“What are dental practices selling for these days?” This a question I am asked every week. Practice owners would like to have a quick way to evaluate the value of their practice and buyers want to know what they will face as they navigate purchasing their own office. There are many different methods used to determine the value of dental practices. Some examples of these include:

Percentage Of Yearly Collection Method

This method is occasionally used by transition specialists, but not usually as the definitive method of practice valuation. Banks, however, use it all the time to evaluate their willingness to approve a loan for the purchase of a dental practice. An example of this type of valuation method would be something like this: A particular practice collects $1,000,000/year and it is determined that practices should sell for 70% of one year’s collection. This means that this practice is worth $700,000. While this method is used especially by banks and non-transition specialists, it can be wildly inaccurate. This is because it does not take into consideration profit, which is the most important aspect of the value of a dental practice

I did a study a few years ago of the last 50 practice sales I had been involved in. When I calculated what percentage the “average” practice had sold for it turned out to be 65.7%, not far from the industry standard at the time of 67%. What was more interesting though was the differences in percentage of yearly collections that those 50 practices actually sold for. The highest percentage that a practice sold for was 104 % of collections and the lowest was 48% of collections. Of the 50, only 7 had sold for between 62%-69% of collections.

Using this example, this $1,000,000 practice would have been worth $670,000 using the industry standard at the time. What if the practice had a yearly profit of $200,000? Most, if not all, of the potential buyers, would not be willing to pay $670,000 for a practice collecting $1,000,000 with a profit of only $200,000 and most banks would not finance that purchase. But if the yearly profit was $500,000 most buyers would gladly pay $700,000 for that practice and banks would be beating down the door to provide financing.. You can see the inconsistency with using the percentage of yearly collection to determine practice value.

Capitalization Of Earnings Method

This is a very complex method of value calculation involving prevailing interest rates and expected growth rates of the practice along with net present value. While this is not often used, when it is used it usually to determine value in divorce situations and for practice valuations for estate purposes. In today’s market it has very little correlation with the value of a dental practice for purposes of sale. It should not be considered when trying to determine the value of a dental practice for purposes of a practice sale.

Multiple Of Net Method

In this valuation method, the net (Profit, EBITA, or other term to denote practice profit), is multiplied by a standardized multiple to determine practice value. An example of this type of valuation would be to look at our mythical $1,000,000/year practice that has a profit of $400,000. By some calculation, let’s assume the multiple is determined to be 1.75. Then the practice value would be $400,000 (net) multiplied by 1.75 (the multiple) and the value would be $700,000. This method while it is more accurate than the methods discussed above still does not take into many of the factors that go into what makes up the true value of any given dental practice, which differ from practice to practice.

Other Methods

I mention “OTHER METHODS” because it seems like there are about as many ways to value a dental practice as there are practices to be valued. Most times, the “OTHER METHOD” valuation will be based on something like this: “My dental school classmate has a practice that is a little smaller in size to mine, with older equipment, and he got $700,000 for his so mine must be worth at least $700,000. Obviously, this type of method should never be used.

When I talk about the value of a dental practice, I am talking about what the practice would sell for on the open market at the time of the valuation. I term this Market Valuation Analysis (MVA). Unfortunately, there is no easy, quick, 3 step method to determine the MVA of a dental practice. We can determine a range of MVA in a few minutes but the true MVA takes more information and study than a quick 20-minute discussion will provide. What is important to keep in mind is that while other valuation methods have their place, when it comes to selling a dental practice the only method that will work in the case of a practice sale is the MVA method. What good does it do for the seller to use the Capitalization of Earnings Method and believe their practice will sell for $700,000 when the MVA method results in a valuation of only $500,000 and $500,000 is all any buyer would be willing to pay or any bank would be willing to finance? It does no good to “believe” your practice will sell for more than it actually will. On the opposite side, if the buyer uses the Percentage of Yearly Collections and thinks the practice is only worth $500,000 and the MVA is $700,000, they will be frustrated when their $500,000 offer is not accepted by the seller. That is why the MVA is the only accurate way to determine practice value. I always try to emphasize, a win-win transition is always the best for both sides. I rarely see a situation where a seller or a buyer wants to take advantage of the other side in a practice transition. But I often see situations where one side fervently believes their valuation method is accurate and the other side’s is not.

Now let’s look at what the MVA is and how it is computed. This method has a lot in common with the Multiple of Net Method in that it strives to determine the true profit of a dental practice and then uses a multiple of that number to determine value. But in the case of MVA, the multiple is determined by what I like to call the Desirability Factor. It is not just a standardized number. The Desirability factor is a combination of specific factors and what similar practices are selling for in the market at the time of valuation.

It should be stated that true practice profit is NOT what shows up on your federal tax return. True practice profit is determined by what is called normalizing expenses. The best way to define expense normalization is to say any given expense is evaluated as to whether a new practice owner would have to pay that expense to operate the dental practice. Obvious examples of expenses that a new practice owner would not have to incur but are listed on the seller’s tax return as deductible expenses are items like depreciation, interest on debt, owner compensation, and staff benefits that were for the seller. Less obvious items to be looked at are continuing education expenses or personal expenses that are deducted from the office expense category. The list of items where profit can be hidden is long and it takes a trained eye to identify them. Once true profit is determined then to calculate MVA, we need to multiply practice profit by a multiple.

As stated earlier, this multiple is a reflection of the desirability of the practice. At The Houlihan Group, we use ten factors to calculate this multiple. These are:

• Location of the practice
• Demographics of the patient base
• Hygiene numbers both as it relates to the number of active patients on recall and hygiene collections
• Procedure mix of the practice and what procedures are referred out
• Clinical schedule of the office
• Staff makeup, staff member pay scale, and the likelihood of the staff staying with the practice after a sale
• Number of new patients seen and existing marketing plan
• The nature of the seller’s transition plan and how much help will they provide to the new buyer.
• The condition of the equipment and will any new purchases be necessary for the new buyer
• THE PREVAILING MARKET CONDITIONS FOR THAT PARTICULAR PRACTICE.

Of the factors mentioned above, nothing compares, when it comes to importance as the practice location and prevailing market conditions.  At present rural practices generally have higher collections, much higher net profit, and much more favorable clinical schedules than practices near larger metropolitan areas but their desirably factor is much lower than suburban practices because of their location and the fact that most of todays practice buyers are not interested in living in a rural area.

As an example, we can use our mythical $1,000,000 practice that nets $400,000. It would most likely sell for between $850,000-$950,000 if it was located in Ann Arbor or West Bloomfield. It might sell for between $650,000-$700,000 if it was located near Jackson or Mount Pleasant. While I can and often do make the case that Jackson or Mount Pleasant is a great place to practice, I seldom see many younger dentists that agree with me. Many of today’s younger dentists are not willing to move to new locations no matter how good the practice is. They have established a lifestyle and routine that does not include moving their family no matter the quality of the opportunity. I try to also make the case rural practices will have much less competition from corporate dentistry in the future which will affect not only work schedules but also staff costs, facility costs, and thus future profitability.  If you are in a metro location you will be forced to compete with our corporate colleagues if you want to survive and thrive financially. Even with the advantages of rural practices as it stands today, all things being equal, a rural practice is simply worth less than a practice in the desirable metropolitan suburb.

In addition to location the other factor having an over-sized impact on practice value is the Prevailing Market Conditions. Currently, dental practices are selling at a premium. The causes of this are numerous and varied. Competition for larger practices from our corporate competitors has driven up the sales prices of all practices, even the smaller ones, particularly if they are in the more desirable locations. The multiple of practice profit used to calculate MVA before 2018 was between 1.4-1.9 while now it is much closer to 1.7-2.3. As mentioned, there are a multitude of factors for this but they all come down to the law of supply and demand. Many more dentists are looking for practices to buy and when you add that to the competition from corporate actors, it means there are many fewer practices on the open market when compared to the number of buyers wanting these practices. This means that practices are selling for more than they did 5-10 years ago.

In summary, determining practice value is somewhat a nebulous exercise, as much art as science, but the only method that is a truly accurate predictor of what a given dental practice will sell for is the Market Valuation Analysis. Any potential practice seller should be aware of what their practice is likely to sell for and make their transition plans accordingly. Practice buyers should be aware if their practice search is limited to very specific areas, it may take a very long time to find the practice of their dreams due to the law of supply and demand and when the do find the practice in their specific location, they will need to be willing to pay a premium for that practice. A transition specialist can help you with your search and evaluate practices you are considering for purchase.