When Buying a Dental Practice, When Is an Appraisal Not an Appraisal?
The question, “Do I need an appraisal?”, often comes up when dental practice transition specialists are working with clients who are buying a dental practice, selling a dental practice, entering partnerships, mergers or litigation, or requesting an appraisal for estate planning. To make a smart decision, dentists need to know the terminology involved.
What Is a Dental Practice Appraisal?
An appraisal—oral or written—is a formal opinion of value based on all the pertinent information available about a dental practice. There are many factors make up “all of the pertinent information,” including:
- gross income
- net income
- fee schedule
- staff information
- PPO, HMO and Medicaid insurance participation
- total number of patients
- number of new patients
- specialties and procedures
- market issues, etc.
What Is a Free Appraisal?
Some dental practice brokers and consultants often offer a “Free Appraisal” when seeking to represent a client who is selling a dental practice. Unless specifically indicated, it is most likely an “Opinion of Value” based on a Rule-of-Thumb approach, not a formal appraisal. The difference between the two approaches can be dramatic. By comparison, the Rule-of-Thumb opinion can be misleading.
Using a Rule-of-Thumb Approach
Based on a Rule-of-Thumb approach, an “Opinion of Value” uses some, but not all, of the pertinent information and then usually applies an arbitrary multiplier to that information to arrive at a value. The most common Rule of Thumb we hear is, “The practice is worth 70% of gross revenue,” or “The practice is worth one times net income.” Unfortunately, neither of these Rules of Thumb are an accurate representation of the dental practice value.
Example: Two dental practices each collect $1,000,000. One has an overhead of 50%, and the other has an overhead of 70%. Using the “70% of gross revenue” Rule of Thumb, each practice would be worth $700,000. In reality, the first practice is significantly more valuable than the second, because of the lower overhead and larger profit margin. Similarly, if one practice has state-of-the-art equipment and technology and a second has 20-year-old, non-digital, out-of-date equipment, it is obvious the first practice is worth more.
A Formal Appraisal
A Formal Appraisal includes all the pertinent information and provides a formal written report. The report can be a Comprehensive Appraisal Report, usually 50-70 pages long, plus supporting documentation; or a briefer Letter Appraisal Report, usually 2-4 pages long, plus supporting documentation.
Both formal reports have completed the same thorough analysis, the difference being that significantly more data and discussion is included in the Comprehensive Report, whereas the Letter Appraisal Report is a summary of the information without much in-depth discussion of the data or findings. Both formal reports must be signed and dated by the appraiser.
For the client buying a dental practice, one critical piece of information in an appraisal is a “Cash Flow Analysis.” This is the most important tool a buyer can have to determine if he or she can afford to purchase the practice and how much earnings will be available to take home after the debt service. The value of the practice is irrelevant if there is not enough money to take home! (The Rule-of-Thumb approach will not provide this important information.)
Brokers Use Different Methods
Unfortunately, there are brokers and consultants who will tell a seller what he or she wants to hear to gain a client. If the seller thinks the practice is worth $500,000 but an official appraisal suggests it is worth $350,000, the seller is going to be more inclined to engage the broker who tells him the practice is worth $500,000, even if the broker knows the practice will end up selling for $350,000. AND, the broker has a contractual period, usually a year, during which the seller will be obligated to work with the broker.
An honest broker tells the seller what the market for the practice is and, by doing an appraisal analysis, give the seller a realistic value. Whether it is in the form of a Comprehensive Appraisal Report or a shorter Letter Appraisal Report, the analysis done by a honest broker is based on all of the pertinent information.
Some clients who are buying a dental practice will request or require a Comprehensive Appraisal Report. Additionally, the banks that finance the transaction will certainly want the same information that the broker or consultant used to arrive at a sale price as a requirement for financing. In the case of litigation, partnerships, mergers or estate planning it is probable that a Comprehensive Appraisal Report would be required.
Since buying a dental practice is one of your most important decisions, doesn’t it make sense that you would want to know its real value? Knowing the difference between the types of appraisals, as well as the information and terminology they use, can make all the difference between the best decision of your career or the worst. Looking ahead, we encourage all dentists to periodically have their dental practices appraised as an element of their net worth, their exit strategy planning, and for estate planning purposes.
Contact A Henry Schein Professional Practice Transitions Professional
Have a question about buying a dental practice? Contact us online and have a Henry Schein Professional Practice Transitions Expert help take the stress — and emotion — out of buying a dental practice.
Henry Schein Professional Practice Transitions, Inc. is a national leader in dental practice transitions. A subsidiary of Henry Schein, Inc. they provide expert guidance for selling and buying dental practices, assessing partnership and associateship opportunities, and performing dental practice appraisals and valuations.