Dental Practice Valuations – April 2008
When a dentists faces legal or business situations such as divorce, selling a practice, adding an associate, buying liability insurance or estate planning, it is necessary to be able to place a value on a dental practice. While hiring a business valuation expert is important, often dentists want to determine the approximate value of assets in the practice. There are several areas of the practice that can be calculated to help estimate the value of a practice using this method.
Dental equipment value is generally the value of the equipment in place and functioning rather than the amount that a dental dealer would be able to obtain when the equipment is removed and resold. The minimum value of this equipment is usually considered to be between 15-35% of the original cost of the equipment, and a standard of 25% has been used as the minimum base value by some experts, with a useful life of 15 years (see William P. Prescott, Business, Legal and Tax Planning for the Dental Practice, 1994, p. 236). Thus a straight line depreciation of 1/15th of the original cost of the equipment per year can be used as an alternative to the 25% minimum base value. The value of the equipment can be lessened or increased by such factors as adaptation to new technology, increased records of maintenance, and layout and functionality of the treatment room. Office equipment such as computers or telephone systems can be valued using a similar system to the one used for dental equipment.
The value of dental supplies in the practice is often viewed as a function of how much of the original supplies will be actually used by an incoming dentist during a practice sale. A stock of two months of supplies is a good indicator of their worth to a practice during a practice valuation (see Prescott, p.238).
The value of improvements to the practice facility such as plumbing, electrical, cabinetry and carpentry either to leased or owned space can be calculated by determining the original costs of the projects and using a depreciation of those improvements over a period of about 20 years. Since dentistry often requires more significant improvements to offices designed to handle larger equipment than many other professional practices, this can be a significant consideration which should be taken into account when valuing a practice.
There are a considerable number of intangible assets that are used to value a dental practice. These include reputation of the practice, number of active patients in the practice, practice location, likelihood that staff will remain with the practice after it is sold, ability to expand the practice facility, assignability and terms of the lease/availability of practice facility (land and building) for purchase, quality of patient records, and overall appearance aesthetics and condition of the practice facility. The list of intangible factors includes many other items that may add to or take away from the overall value of the dental practice. These factors can be used as multiples of calculable figures such as gross revenues and net income to arrive at a value of intangible assets when adding to tangible assets to approximate a value for the entire practice. William P. Prescott in Business, Legal, and Tax Planning for the Dental Office (1994, p.242) starts with a multiple of 35% of gross revenues and 135% of net income to complete the figure. A computation of the fair market value of the intangible assets adds these two figures. Then the value of the tangible assets plus the value of intangible assets completes a figure that can be used as a possible total purchase value of a dental practice.
While it is important to obtain an experienced dental practice valuation expert when looking at an actual sale of the practice, a dentist may want to have a rough estimate of the value of his or her practice ready for many situations such as a divorce or adding an associate. The above methods may be used to arrive at that figure before hiring that expert to make a detailed review of the value of a practice.
How Much is Your Dental Practice Worth? – February 2011
When a dental practice owner is considering selling a practice, or a new dentist is considering buying one, where do you start in determining how to value the practice. A business valuation expert can assist you in this process, a lawyer can show you the documents you have to produce, and an accountant can provide the figures needed. There are various methods used to value the practice, and dentists should generally be aware of methods used by these professionals in assisting you.
The simplest method, yet the “least accurate and most abused method in use,” according to the Henry Schein Dental, is the gross revenue multiplier approach example. One respected business and legal expert, William P. Prescott, M.B.A., J.D. noted in Business, Legal and Tax Planning for the Dental Practice (1994, p. 247) that a multiplier of 64% of gross revenues is an average value for dental practices. This of course, doesn’t recognize the profitability of the practice and numerous other factors.
The two most accurate methods that are commonly used by valuation experts to determine practice value are the Asset Summation Method and the Capitalized Earnings Method. The Asset Summation Method adds the present fair market value of tangible assets of the practice to the fair market value of intangible assets. Tangible assets used in making this computation include dental equipment and cabinetry, office equipment, dental supplies during the previous year, office supplies during the previous year, accounts receivable (with adjustments for collectability and aging), and leasehold improvements. Depreciated value, based on age and original cost is often the figure used for estimating equipment value. The fair market value of intangible assets includes such valuation of “good will” (determined by a variety of factors such as non compete agreements and patient records) or whether a patient will remain a patient for the new practice based on the owner’s recommendation and reputation.
The Capitalization of Earnings approach uses the Profit Loss Statement to arrive at an income stream level per year. Then that level is divided by a capitalization rate, or the expected rate of return taking into consideration in the risk of using the asset as an investment. Gross revenues per year minus operating expenses, and minus unique owner expenses such as contributions to a retirement plan, health insurance plan, or travel expenses. That number, or annual profit stream, is divided by the capitalization rate, which would indicate the number of years needed to pay back a purchase of the practice. Usually, according to Prescott, this rate is often about 20% for dental practices (banks like to see an investment paid off within five years). The ADA uses figures between 15%-35%, adjusted up or down (with the lower the rate the higher the value), according to intangible assets such good will. An annual profit of $100,000 divided by a 20% capitalization rate would equal a practice value of $500,000.
Another valuation method is the Excess Earnings Approach, which is sometimes used by the IRS and involves the value of tangible assets plus the rate of return on those tangible assets plus the value of intangible assets. Most business valuation experts use a variety of the methods available to come up with an estimate of total value for the practice, and of course look at the value of similar practices as well.
The legal documents that must be weighed in order to look at intangible asset valuation include the value of leases, what kinds of employment agreements the owner has with employees or associates, and other contracts such as equipment contract terms. Your lawyer can work with your accountant when preparing these documents to arrive at the best possible language to use in contracts.