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Determining The Sale Price Of A Dental Practice When It Comes Time to Sell...

Appraising the professional practice is much more of an art than a science. Some appraisers seem to take a "bunch" of numbers, apply some magical secret formulas, and the outcome represents the value of a dental   practice.

There are as many methods as there are appraisers, but the best appraisers will use several methods to cross check the validity of the values they have determined. Hopefully, the following will help solve some of the mystery during the appraisal process.

Appraisal Purpose:

There are many reasons to have a professional practice appraised. The following indicate the most frequent reasons for an appraisal: dental practice sale, partner's termination from practice, associate buy-in, merger of practices, sale to a third party, estate planning, divorce.

The outcome reached in a practice appraisal may be dependent upon its purpose. Each method will usually yield a different value. For instance, if the cause of the availability of the practice for sale is due to the death of the sole proprietor, the appraisal method will be based upon a depreciating method of appraisal. In this instance, the value will rapidly deteriorate over a matter of months if another provider does not immediately step in. A partner termination may be due to a voluntary or involuntary termination of employment and subsequent buy-out of equity interest in the practice. Loss of license, death, or disability may all have different consequences. Frequently, in the event of termination, the method of appraisal will be dictated in the employment and other agreements and the normal rules of appraisal will not apply.

With the advent of practice buyouts by hospitals or other large corporate buying groups, many of the traditional methods of appraisal do not apply. In this instance, the appraised price is driven by the market and tends to be far in excess of normal appraised values. Estate planning always requires a market value approach, and yet, due to the conditions that may be present at the actual time of the sale, the actual sales price and/or new appraisal done at the actual time of the sale may be totally different than the arrived at for estate-planning purposes.

Appraisal Methods:

Most appraisal methods are variations of  four commonly recognized classifications which are: market value, revenue multiplier method, asset summation method, capitalization of earnings method.

Market Value Approach:

This approach frequently blends three different approaches, giving more weight to the approach the appraiser feels is more relevant. The replacement cost of the item being appraised is used, with an allowance for present wear and tear. This is blended with an appraisal based on best use of the item to generate revenue, and the earnings are capitalized to yield a value for the item as an investment.

Finally, the item is appraised using comparable sales. This method relies on the frequency of sale of the particular item being appraised and the ease of comparability of the items being sold. There is, however, not enough comparable sales occurring to allow for the setting of industry standards—and, there is a tremendous demographic effect on the value of practices. Practice sales are available for comparison, but are spread out nationwide. There are a number of variables involved in what is or has been sold, and this often makes a comparison of two sales meaningless. Averaging approaches gives a best guess by the appraiser as to what the practice might be sold for on the open market.

Gross Revenue Multiplier Approach:

The most easily understood and easily taught method of appraisal is the "Gross Revenue Multiplier" approach. This method can be taught in about one hour. It is most widely quoted by practitioners when discussing what their practice value, because it allows an easy comparison of perceived practice value. Although commonly used because it determines value through an easy "rule of thumb," it is the least accurate and most abused method in use. The method takes a percentage and multiplies it times the previous year's gross revenues. The appraiser will say, "Practices on the average are presently selling for X% of last year's gross." However, there can be difficulty in comparing two average sales.

The problem with this method is that the determination of X becomes the "magical variable." Each appraiser has his/her own secret formula for determining X. Many will actually increase their chance of accuracy by giving a range, i.e., "practices have been selling for Y-Z% of last year's gross." Generally, the higher the gross, the lower the net percentage is of gross. Therefore, the GRM approach yields a higher appraisal on a less profitable practice.

The two most accurate methods of appraisal for the professional practice are the "Asset Summation" and the "Capitalized Earnings" methods. Once the method has generated a basic value, there are variable factors that must be applied to either method before the final figure can be determined. A partial list of these variables and their affect on practice value follow.

Asset Summation Method:

The Asset Summation method uses the sum of the present market value of various hard assets, then adds the value of the intangibles—or "goodwill" items. The items commonly valued include equipment and furnishings, supplies (office supplies, clinical supplies, drugs), leasehold improvements, and accounts receivable.

Used equipment and furnishings are generally valued using the estimated useful life of the item compared with its original cost. The supply figure is based upon the total supply purchases for the previous year. Accounts receivable need to be adjusted for aging and costs of collection. Goodwill, whether it is called "goodwill," "client records," "non-compete agreements," represents the intangible portion of the dental practice value. Goodwill constitutes the value of whether a patient will continue to seek services from the new buyer based upon the previous owner’s reputation and recommendation.

Capitalization of Earnings:

This method, the "Capitalization of Earnings" approach, is dependent upon the use of an adjusted income statement. This method determines net profit, subtracts the cost of professional labor, and then determines what the value of the available practice earnings are on an investment basis. Although the most scientific and subsequently most reproducible of the appraisal methods available, there are certain financial practice conditions that may not render an accurate value using this method. This is the reason most appraisers will use more than one method to verify final value.

This method begins with an evaluation of the practice's profit and loss (P & L) statement. There are many legitimate items that can be expensed through the professional practice, but they are not all necessary for the actual production of services. The P & L must be adjusted for all elective expenses, any expenses that could be classified as part of the doctor's compensation package, or which are not necessary for the provision of services. This would include continuing education expenses, pension and profit sharing expenses, personal auto, country club dues, etc. Also subtract the cost of depreciation and interest for practice acquisition or equipment purchases. Lease payments are allowed. Deducting these items yields the true cost of providing services prior to owner compensation.

From this net pre-owner available compensation, the cost of hired professional labor replacing what the owner is producing, must be subtracted. What is left is the true net value of owning this asset, the professional practice. This is the amount of money the asset itself generates. This number is then divided by the capitalization rate, i.e., the expected rate of return given the level of risk the asset has for investment purposes.

Factors Affecting Appraised Value:

The following is a partial list of the other factors that will have an affect on the practice value. This is a partial list containing major things affecting value, such an area's population, employment, and physical location demographics and the method of payment for equity transfer: all cash, bank financed, owner financed, reallocation of earned income, a combination of the above, deferred compensation to seller. Also consider:

Summary and Conclusions:

There are many variables to consider when appraising a practice. The validity of the appraised value determined will depend upon the appraiser's experience.

For doctors who wish to determine for themselves an approximate idea of the value of a practice, using the sum of assets approach is the easiest and best "rule of thumb" guesstimate. The unknown that the doctor will need to determine will be the appropriate multiplier for the goodwill calculation for the practice. However, if the purpose of the guesstimate is to sell part or all of the practice, a miscalculation could cost the doctor substantial dollars. It is clearly in the doctor's best interest to obtain competent professional assistance.

For more information, please contact us with your questions.

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