Let’s be honest, not many business owners celebrate the idea of undergoing a formal valuation. If you’re looking to sell your practice, you likely have a dollar figure in your mind that you’re eagerly hoping for and would be none-too-thrilled if the end estimate wasn’t close. Striking a fair deal with a buyer remains not only a necessity in completing a transition, but it also appeases the financing entity, such as a bank.
How the Numbers Tell the Story
Evaluating a practice’s income serves as a model for many valuations. Simply stated, the appraiser will gauge the value based on the cash flow. In the case of a dental practice, your production, your service, drives cash flow. Due to their unique nature, dental practices present excellent opportunities for growth and profitability, however they also carry an above average risk. A valuation will observe both the practice and the industry to place a specific level of risk which relates to the ultimate value. Associated risk factors include the practice’s location, condition of fixed assets (building, lot, other infrastructure, etc.), and what the outlook is for the area. What is the current patient base? What is the potential patient base? How does competition factor in?
Effective evaluation not only assesses a current value, but what also try to understand what the value could be moving forward based on the factors mentioned above. Often, a valuation specialist (like NDP) will leverage multiple approaches to fully unlock an accurate business value. For example, comparing pricing and revenue indicators from similar practices serves as common alternative, and is otherwise known as the market approach However, this method is less common (and less accurate), as most dental practices are private, and do not publish their financial information for public consumption.
An asset-based approach will factor in, you guessed it, the business’s assets. Equipment, inventory, and credited amounts owed to the business all comprise a company’s assets. Valuations might look at some or all of these assets to provide a valuation, preferably via site visit. While certain assessments can be made remotely, an asset-based approach should include a site visit. It’s hard to accurately value a company’s inventory if it’s claiming supplies on its balance sheet that haven’t been touched since the Y2K scare. Asset-based approaches are less common in dental practice evaluations, as dentists are service based businesses. If used at all, its when valuing an over-leveraged company in the midst of a turnaround or a budding startup that lacks the cash flow, patients and reputation to support a traditional loan.
As a fundamental practice, we at NDP and many others in the dental industry lean on the capitalization of earnings method under the income approach. This approach values a business by reviewing the historical true cash flows of the business and applying a risk rate to determine an expected value for the business. Basically, what are you willing to pay for a business today that has shown historical and current earnings of X? When acquiring a dental practice, it’s history is the most likely predictor of future success – you aren’t paying for potential, you are paying and valuing what has been. Similarly, the aim of this method is to put a value on the practice as it stands today. This approach is particularly useful when a practice maintains stable earnings over time.
Regardless of the methodology, understanding a practice’s financial situation and what is being valued and offered remains a cornerstone of valuation. This goes beyond revenue or the size of the active patient base, . Effective valuations will also note the overall overhead, break out fixed and indirect costs, administrative expenses, sales and marketing, , and anything else eating into your bottom line. Increasing sales and revenue feel great, unless you incur disproportionate operating expenses, leading to poor margins and a lack of profitability (and therefore a lower valuation).
Lastly, understand your patient mix. Do you predominantly service PPO patients? If so, what kinds of insurance are you credentialed with? Are you primarily fee for service? Do you offer in-house financing? Sources of payment as they relate to service will not only impact the pricing, but also the collections, and reimbursement mix will impact the valuation.
How the Numbers Don’t Tell the Story
While practice valuation remains primarily based on the hard-numerical data, there exist factors that can tilt the valuation results in or out of your favor. For longer-standing businesses, reputation accounts significantly when it comes to value. Word of mouth is now largely digital, and poor service results in a major hit to the earning potential of any practice. If you’re a seller, how do you make up for a lackluster public perception? If you’re a buyer, how hard will you need to work to rebuild goodwill within the community?
On goodwill (the excess amount of the purchase price versus the fair market value of your tangible goods), some valuation specialists will factor in goodwill to the valuation of a practice. However, these values can often fluctuate based on a variety of numerical and non-numerical variables. As a seller, you may have a substantial amount of goodwill on the balance sheet, but this will not always translate to that dollar figure you’re holding onto, as goodwill itself remains largely subjective.
Though financial data largely drives the conclusions that determine value, assumptions can still account for part of the process. Depending on the structure of the practice and thoroughness of its reported financial history, assumptions may account for more or less of these conclusions. Regardless, any comprehensive valuation requires extensive research and intimate knowledge of both the practice and the industry.
The Nuts and Bolts of Dental Practice Evaluation
Don’t be lulled into a false sense of security stemming from armchair valuations or “rule of thumb” based estimates. Anything but a formal valuation conducted by experienced professionals (preferably a Certified Valuation Analyst) will only provide inaccurate information and educated guesses.
Valuations, though stressful at times, can also provide a great deal of insight into your practice. Ensure that post-valuation, the analyst provide you with a comprehensive written report detailing how they conducted the valuation, the findings, and the reasoning behind the end result. This will afford an honest assessment of the practice, present accurate information for sale negotiations, and streamline transition financing.
NDP is dedicated to providing consistently reliable dental practice valuations, guiding you through the process from inquiry to sale. We realize how critical a fair and honest valuation is, so let us guide you by offering free education resources and answering your valuation questions.
