The Value of a Valuation

For some, a valuation is a mystic novel of unnecessary words, numbers and calculations only to be understood or decoded by those who are financially trained.  If you have had the opportunity to review more than one valuation you know that they run the gamut – some are very descriptive,  some have extensive charts and graphs and most have varying degrees of detail about the practice being valued.  If you find yourself in the situation to buy or sell a practice, what you will also find is that this “cryptic” and sometimes confusing document can also bear significant weight in the practice transition process.  It is used by banks and advisors on both sides of the transaction and in most cases, greatly influences the asking price of the practice.

So while  the formal valuation is often seen as a critical component to the process, often buyers and sellers are left looking at a thick booklet and an uncertainty to “what does this really mean” and “how do I trust it”.  First, it’s important to understand that the formal valuation does need to be formal.  An appraiser and valuation company, like NDP, are held accountable for the opinions set forth in the formal valuation, so it’s important that what is known, not known, what has been assumed and what has been presented as fact to the appraiser is clearly spelled out. This unfortunately often leads to more words than you (or us!) would typically prefer.  Regardless of length or formality, in the end, NDP believes a valuation should tell a story about the practice and allow the reader to feel comfortable with the resulting value.

So what do you need to know……

All industries are different and have different factors that have to be taken into account during the valuation process.  There are generally three accepted valuation approaches you may see:

1) Asset Approach – this approach looks at the assets and liabilities of the practice and attempts to assign a value to the company based on the net value of the assets.  Although dental practices generally do have investment in dental equipment and other tangible assets, a dentistry is more of a service driven industry that can be profitable and have value) regardless of the actual value of the assets.  There are times when the asset approach may be appropriate, for example, in the event of a start-up practice.  If a start-up was looking to sell before a historical cash flow could be established, the value of the practice may be more representative of the recent investment made in the equipment.

2) Market Approach – this approach looks at comparable sales in the open market and attempts to value the company in question based on pricing relationships  (revenues to price, earnings to price, etc.) of similar companies sold.  This is the method that most are familiar with as its used in the real estate market and in assessing publicly traded companies.  Because most dental practices are private, the amount of comparable data is often limited and the reliability of that data isn’t as available.  Can you compare a general practice in rural Indiana with collections of $500K to a practice in Dallas with collections of $1.5M?  Maybe, but maybe not.  in our experience, because of this lack of data, this approach is often used as a “check” and not used as the primary method of valuation.

3) Income Approach – this approach is used for professional service companies, such as a dental practice where the services provided, rather than the sale of a tangible product, drives the cash flow and that cash flow, or benefit stream, drives the value.  This isn’t to say that the assets of the company aren’t included or valued – they absolutely are, the assets are just seen as the mechanisms for the production of cash flow rather than the driver of the value as with the asset approach. In this approach the risk of the company is calculated by assessing the risk of the overall economy and market, the industry and the specifics of the practice being valued. This calculated risk rate is applied to the cash flows to provide a value.  We believe this approach results in the most representative calculation of value for a  dental practice and therefore utilizes the income approach in most of our valuations .

As a buyer or seller of a dental practice you should also understand that, while the detail surrounding the national and local economy or the outlook of the dental industry aren’t exactly an exciting read, they are incredibly relevant to the risk of your practice and therefore a critical component in the valuation process.  So cozy up and read up!

The lack of information in a formal valuation can also be important!  Did the appraiser review pictures of the practice or have a site visit?  Did the appraiser have the seller complete a questionnaire or profile that provides specifics of the practice?  Is there information about the insurance ratios, patient make-up, staff history, and local competition?  What improvements have been made in the last 5 years? What is referred out?  They say the devil is in the details, so while the big picture of a valuation may be the same practice to practice, each practice is different and an appraisers analysis should include all the specifics that make-up that larger picture.  In other words, the more you know the better.

So what’s the value in the valuation?  Overall, the valuation can be a really helpful tool to understand the practice and the potential investment,  but only if the appraiser has taken the time to understand the dental industry, the unique aspects of the practice and have provided a formal report that provides their full analysis and  transparency into their process. So what if you feel like you didn’t get this information or think your valuation may have not covered all the areas? 

Ask the questions! 

Knowledge allows you as a buyer or seller to feel confident as you move forward with the biggest investment (or sale) in your career!

Read more about NDP’s valuation services here!