How Banks Calculate a Practice's Value

February 22, 2016
Ed Rabinowitz

Your practice is your life's work and your workplace. But it's also a major investment. Just how much is that investment worth? We ask a banker.

How much is your dental practice worth? It’s important to know, whether you plan on selling at some point in the near future, are considering merging with or acquiring another practice, or need to take out a loan. There are many factors that go into determining the value of a dental practice, including the dentist.

“When banks are looking at a dental practice loan, the collateral is usually the personal guarantee of the dentist and the practice itself,” explains Dan Croft, the head of healthcare practice solutions for TD Bank. “They look at external expert appraisals that come from dental CPAs and dental transition consultant specialists.”

And, Croft points out, they look at global debt service coverage ratio, a measure of the cash flow available to pay current debt obligations.

Multiple Considerations

Croft explains that among the many factors that impact global debt service coverage ratio is the dentist’s credit, the practice’s cash flow, net income margins, number of active patient records, and location of the practice. For example, is the practice in New York City, or upstate New York?

“How quickly is it possible to sell the practice?” Croft asks.

Banks also look closely at collection sources. Is the practice fee-for-service, or is it a PPO practice? Is it a Medicaid/Medicare practice? All of those elements impact a practice’s value.

And then there’s the dentist.

“We don’t tell you a practice is worth A, B, or C,” Croft says. “But if you’re asking us, will we lend the $500,000 against this practice, it’s not just the profitability of the practice, it’s who’s buying it. How much money do they need to live on?”

For example, an individual buying a practice who has living expenses of $50,000 is in a different category than someone needing $100,000 to live on.

“That goes into the whole global debt service coverage ratio, which impacts the ability for banks to lend against,” Croft says.

Good Environment

Croft says that the current market environment for borrowing money, overall, is positive. Location, again, plays a key role. In northern Virginia or other major growth markets practices are selling in higher multiples. Those are seller’s markets because of supply and demand. Rural areas, however, are a different story.

“In a lot of rural areas, candidly, there are fewer people who want to buy a practice even though they may often be more profitable than practices in urban areas,” Croft says. “Usually they’re going to sell in lower multiples, and buyers can get unbelievable discounts buying that same practice. Sometimes they’re selling for 20%, 30%, or 40% less than in an urban area.”

There are also many entrepreneurial dentists who are grouping together and purchasing multiple practices, often owning a half-dozen or more practice within the same area. That trend, Croft says, also impacts the value of a practice.

“If someone wants to sell their practice to their associate, their price might be A, where corporate dentistry might say, we’ll offer you 20%, 30% more for the same practice,” he says. “They may not get a hundred percent cash; it may be a portion of it is cash, some of it is earnings, some of it is stock. But they’re usually offering higher prices to purchase practices that are from these larger groups than if they sold it privately.”

Experience Counts

Croft acknowledges that, when it comes to lending money for a practice purchase, more emphasis can often be placed on the dentist making the purchase than the actual value of the practice. Most banks, he says, would like to see the purchaser have at least a year or two of experience after coming out of dental school.

“You can basically get a sense of what their clinical skills are, what their production levels are, what procedures they can do,” he says. “If the practice did a million dollars, and 33% of it was hygiene and then you have $700,000 in procedures, compare that to the person who wants to buy the practice. Can they produce $700,000? Can they fill the shoes of the seller?”

For established practices, Croft says that practice management consultants can offer sound advice for maximizing the value. For example, it’s important to “move the needle” and show that the practice is making money. That means optimizing your staff as far as your ability to sell more dentistry.

“What does your average patient make and, therefore, what kind of procedures can you do?” Croft says. “Can you do some more higher-end procedures? Can you grow your hygiene department, which is a profit center? So you take a look at sort of smart efficiencies. You look at productivity and you look at ways to really increase not only revenues, but obviously decrease overhead and take a look at the profitability.”