Accurately Valuing Your Dental Practice

September 27, 2022

Wondering how to value a dental practice? Accurate dental practice valuations are often necessary, but the many methods to calculate your market value can lead to confusion.

We've put together this handy how-to to help you paint a precise picture of what your practice is worth. We'll take a look a the multiple methods available and how you can combine them for a holistic, comprehensive approach to determining your practice's value.

If you're thinking of selling or buying a practice or simply want to be aware of your business's potential worth, read on to learn about the different practice appraisal methods for determining sale value.

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When Do You Need a Practice Appraisal?

Do you need a practice appraisal? The short answer is yes. But when, and for what, exactly?

To give you an idea, we've provided a list below of situations in which dental practitioners would need a current and accurate evaluation of the market value of a dental practice.

  • Buying or selling a practice
  • Litigation purposes
  • Bringing on new partners
  • Mergers
  • Estate planning
  • Hiring associates

To ensure the accuracy of a practice's valuation, it is generally recommended that practice owners and DSOs perform practice appraisals annually.

What Does a Comprehensive Valuation Include?

A complete dental practice appraisal gathers all relevant practice information into a formal written report. The report is typically a short form report (referred to as a "limited" report) which ranges from two to four pages plus any supporting documents. The longer "comprehensive" reports, including supportive documentation, run between 25- 35 pages.

Although both reports require the same analysis and must be dated and signed by the appraiser, the difference lies in the amount of data and information included in each report. The limited report is a summary with little explanation regarding the data or findings. In comparison, the comprehensive report is thusly named as it includes significantly more data and in-depth discussion on determinations.

Various elements are considered when determining a practice's current market value. To come to a fair and precise valuation, you'll need to consider the following contributing factors:

  • Gross Income: The average sum of all earnings. As this is gross income, do not subtract any taxes and deductions.
  • Net Income: The amount of income the practice generates per year, this time minus taxes and deductions.
  • Annual Revenue: The average yearly revenue of your practice.
  • Growth Potential: Your growth potential includes any future opportunity the practice has to increase production capacity and generate more profit.
  • Patient Base: The size of your patient base compared to other dental practices within your area.
  • Patient Attraction and Retention: How well are you attracting and retaining new and existing patients?
  • Practice Reputation: Your overall reputation among patients speaks to how well you are servicing them and if changes are necessary to increase service quality.
  • Staff: The size of your staff and payroll.
  • Discretionary Expenses: Discretionary expenses are any outlay of cash that, although maybe excusable, are not entirely necessary for operations and, therefore, are up to your discretion. This could include office parties, business trips, meals, or entertainment.
  • Equipment Asset Value: You'll need to determine how much your equipment is currently worth, taking into consideration its age and condition. Obviously, 20-year-old equipment will be worth much less than new, state-of-the-art equipment with the latest technology. This could include items such as computers and x-rays.
  • Practice Location: Practice location, including the number of competitive practices in the area and if it's in a High Cost of Living (HCOL) or Low Cost of Living (LCOL) area. 
  • Real Estate Condition: The condition of your property, taking into consideration any necessary essential renovations a buyer would need to perform.
  • Leasehold Improvements: Any physical improvements made to your dental office since its purchase.

Methods of Valuation

As you can see from the above list, there is a lot to be taken into account when estimating the fair market value of your dental practice.

As the valuation methods available do not account for all of the factors within their formulas, we suggest you choose a method most suited to your business to come to an accurate appraisal. Looking at the specificities of your situation, find a method that factors in the elements that will most significantly impact your valuation.

Alternatively, you can use a few or all of these methods and then calculate the average of your final valuations for the most comprehensive result.

That being said, performing practice appraisals can be time-consuming. So, if, for your purposes, a rough estimate of your market value will do, then pick whichever method you feel will be easiest for you to complete.

The Capitalized Earnings Method

One of the more popular income-based methods, the capitalized excess earnings method, examines your current net earnings and considers the value of your anticipated profits to predict your long-term performance.

The method determines your practice valuation by dividing your net present value by a capitalization rate, which, depending on your practice size and type, can fall between 15% - 30%. A smaller practice would likely use a rate between 20% - 25%.

The method does have its challenges, however. For example, future earnings can be tricky to predict and is a major factor in the capitalized excess earnings method. Depending on the age of your practice, you may or may not have enough data. If you're short on historical data, you'll have to complete adequate research to ensure a fair and relatively accurate estimation of future performance and profits.

The method does have its challenges, however. Future earnings can be tricky to predict and is a major factor in the capitalized excess earnings method. Depending on the age of your practice, you may or may not have enough historical data to help you foresee the future. Therefore, you'll have to complete adequate research to ensure a fair and relatively accurate estimation of future performance and profits.

The Net Asset Value Method

Another way to estimate your market value is to total your net assets, including tangible assets (equipment, computers, real estate, etc.) and intangible assets (brand awareness and reputation, intellectual property, patient lists, etc.).

Intangible assets will be more difficult to appraise, so your final valuation may not be as accurate as if you used another method. However, if you know you've performed well in these areas, you may not want to completely disregard it. Instead, we recommend using at least one other method to give you another reference point or a few to average the results.

Annual Net Receipts

The Annual Net Receipts (collections) method measures a practice's value based on its average annual net receipts over the last three years and is stated as a percentage. 

Typically the percentage falls between 50% to 80%. So, for a dental practice with annual net receipts of $1,000,000, value would fall between $500,000 and $800,000. The actual percentage utilized is determined through a comparative analysis of other practices sold in the region or state within the last few years.

Because the method considers collections and not profit, the percentage applied can vary greatly. However, valuing a practice based on collections alone fails to consider operating costs, how effectively the practice operates, and any changes in reimbursement or future receipts. 

Therefore, the method may not be appropriate for many situations, such as setting a sale price or bringing on investors. However, the method is valuable for analyzing collection performance and trends and can be a handy measuring stick.

Average Annual Earnings

Similar to the capitalized excess earnings method, this technique uses the average net earnings available to the business owners, typically averaged out over the last three years. However, it does not take into account doctor compensation as a percentage of doctor production.

A factor is determined by comparing the sales and purchases of other dental practices during recent years and within the same state or surrounding area. The annual net earnings are then multiplied by the factor.

As the method ignores doctor compensation for their portion of production, if a doctor produces a large portion of the practice's overall collections, this method will likely produce a higher valuation compared to the capitalized excess earnings method. 

However, if practice production is generated by other individuals (rather than the doctor), then the capitalized excess earnings method will produce a higher evaluation than the average annual earnings method.

Discounted Cash Flows

This method allows you to calculate your valuation based on estimated future cash flows by looking ahead ten years, forecasting your net income over the next ten years, and calculating the value of the total income adjusted for the time value of money.

To calculate this, determine your expenses and projected growth rate for each year, then multiply them by a discount rate to calculate the present value of your future cash flows. The accuracy of this method may be questioned, however, as the method is heavily dependent on estimating future cash flow.

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