How to navigate dental practice transitions

October 13, 2015

There are shortcut approaches to determining the price to pay for the acquisition of a dental practice. An experienced advisor may know certain rules of thumb to give a quick insight into value.

There are shortcut approaches to determining the price to pay for the acquisition of a dental practice. An experienced advisor may know certain rules of thumb to give a quick insight into value.

How much is the dental practice worth and what price should be paid?

 Those who are interested in a safe path to establish a value to finance an acquisition will retain a dental practice evaluator. Rules of thumb may be good for a quick view, but without the details learned in a formal valuation, thousands of dollars may be spent needlessly on the purchase.

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The “back of the envelope,” approach gives the dentist an idea, but spending little money for a valuation could be a disaster for the purchasing dentist in terms of future losses and mental anguish. Just like buying a home where an appraisal for proof of value and verification of the ability to lend against an asset is needed, the dental practice valuation will give pricing protection to the buyer and the capacity to have that acquisition financed.

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It is important to know that a valuation for an acquisition will have a different format than one used for a divorce, partnership dispute, damage claim or other purpose.

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What methods are used to determine the value of a dental practice?

There are a number of methodologies employed by an experienced dental practice evaluator. The normalized net income approach allows discretionary items written off by the seller to be added back to determine what was historically available for the seller to spend. If family members are employed and are paid in excess of market value for their skill set, as an example, those amounts are really available for debt amortization by the buyer, since he or she may not have family members employed. Retirement plans are discretionary and the amount paid by the seller to his or her deferred compensation plan would be added back to normalize the profit as well.

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These are but two examples used by an experienced dental practice evaluator to reflect the normalized profit to the dental practice. Any assets on the books of the dental practice would be included. Equipment, furniture, computer software and hardware enhance the value of the dental practice. These assets at their market price are added to the normalized net income method approach to determine the amount that can be financed by the buyer. Another acceptable method to determine value is to use the capitalization of earnings method. This is a concept where the historical normalized net earnings are capitalized to determine the worth.

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Lenders typically rely on these methodologies to know that their lending policies are protected and the borrower is buying at an appropriate price where repayment terms can be satisfied.

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What research does an advisor do to assist in determining the market? 

Besides the experience of the dental practice evaluator, there are publications describing the detail of recent sale prices across the country. Percentages of various points of concern for dental practices are referenced in these communications so the evaluator can compare his or her own client’s data to those across the country. These reports contrast the percentages of goodwill to gross revenue and the operating profit or expense ratios to gross revenue.

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These reference sources, plus the evaluator’s preparation of many dental practice appraisals will enhance the evaluator’s credibility as well as securing a reliable focal point to begin the negotiation process. The expertise of having prepared many dental practice valuations also assists the dental practice evaluator. Experienced dental practice appraisers have the knowledge and know where to look for support of their conclusions to justify their charge as well as to determine acquisition prices based on that expertise. Their own publications are also an excellent source of reference.

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After the valuation by an expert, is anything needed to close on the acquisition? 

Once the valuation has been sent to the lender and the credit worthiness of the buyer has been verified, the due diligence of the lender will require the review of data from the seller. Items such as tax returns, descriptions of the practice layout and acceptance of the data necessary to acknowledge the ability to service the debt will be crucial. An interview with the acquiring dentist will also be an important step to conclude the process and to prepare for the closing.