The Top Five Factors Affecting Dental Practice Values

I am frequently asked by accountants and lawyers to comment on the methodology we use to appraise practices. They ask me to explain what factors can affect practice value the most. While a professional appraisal should consider hundreds of items, there are five key elements that can impact upon value the most.

1) Annual Cash Flow

The most significant item when determining business value is the annual cash flow produced. Purchasers look at cash flow with more interest than any other factor. Accountants, credit officers at lending institutions and dental consultants also pay the most attention to this figure. A banker recently told me that annual cash flow (while the purchaser is servicing a debt load equal to 100 per cent of the sale price) is the most important figure when he is reviewing a loan application. A study of the last 100 appraisals I signed indicates that a typical dental practice will have a cash flow equaling 40 to 60 per cent of annual gross income. This figure has been adjusted for non-practice costs such as spousal wages, non-dental supplies, excess travel and continuing education, and “one-time-only” expenses.

2) Annual Gross Income

Annual gross income is the second-highest determinant to value, as it indicates how busy the purchaser will be. This income will indicate the number of days and hours required to produce these fees. The fees charged and types of treatment performed will affect gross, and purchasers will ask many questions about the practice modalities to understand the dentist and hygiene production figures.

I recently sold a practice that chose to use a fee structure that produced average hourly billings of $600 and annual billings of $550,000 on 850 hours per year. This is a classic example of how gross, in relation to fees and philosophy, can create a very profitable practice on a relatively easy workweek of 24 hours. This particular owner took 12 weeks of holidays as well.

While not every practice has patients who will be receptive to this type of fee structure, it certainly shows you why purchasers who only want to work a three-day week must be careful when looking at the style of practice, and think about more than just the cash flow generated. Some dentists have a “psychological barrier” when looking at the size of a practice and, as such, gross income has become the second most important factor in calculating value. In summary, purchasers use gross income to determine their ability to sustain the business and to identify if the business meets with their personal and clinical needs.

3) Asset Value

Asset value, also known as net tangible assets, has a significant bearing upon final price too. I recently had a debate with an accountant who said it doesn’t matter what the equipment is worth – the only number that counts is cash flow. However, two practices with identical cash flow and gross income can have drastically different equipment value.

For example, the practice mentioned above had a total appraised value of $58,000 for the equipment and leaseholds. I recently sold another practice that had the same cash flow and gross income; but this practice used three rooms of very modern equipment, along with intraoral cameras, panorex X-ray, an elaborate computer-imaging system and several other high-tech items, together valued at over $250,000. Consequently, the sale price was about $200,000 higher than that of the first practice. If we had relied solely upon a formula based on the cash flow or gross income to value the practices (as the accountant had suggested) one of the dentists would have sold their practice for well below market value.

4) Patient “IQ”

When I use the term IQ, I am not referring to the standard definition, but simply the ability of a patient to understand and accept any treatment planning delivered by a dental office. Most practices include patients from a wide variety of backgrounds, and it is in a dentist’s best financial interest to ensure they all have a solid understanding of any dental services performed.

In this regard, I am a firm believer in visual demonstrators for patients. Dentists who treat patient education as a cornerstone of their practice are likely to have higher gross revenues and higher annual cash flow. This philosophy was commonly referred to as the “patient-centred practice” by consultants in the 1960s and its tenets still hold true today. Look at most of the continuing education gurus who charge large fees to disclose their secrets: often, the common denominator in their message is to be both a teacher and treatment planner. The theory here is that, in doing so, patients will discover benefits by themselves, resulting in a higher level of case acceptance.

5) Location, Location, Location

Just to emphasize, I’ll offer an example using a five-year-old practice I recently sold. It was averaging 45 new patients per month, and the plaza where it is located is very busy, the space being fully leased from day one. The owner had actually attracted more patients than she could handle because she chose to work only about 30 hours per week. The result was a practice with almost 2,000 patients who were receiving very basic restorative care and little more. The annual billings were about $450,000, which equates to just over $200 per patient/year in fees.

The owner was doing all the new patient exams herself; a very nice gesture, but it consumed two hours of her day on average. The lone hygienist (two on some days) saw one patient every 45 minutes. Overall, this location was fabulous but the owner simply did not have the time to treat all the patients. The new owner will be expanding the hours, and in my estimation, this practice will soon produce fees in excess of $600,000 a year. This example of a superior location adds to my position that gross income alone is a very unreliable method for valuing a practice.

What’s Your Practice Worth?

As of this fall, my company alone has over 150 qualified dentists looking to buy an established practice in the Greater Toronto Area (GTA). The fundamental law of supply and demand will dictate that the more purchasers there are for practices, the higher the selling price will be. I predict thriving practices in the GTA will continue to enjoy very high values for another two to three years. I also predict that purchasers will continue to drive values upwards for those practices that have combined the five most important factors into a smooth-running practice.

If you want to know if your practice measures up to the most valuable ones in terms of these five factors, I suggest you hire a professional appraiser, who will place a monetary value on them for you. If there are any opportunities to increase the value of your practice, a thorough appraisal will identify any areas for improvement. In addition, consultants can assist with the day-to-day implementation of a plan to reach the goals you may have set following an appraisal.

Ontario Dentist – November 2000