April 19, 2020

Valuing a Dental Practice

Valuing any asset is typically complex exercise and parts of it can feel more art than science.  At its core, the value of any business is the value in today's terms (present value) of its future net cash flows.  The tricky parts of the process are accurately projecting future cashflows and knowing the best way to discount them based on the risk of business.

Given the inherent uncertainty in the aforementioned process, many industries develop simplified benchmarks to value businesses.  In the dental world, the two of the most common benchmarks are 65%-85% of collections or ~3-5x capitalized excess earnings (collections net of operating expenses including a dentist salary).  A business will be valued higher or lower in these guided ranges based on factors that impact the growth of cashflows or its risk profile.  Remember that most of what you are paying for is goodwill—an expectation that there will be significant revenue and profit in the future due to the client book operations built.  Characteristics of businesses that would drive higher value are as follows:

  • Higher growth expectations (e.g. great location, low competition etc)
  • More efficient practice (e.g. low operating expense ratio <60%)
  • Trajectory of business (e.g. increasing revenue and lowering expense ratio)
  • Active good client base (e.g. <10% churn of clients in 18 months). Note you should typically expect churn of ~20%+ clients when a practice changes ownership.
  • More pay-for-service/fewer insurance plans (higher collection rate and lower operating expenses)
  • Newer equipment (lower maintenance and later replacement)
  • Quality of staff

A skilled broker working for you can help you navigate the nuances of the valuation process and help you with the right questions to ask.  Note, however, that many of the brokers represent the seller and are often only paid when a transaction closes.

The broker along with CPA's, consultants and sometimes legal counsel can also help you diligence the financials of the business to ensure that the information disclosed is credible and that the business will continue to operate per your expectations post-acquisition.

At Legacy, we have analyzed multi-year financials of numerous practices and interviewed dozens of experts to compile a knowledge base.  We also have a network of trusted advisors to support in your valuation or acquisition/sale of a practice.  If you would like to learn more, please contact us here.

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