I recently met with a young dentist who asked if it was better to invest his money into buying or setting up a new practice, versus staying as a career associate and buying other income-producing assets.
I performed a brief analysis of traditional investments compared to the average annual return from a dental practice, and concluded that a dentist will earn a higher rate of return on capital employed in dental practice ownership compared with most other investment vehicles.
Let’s use an established dental practice that grosses $400,000 per year as an example. Most dentists manage to pay off their set-up or purchase loans and equipment leases within eight years of start up. For this calculation, the total time in ownership is 28 years, and I assumed that operating expenses (true overhead) are 60 per cent of gross, and the owner draws 30 per cent of annual gross ($120,000 per year) in salary. After the debt is retired, the annual profit is 10 per cent of gross income, or about $40,000 per year, for a term of 20 years. For comparison, it requires about $800,000 in cash investments to generate $40,000 per year in pre-tax profits, at a five per cent rate of return.
I then would calculate the net present value (NPV) of an income stream of $40,000 per year for 20 years, using an expected rate of return of five per cent. The resulting NPV, in 2003 dollars, is $498,000. Investment experts often use this type of calculation and it suggests that $500,000 is a rational sale price for this practice. Unfortunately for the owners, the average dental practice does not sell for more than its annual gross, but a select few have indeed sold for more in the past year.
When I study actual, open market sales figures for the typical dental practice, and factor in the initial capital that was required to create that practice 28 years ago, as in the sample calculation, the actual rate of return is well in excess of five per cent for today’s sellers. This is due to current sale prices compared to the initial cost ($25,000 to $50,000) to set up back in the late 1960s and early 1970s. Set-up costs then began to increase, and combined with the declining average time of ownership (roughly 15 years for females and 25 years for males) the rate of return decreases. Within a decade, the average number of years in ownership will likely be less than 20 years for all dentists, as this trend is already emerging.
A typical practice sale price in 2003 will be about $350,000 to $450,000. If the trend of the last 30 years continues, will practices sell for millions in the year 2030, when some of today’s graduates will be selling? Unfortunately, I doubt that they will.
With the upcoming surge in the number of practices that will be for sale, and the resulting drop in practice values, the dentist who buys a practice today may experience a marginally lower rate of return when compared with the previous generation, yet the security of the investment should continue to be high and the risk mitigated.
The best dental practices will likely continue to sell for as high as one year’s gross until the year 2005. After that, and assuming the trend towards early retiring baby boomer dentist emerges, practice values will begin to decline somewhat and they will be selling in the range of 30 to 80 per cent of annual gross with prices trending, over a five- to 10-year term, toward the lower end.
There are many intangible benefits of ownership, and they are uniquely different for everyone, yet ownership continues to be one of the top objectives of graduates. Some buyers tell me that they prefer ownership mostly for job security, due to the ever-present uncertainty of being an associate.
There are risks associated with all investments. However, a dental practice should deliver a highly predicable return for many years, reducing the risk. I also believe that this income stream is secure because the dentist is in sole control of the business with little or no outside influences.
With all the investment options in mind, a dental practice is one of the best investments that a dentist can make and will remain so for many years to follow, regardless of the trend towards lower valuations.
Ontario Dentist – June 2003