Appraising the Dental Practice Appraisal Methodology

March 21, 2012

I recently attended a Transitions Seminar presented by a well known dental advisor. The presenter was an attorney and has spent a significant number of years dealing with dentists as well as with other professionals advising them on wealth management, practice management and transition strategies.

I recently attended a Transitions Seminar presented by a well known dental advisor. The presenter was an attorney and has spent a significant number of years dealing with dentists as well as with other professionals advising them on wealth management, practice management and transition strategies.

Most of what was presented was standard information related to planning and preparation for retirement, with suggestions on the necessary amounts needed for retirement and the related tax issues. One period of the presentation was also focused on determining the value of the dental practice as a component of the retirement portfolio.

Having been a member of the Institute of Business Appraisers for over twenty years, attending multiple American Society of Appraisers workshops and seminars and spending years associated with qualified and experienced appraisers that adhere to the Uniform Standard of Professional Appraisal Practice I was not only surprised, but severely disappointed at the totally unsupported approach used by this presenter in his dental practice appraisal example.

The premise was that a practice grossed $850,400 and had an adjusted net income of $360,000.  The valuator multiplied this net income figure by 150% (why?) then reduced the original cost of the equipment, furniture, fixtures and leasehold improvements by 1/12 per year of use (why?) then determined replacement value of supplies and 50% of cost of instruments (why?) to arrive at a value of the tangible assets. The next step taken was to assume a 20% loss of profit (based on what?) and then adding the adjusted profit to the adjusted tangible asset value to arrive at a practice value.

None of the above assumptions made has any basis in fact or theory. They are just numbers that have been pulled out of the air and applied to information provided by the seller. It is very easy to get the actual fair market value of the tangible assets by asking for an appraisal from an equipment/supply dealer. Determining the goodwill value requires more information as risk factors, such as; what are the economic issues in the area, how many new patients are being seen, is the practice increasing in revenue or decreasing, are key staff members staying in the practice, etc., are required to determine the goodwill.

The fatal flaw that discredited the entire valuation process was multiplying the net income by 150% to determine the goodwill. Where does that number come from?  All the numbers used to determine value must have a legitimate source, whether it is a capitalization rate used in the Capitalization of Earnings Approach, the comparables or “comps” that are used in the Market Approach or using an Earnings Approach based on present value of discounted future earnings. 

All of these approaches to value use very specific formulae and/or processes to reach a determination of value. Dr. Shannon Pratt, author of “Valuing Small Businesses and Professional Practices” outlines in very clear detail the methodologies that can and should be used in valuing a Professional practice, and in specific, dental practices.

It is very disturbing that the dentists present at the seminar listened to, and accepted the speaker’s approach, not knowing or being aware of the fundamental flaws that were presented. If, in fact, they used the model presented there would be little or no correlation to the actual value of their practice.

The best I can say for the approach presented was that it was a “rule of thumb”. We have all heard the rule of thumb that a practice is worth 60%, 70% or even 80% of gross. As a practical matter let’s take two practices, each grossing the $900,000 in the presenter’s example. Do they both have the same value if one has all new, state of the art equipment and the other has 20 year old equipment?  What if one is all fee for service and the other is all HMO? Are they equal in value? I would suggest not, but this presenter did not differentiate any of the issues that should go into a legitimate appraisal such as: stability of income, age and condition of equipment, fee schedules, amount of reduced fee dentistry in the practice, procedures performed, source and number of new patients, etc.  All of these conditions and several more must be assessed and evaluated to determine the health and value of a practice.

It is not just this presenter that creates an unacceptable method for appraising practices, but just this week I spoke to a dentist in Michigan that had approached a general business appraiser to appraise her dental practice.  In reviewing this appraiser’s web site, once again, there were no credentials supporting his ability to value dental practices, yet contrary to all the standards in the appraisal practice, he was going to accept the assignment and do the appraisal.  One of the fundamental rules of appraising is that you do not accept assignments outside of your expertise, yet I see it all the time. 

Having an updated appraisal is incredibly important for your practice. Not just for financial/retirement planning, but further as an aid in the case that you, the dentist, were ever impaired such that you were not able to practice (disability or even death). Beyond that, just for the point of knowledge, it is important as, most often, your practice is the most valuable asset you own! That said, an appraisal is not an inexpensive undertaking and if done improperly, can either give you unrealistic expectations as to what you can sell your practice for, or cost you severely if undervalued.

There are very specific, acceptable methods of valuation established by the Uniform Standard of Professional Appraisal Practice  and adhered to by the appraisal community and accepted by the court systems and the banking institutions that provide financing to those purchasing dental practices. The old standby is still sound advice: Caveat emptor! Buyer Beware! Make sure the person or firm you choose to do your appraisal is qualified to do dental practice appraisals.  Interview and examine the credentials of those you engage to perform this very important element of your transition process.  

Hy Smith, is the founder of Professional Transitions, Inc and a thirty-five year plus veteran of practice transitions.  Professional Transitions is a full-service firm providing comprehensive transition services for dentists from graduation to retirement.  The central focus and purpose its to assist clients in realizing lifetime personal, professional and financial goals in win-win-win-win (seller-buyer-staff-patient) structured transitions. Hy, a resident of Naples, Florida for twenty years, now owns a home in Sarasota, Florida as well as southern Oregon. He received his MBA from the University of Utah. Hy has been consulting and brokering practices since 1974. He has presented many courses on practice management and practice transitions. He is a former president of ADS (formerly American Dental Sales), the director for Exit and Transition Strategy for the Pride Institute and the author of the Dental Practice Transitions Handbook. Hy can be reached at hy@professionaltransitions.com or by calling 888.229.5764.