Understanding the common methodologies used in assessing a practice's value. 

By Dr. Phillip Palmer. 

Estimated reading time: Approx. 7-10 mins.

It’s natural that any business owner wants to know what their dental practice is worth - and dentists are no different from anybody else. They expect that there is a secret handshake formula that can be used under all circumstances, that will give them an accurate read on what they could get for their practice if it was put on the market.

The reality is that no such formula exists, even if there are some common ones used.

Over the years, various methods of appraisal have been used for dental practices. No single method was ever a silver bullet that worked in all circumstances. All of them have blind spots that make them less useful under certain circumstances.

Let's review some of the most common approaches...

Method 1: Equipment plus goodwill

The best-known methodology for valuing a dental practice involves valuing the equipment and the goodwill separately, and then add the two together. The goodwill was commonly valued at 30-50% of turnover, depending upon the risks, location and stability of the underlying business.

Traditionally, this was the main way that dentists bought and sold practices.

What is good about this method?

Valuing the equipment separately like this gives the vendor the sense that they are getting credit for every nut and bolt in the practice.

What are the problems with this method?

1. One would think that the hard assets of a business (equipment and fit-out) are the easiest to identify and to put a precise value to but, in reality, it’s very much the opposite.
   
   Valuing equipment is far from an objective pursuit where two valuers would come to the exact same amount independently. It is something that is a ballpark appraisal, rather than a scientific accounting.

To give you an example of this, ask yourself how you would value a 5-year old ADEC chair or high-end fit-out. Is it worth…

• its replacement value (no…that can’t be right…it’s second hand),
• its depreciated value (…but many people depreciate things fast to get the tax benefit),
• its value on Gumtree (…but surely, it’s worth more in situ than if you have to move it?),
• more if it is well maintained and serviced, compared to one that isn’t (Is the valuer meant to know the working condition of each piece of equipment when they value it?).

2. A well-equipped dental practice that has a history of losing money and no future prospects of changing is not worth the value of the equipment in situ. This is because a purchaser will usually buy a business because of its ability to make money, and not because of how well equipped it is.
   
   

Method 2: Multiples of Profit/EBIT/EBITDA

Most appraisers or valuers of larger practices in today’s market would do exactly what any corporate dental aggregator would do.

First, they would assess the true profitability of a dental practice. This has some relationship to what dentists show as “profit” in their P&L statements in their tax return but, in many cases, that relationship is somewhat tenuous, due to the ‘add-backs’ (expenses of a non-recurring or personal nature as well) and interest, depreciation, etc.

Then they would ascribe a multiple to the profit to determine the practice’s value. The lower the risk inherent in the business, the higher the multiple.

Here are some factors that can assist in lowering that risk:

• The vendor agrees to be contracted to stay post sale.
• If the vendor guarantees turnover, profit or both.
• A long lease on the premises.
• An easy location to attract and recruit dentists.
• If the practice is not ‘key-man’ dependent for income, or anything else.

If the buyer was a private owner operator buyer, they would normally expect to pay a slightly lower multiple of the profit than a corporate buyer, because they would not ask for the same assurances from the vendor post sale.

In many, if not most cases, when a private buyer takes over a dental practice, the vendor leaves, within a year.

What is good about this method?

This method values the practice based upon the benefit it would bring an arms-length investor who is not going to work in the practice.

What are the problems with this method?

1. It only values profit to an arms-length investor. It doesn’t ascribe any value to an owner operator dentist’s high salary.

Take, for example, a dental practice which is turning over $1 million after lab fees. Due to high rent, staffing and advertising costs, the dentist is taking home $390,000, as remuneration and profit.

If we say that a dentist’s market rate salary is 40%, then this practice is actually making a loss. Using the multiple of profit technique, this practice would be worthless and yet many dentists would pay a significant sum for a steady income of $390,000.

2. This method in isolation does not ascribe any value to equipment and fit-out. A brand-new fit-out and a 20-year-old fit-out gets the same price. An adjustment would need to be made for any capital expenditure that would need to be spent on reinvestment shortly after purchase.
   
   

Method 3: Multiple of Owner-Operator Take-Home

This method takes the full take-home compensation of the owner operator dentist (that is, the profit of the business plus the salary/ wage/ commission for their clinical work as a dentist) and applies a multiple to this figure (depending on the situation, it could be anywhere from 1.2 to 1.75).

What is good about this method?

This appraises the full benefit of the business to an owner operator - and most dental practices are being sold to an owner operator.

What are the problems with this method?

1. A non-owner operator cannot use this method, as it ascribes value to the principal dentist’s salary.
2. This method in isolation also does not ascribe any value to equipment and fit-out. A brand-new fit-out and a 20-year-old fit-out gets the same price. An adjustment would need to be made for any capital expenditure that would need to be spent on reinvestment shortly after purchase.

What is wrong with all of the methodologies?

If a valued piece of real estate is taken to auction, it is expected that the result of the auction could vary somewhat from the result on the valuation. Why?

A valuation is usually the work of an expert, based on financial analysis, whose knowledge of the market place includes comparative sales and supply and demand.

HOWEVER, that is not to say that a valuation is ever viewed as an objective truth that can be traded for cash. A level of variation is expected because:

• There are short term variations of supply and demand that influence the outcome.
• There are short term variations in interest rates and global and local economies that can influence the outcome.
• There are sometimes no direct comparatives (this is especially true of specialist or rural practices) to assist with the valuations.
  
  

No one-size-fits-all solution.

Each situation has its idiosyncrasies that might make one valuation methodology more valid than another. This article is intended to give general information to help someone get an idea of the methodologies used to assess a practice’s value.

In the end, of course, the market will always be the final arbiter.

Got any questions? Feel free to email Dr. Phillip Palmer at:ppalmer@primepractice.com.au.

About Dr. Phillip Palmer

Dr. Phillip Palmer is the founder and Chairman of Prime Practice P/L, and a director of Practice Sale Search P/L. He has lectured extensively around the world on practice management topics and has a thorough understanding of all the different management, financial and professional issues that dentists face.

He has been invited to speak about practice management and practice exit planning throughout Australia and New Zealand, in China, Singapore, India and the US. He is regarded as one of Australia’s leading experts in the business of dentistry.

Dr. Palmer has performed many hundreds of market appraisals of value of dental practices for Practice Sale Search over the years and has run workshops through Prime Practice and ADANSW for many years on buying and selling dental practices.