On a daily basis, I am asked by accountants and lawyers to comment on the methodology that we use to appraise dental practices. They ask me to explain what factors affect practice value the most. While a professional appraisal should consider hundreds of items, I believe there are five key elements that impact practice value the most: cash flow, gross income, asset value, patient profile, and location.
The most significant item, when determining practice 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 reputable 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% of the sale price, is the most important figure when he is reviewing a loan application. A study of the last 100 appraisals I have personally signed, indicates that a typical dental practice will have a cash flow of 40% – 60% of annual gross income. This figure has been adjusted for “non-practice” expenses such as spousal wages, non-dental supplies, excess travel and continuing education and non-reoccurring expenses.
Annual gross income is the second major determinant of value, as it indicates how busy the purchaser will be. Gross income will indicate the number of days and hours that are required to produce these fees. The fee guide used, and the types of treatments performed will affect gross income 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 guide that is 30% higher than the suggested fee guide. This produced average hourly billings of $600 and annual billing of $550,000 on 850 hours per year. This is a classic example of how gross income in relation to fee and philosophy can create a very profitable practice on a relatively easy workweek of 24 hours. This particular owner took 12 weeks of holiday as well.
While not every practice has patients who will be receptive to this type of fee structure, it certainly shows why purchasers who only want to work a 3-day week must be specific when looking at the style of practice and not just how much cash flow they will make.
Some dentists have a “psychological barrier” when looking at the size of practices, and as such, gross income is the second most important factor in calculating value. In summary, purchasers use the practice’s gross income to determine their ability to sustain the practice and to identify if the practice meets their personal and clinical needs.
Asset value, also known as “net tangible assets”, has a significant bearing upon practice value. I recently had a debate with an accountant who believed that it didn’t matter what the equipment was worth and that the only number that counted was cash flow.
Two practices with the exact same 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. However, the second practice used three rooms of very modern equipment, along with intra oral cameras, panorex x-ray, an elaborate computer imaging system and several other high tech items valued at over $250,000. The sale price was roughly $200,000 higher for the second. If we had relied solely upon a simple formula based upon 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.
When I use the term patient profile, I refer to the ability of the patients to understand and accept treatment planning delivered by the dental office. In other words, some patients are more educated and possess the financial resources to pay for un-insured services, while other patients may be totally dependent upon insurances or social assistance to pay for their dental care.
A dentist cannot change the social structure of his patients, but he/she can change the way a patient learns about dentistry. I am a large believer in visual demonstrators for patients and I believe the dentists who focus on patient education, as a cornerstone of their practices are likely to gross higher fees, and earn higher annual cash flow. This was commonly referred to as the patient centered practice by consultants back in the 1960âs and it still holds true today. Look at most of the continuing education gurus who charge large fees to learn their secrets. The common denominator in most of their messages is to be both a teacher and a treatment planner and the patient will uncover the benefits by themselves, resulting in higher case acceptance.
The last key element impacting value is location, location, location. I just sold a five-year-old practice that was averaging 45 new patients per month. The plaza is very busy and has been fully leased from day one. The owner had actually attracted more patients than she could handle because she chose to work only 30-32 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. This equates to just over $200 per patient, per year in fees.
The owner was doing all the new patient exams herself, a very nice gesture, but this consumed two hours of her day on average. The hygienist (two on some days) saw one patient every 45 minutes. This location was fabulous but the owner ran out of time to do all the potential patient treatments. The new owner will be expanding the hours and I believe this practice will produce fees of $600,000 + per year in no time at all. This example of a superior location demonstrates my position that gross income alone is a very unreliable method for valuing a practice.
As of this fall, my company 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 available practices, the higher the selling price will be. I predict that thriving practices in the GTA will continue to enjoy very high value for another two to three years. I also predict this demand may drive values even higher for those profitable practice selling that have combined the 5 most important factors into an efficient and profitable practice.
When it is necessary to determine the fair market value of a dental practice, the five factors should be the very minimum that are taken into account by the professional appraiser. Every dentist employs a unique practice philosophy. Therefore, appraised fair market values may vary substantially, yet these factors will address the key issues that all dentists should understand.
IBA – September 2002