The Practice Buyer's Corner - Random Musings from the Buy-Side
The Practice Buyer's Corner - Random Musings from the Buy-Side
The purpose of this blog is to share current, real world, experiences on the topics of practice valuation, practice transition, retirement planning, and building equity value - over time - in your dental practice.
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seanepp
seanepp

Dental Practice Valuation Methodologies

4/30/2013 7:08:28 PM   |   Comments: 2   |   Views: 1307
The most common industry vernacular for expressing the valuation of a dental practice is as a percentage of annual receipts (collections) - e.g. "...I sold my practice for XX% of my receipts for the last twelve months..."

Now, inasmuch as this is the long-standing tradition of discussing valuations in general what is not clear is that this is not a valuation methodology in and of itself.  It is simply a way to translate the valuations of a myriad of practices into a common language.  It is akin to real estate comparables - directionally accurate at best and, at worst, horribly misleading or entirely inappropriate.  Moreover, these are living, breathing businesses - not static assets like real estate.

Like any business, the valuation of a dental practice comes down to a few simple tenets:

- "Customer" metrics - the fundamental asset being conveyed in any practice sale is the patient base.  Any buyer needs to develop an in depth understanding of the patient metrics in the practice - i.e. true "active" and "new" patients.  Don't be fooled by software reports - drill down on the raw data (production by ADA code) to sift through these crucial elements.

- Sustainability/repeatability of results - i.e. are the production per patient and service mix something the next owner can be reasonably expected to replicate?  If not, you could easily overvalue the practice.  For example, is the seller producing $1k per hour or $1k per active patient per year?  If so, be very leery - those are >2x industry averages and not repeatable long-term.  If the patients metrics are at or below industry averages, there may be some blue sky for the next owner depending on their drive and skills.  Note, this is not something the prospective buyer should reward the seller for - this is something to realize for the new owner at their risk/reward.

- Overhead - % of revenue means nothing without an OH ratio to bring matters into perspective.  All else being equal - collections, equipment quality, facility quality, etc. - which practice is worth more, the one with 50% OH or 65% OH?  Exactly!  Don't get duped into relying on % of revenue/receipts/collections - you can and will get burned.

- At the end of the day, the "owner cash flow" - i.e. those profits derived by the owner above and beyond paying themselves a market associate salary - is what is going to pay off your acquisition debt, finance expansions and improvements, and build wealth for you over a career.  Good valuations include a "capitalized earnings" valuation.  Great valuations use a real world discount rate (30%+) and further account for embedded capital investments - e.g. outdated facilities, non-current technologies, etc.

To reiterate, the % of revs/receipts/collections provides an interesting data point to compare various practices in similar markets but should never be used as a stand-alone valuation methodology.  Not discussed in depth here, but "asset based" valuations are typically reserved for chart sales and liquidations - not the best way to maximize value for a healthy, salable practice. 

You don't pay off debt and build equity value with revenue but rather cash flow - this is the only number that really matters when valuing a dental practice or any other business for that matter. 

Best,

Sean
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