to determine value, it's going to increase your practice price.
- Cut Overhead – Now is the time to cut any unnecessary overhead. Doing so will create more profitability in the practice which will be used as a determining factor for valuation.
- Focus on New Patient Growth – It’s important to cultivate a vibrant healthy practice.
- Lease Considerations – Work with your landlord to get a transferability clause to assign the lease to the buyer.
- Improve Office Aesthetics – Present an attractive and healthy picture of the practice to the buyer by cleaning up the office aesthetics.
- Assemble a Quality Support Team to Assist in the Sale – A skilled advisory team can make sure you get the most for your practice.
- Prepare To Be an Advocate for Your Practice – Know the positives of your practice and why a buyer should purchase it over another practice. Be an advocate, be prepared to have that information available, and be a salesman for your practice.
Assemble Your Advisory Team
An experienced advisory team can help you with the valuation and sale of your dental practice. A team of advisors can guide you on strategies, tactics, and all the documentation you’ll need for a successful transition. SVA Dental Services strives to help practice owners identify and prioritize their objectives with respect to their business, their employees, and their family.
If you are ready to talk about your goals for the future and get insights into how you might achieve those goals, we would be happy to sit down and talk with you. Contact us today.
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