WHAT IS MY PRACTICE REALLY WORTH?

What is my practice worth? Well, it depends on who you ask. Value is largely a concept of perception. According to the IRS, fair market value is defined as “the price at which a [practice] would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, with both parties having reasonable knowledge of the relevant facts.” Although the definition may be stuffy, the concept is sage: the fair market value will be determined by the marketplace and is subject to the economic forces of supply, demand, and transferability.

There are a number of popular “rules of thumb” used by doctors to estimate a rough value for their practices. For example, many practices will sell for a value equal to between 60 to 80 percent of the most recent year’s gross collections. Similarly, a practice value will often fall into the range of 1.5 to 2 times net income, i.e., the doctor’s take-home pay before taxes, plus any expenses of the practice that would be considered as a direct benefit to the doctor. There are other simple formulas one can use to estimate value; however, it should be remembered that these formulas are just that—simple tools used for estimation only. They do not take into account some of the other critical practice characteristics that affect value which will be addressed later in this article.

As a general rule, up to 80 percent of the value of an average general dental practice will consist of goodwill. The term “goodwill” is primarily connected with the existing patient load and corresponding cash flow of a practice. It is an intangible consideration that usually comprises the most valuable asset of any professional practice. It relates to the assembly of necessary equipment into a productive unit; the availability and existence of trained employees; the existence of systems, controls, and methods that are part of the operations of the practice; and the existence of a loyal patient base. Naturally, a practice with a high active patient count in relation to revenues will be worth more than a practice with fewer patients. Thus, the patient-production ratio will have a significant impact on the value of a practice. Another crucial element that affects practice value is specialty or sub-specialty practices which require the buyer to have a certain skill level or philosophy to take over the practice and retain patients.

The value of any professional practice can be summarized as its capacity to generate cash flow. That capacity is made of two essential elements: tangible and intangible assets. The tangible assets consist primarily of clinical equipment, office equipment, furniture, fixtures, instruments, supplies on hand, and so forth.

The intangible assets consist primarily of goodwill, or essentially the relationships existing with patients and referral sources that have been cultured and nurtured over the years, as well as the relationships between the doctor(s) and staff members.

The combination of tangible and intangible assets, when efficiently utilized in tandem, generates a “going concern” that possesses value. That "going-concern" value is best demonstrated by a track record of generating a certain level of cash flow and profit. The method and means by which the cash flow and resulting profits are generated--and in what amounts--determines, in part, the price a practice will likely command in the marketplace.

As a general rule, most appraisers use income-based valuation methods to evaluate a dental practice. This income-based approach is not limited simply to an analysis of the historical financial information of a practice but also takes into consideration many other elements of the practice that contribute or detract from value such as the type, age, amount, and condition of clinical and office equipment and furniture; outstanding accounts receivable balances and strength of financial policy; office fee schedules; supply inventory on hand; management systems; patient profiles and demographics; active patient count; new patient flow figures; participation in discount insurance plans; practice location (both generally and specifically); office lease arrangements; facility size and condition, including tenant finishing; practice type and philosophy; production by treatment class analyses; status and employment history of staff and/or associate doctors; market and economic factors affecting the practice, et. al.

As evidenced by this list, there are a number of elements that can and will influence the value of a professional practice; however, as a general rule of thumb, a general dental practice will typically sell at a price in the range of 4 to 6 times its adjusted net income. By definition, adjusted net income is the net income after operating overhead expenses, not including certain expenses such as interest, taxes, depreciation, amortization, and certain discretionary items, and inclusive of compensation to the doctor, but only at a reasonable, going-market-rate. Practice appraisers often refer to adjusted net income as "Earnings Before Interest, Taxes, Depreciation and Amortization" or “EBITDA.” The EBITDA of a dental practice gives an indication of the current operational profitability of the business. It shows them how much profit the business makes given its current set of assets and operations and the services it renders to patients.

All things considered, few things influence the selling price of a practice more than prevailing buyer perception. After all, a practice is only worth what a buyer is willing to pay for it. A buyer’s perception of value will be influenced by all of the factors mentioned above, as well as general market and economic conditions. That being said, it is a good idea for a dentist who is serious about selling their practice to seek an appraisal by a professional who is both qualified and unbiased, regardless of whether the dentist plans to retain the services of the professional to sell the practice. Doing so will lend substantial credibility to the asking price and make the due diligence process much easier–for both parties.