The question of “do I need an appraisal” often comes up when working with clients, whether sellers, buyers, clients entering into partnerships, mergers or litigation, or for estate planning. The simple answer is yes because in each of these situations it’s critical to have an up-to-date assessment of the current market value of the practice, though for different reasons.
First, let’s define what an appraisal is. A dental practice appraisal is a formal opinion of the practice’s market value based on all the pertinent information about the subject—in our case, a dental practice. So, what goes into valuing a dental practice? There are many factors that go into “all the pertinent information,” including:
- Gross income
- Net income
- The fee schedule
- Staff information
- What type of insurance and/or payment is accepted (e.g., PPO, HMO and Medicaid insurance participation)
- Total number of active patients
- Number of new patients a month
- Specialties and procedures done in-house
- Patient and area demographics
- Market issues
- The practice’s goodwill
The above list is far from comprehensive. All dental practice valuations should include a written report and must be based on all the relevant information and not just selective pieces. This includes both tangible and intangible aspects of the practice.
Some practice transition specialists and consultants often offer a “Free Appraisal” or “Free Valuation” of a practice when seeking to represent a seller. Unless specifically indicated, it is most likely that this will be an “Opinion of Value” based on a Rule of Thumb approach, not a true “Valuation”. So, what’s the difference?
Using a Rule of Thumb for Dental Practice Evaluations
A Rule of Thumb uses more limited 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.” Neither of these Rules of Thumb is an accurate representation of the practice value. If you ever wondered how to “evaluate” a dental practice, it might look something like this—a surface-level look at the business as it currently stands. You could refer to this as a dental practice “evaluation” as it is far less substantive than a true valuation.
An example: Two practices each collecting $1,000,000. One has an overhead of 50% and the other 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 larger profit. 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 (but how much more?). Additionally, none of these assessments take into account some of the most important factors in valuation, the intangible factors, or the active patient base.
A Formal Dental Practice Valuation
A dental practice appraisal includes all the relevant information and provides a formal written report. The report can be a Comprehensive Report—usually from 50 to 70 pages of information that includes supporting documentation or a Limited Report, usually from 2 to 4 pages plus supporting documentation. Both reports have completed the same analysis, the difference being that significantly more data and discussion is included in the Comprehensive Report, where the Limited 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.
Transition Specialists Use Different Methods
Unfortunately, there are transition specialists, brokers and consultants who will tell a seller what he or she wants to hear in order to engage a client. If the seller thinks the practice is worth $500,000 but an official dental practice appraisal suggests it is really 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 transition specialist 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 transition specialist.
An honest transition specialist is going to tell you what the market value for your practice is and, by doing a valuation analysis, give you a realistic selling price that you can count on. The valuation does not have to be in the form of a written report, either Comprehensive or Limited, but the analysis that the transition specialist does comprises all of the pertinent information that would go into a formal written report.
Why might you need a formal valuation at all?
Some banks that finance the transaction will certainly want the same information that the transition specialist or consultant has 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 written appraisal report would be required.
For doctors who are veterans in practice, since your practice is one of your most valuable assets, doesn’t it make sense that you would want to know its true value? We encourage all dentists to periodically have their dental practice appraised as an element of their net worth, their emergency exit strategy planning, and for estate planning purposes. Not only does it give you the peace of mind to know what your practice is worth, the process can turn over rocks and open shades that could allow you to be more effective, efficient and profitable, now and in the future. Not only does that help you in the short term and allow you to sleep better at night, but it could be a long-term plus for you, your family, and your retirement.
For younger doctors, since purchasing a practice is probably one of your most valuable decisions, doesn’t it make sense that you would want to know its real value? Knowing the difference between “appraisals” and the information and terminology they use can make all the difference.