When is a ‘Valuation’ not a Valuation?

When is a ‘Valuation’ not a Valuation?

Why it’s Important-Know the Difference

Did you know that Henry Schein Dental Practice Transitions completes more practice valuations or appraisals per year than any other transition firm in the country?  Due to that volume, it’s often that we are posed the question of “do I need an appraisal?” when working with clients, whether sellers, buyers, clients entering partnerships, mergers or litigation, bringing on an associate, or for estate planning. 

First, let’s define what a practice valuation is. A practice valuation or appraisal is a formal opinion of value based on all the pertinent information available about the subject– in our case, a dental practice. There are many factors that go into “all the pertinent information,” including gross income, net income, fee schedule, staff information, PPO, HMO, and Medicaid insurance participation, the total number of patients, number of new patients, specialties and procedures, demographics, market issues, etc. Valuations can be oral or written but must be based on all of the information, not selective pieces.

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 “Valuation”. So, what’s the difference?

Using a Rule of Thumb

A Rule of Thumb uses some 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 80% of gross revenue,” or “The practice is worth one times net income.” Neither of these Rules of Thumb is an accurate representation of practice value.

A classic example: Two practices each collecting $1,000,000. One has an overhead of 50% and the other an overhead of 70%. Using the “80% of gross revenue” Rule of Thumb, each practice would be worth $800,000. In reality, the first practice is significantly more valuable than the second because of the larger profit; i.e. a buyer would pay more for a net profit of $500,000 compared to $300,000. Similarly, if one practice has state-of-the-art equipment and technology and a second has 20-year-old, non-digital, out-of-date equipment, it is obvious the first practice is worth more (but how much more?) if all else is the same.

A Formal Appraisal

A Formal Appraisal includes all the relevant information and provides a formal written report. The report can be a Comprehensive Report or a Limited Report and although both have completed the same analysis, the amount of data and discussion can vary.  Both formal reports should be signed and dated by the evaluator and should be able to be fully explained.

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 $600,000 but an official valuation suggests it is really worth $450,000, the seller is going to be more inclined to engage the broker who tells him the practice is worth $600,000, even if the transition specialist knows the practice will end up selling for $450,000.

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 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 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 annually have their dental practice appraised as an element of their net worth, their exit strategy planning, and for estate planning purposes. Not only does it give the peace of mind to know what the practice is worth, but the process can also turn over rocks and open shades that could allow you to be more effective, efficient, and profitable, now and in the future.

For younger doctors, since purchasing a practice is a life-changing decision, doesn’t it make sense that you would want to know its real value? We can evaluate a practice you’re considering purchasing, particularly if we have not listed it.  Knowing the difference between “appraisals”, though, and the information and terminology they use can make all the difference.

Are you wondering about the value of your practice? Inquire about a practice valuation today and we’ll be happy to discuss the different options in more detail so as to best fit your needs.