Multiple Methods Capture Multiple Aspects Of Your Practice’s Value
We constantly receive calls from potential sellers and buyers asking what practices, in general, are worth. Almost always callers want a simplified answer such as the percentage of collections that practices sell for. We can give them a simple answer based on our standard deviation analysis of databases that contain information on practice sales and practice appraisal results. We tell them that 75% of practices sell for more than 50.9% and less than 74.5% of their annual collections. That’s a wide range, representing for example, a $165,200 range of value variance for practices collecting $700,000 per year. For each individual practice there are specific characteristics and attributes that push its individual value up and down within this range and that in 25% of cases push its value out of this range.
Any attempt at a simplified answer is no more than a rule of thumb. When establishing an asking price from a seller’s perspective, the use of a rule of thumb leaves open the risk that the seller’s practice is undervalued and that the seller does not receive full fair market value from his/her sale. From the buyer’s perspective, the risk is that a rule of thumb over-values any one specific practice.
Buyers and their advisors typically put no faith in asking prices that are based on no more than rules of thumb. Without a comprehensive appraisal there is nothing to serve as a logical support to the asking price during negotiations. The true value of the practice is not documented. Negotiations are difficult. Negotiations may break down, or they may result in a sale price that is grossly unfair to one party or the other.
No Single Appraisal Methodology Is Adequate
No single appraisal method captures all aspects of a specific practice’s value. The use of only one appraisal method risks that some major factor in a practice’s value is not given adequate consideration. Multiple appraisal methods are necessary. From the results of several different appraisal methods, the experienced practice appraiser must then determine the final value, giving consideration to the weight that should be given to each method’s result.
The appraisal methods that we use for any one specific practice may need to vary, based on the characteristics of the specific practice and the range of practice data and information that is available to us. But, in most cases, given adequate data, to give adequate consideration to multiple components of a practice’s value, we will use at least 3 of and most often all 4 of the following appraisal methods:
1. Single Period Capitalization of Earnings. A capitalization rate, derived from market data, is used to determine the value of the practice based on the total of all dentists’ earnings derived from the practice.
2. Asset Summation - With the Goodwill Component Revenue Based. The theory is that the whole is worth the sum of the values of its parts. This method determines the value of the goodwill component of the practice based on comparative market data that correlates the value of goodwill to the annual collections of dental practices. The value of other assets are then determined by various methods, and added to the goodwill value to determine total practice value.
3. Asset Summation - With Goodwill Component Earnings Based. Again, the theory is that the whole is worth the sum of the values of its parts. This method determines the value of the goodwill component of the practice based on comparative market data, as in the previous method, but in this case it does so with market data that correlates the value of goodwill to the annual earnings of dental practices. As in the previous method, the values of the other assets are then added to the goodwill value to determine total practice value.
4. Market Transactional Data. There is significant data available from which to determine price to collections and price to earnings ratios known as multipliers that allow the determination of the value of one practice by comparable means to prices paid for other practices. Of the market methods, comparing earnings multipliers versus revenue multipliers, based on R squared statistical analysis revenue multipliers are more statistically accurate and/or predictive of the prices of practices in the dental practice market. Therefore, revenue multipliers are used in this method, as opposed to earnings multipliers.
When all 4 of the above methods are used in conjunction, Method 1 considers earnings, Method 4 considers collections, Method 2 considers both collections and the value of tangible assets such as dental equipment and computers, etc., and Method 3 considers both earnings and the value of tangible assets.
How Is Dental Equipment Valued?
For Methods 2 and 3 above, you may ask how the value of dental equipment and computers is determined. There are two possible approaches.
1. Functional Life Equipment Valuation. This method values “used” equipment items, logically in our judgment, based on the utility value that the used equipment items have to an owner (or the utility value they’ll have to a buyer), rather than by trying to estimate what each item would sell for in the used equipment market (a market that does not exist to any degree). Functional life valuation incorporates considerations of: 1) the expected life cycle of dental equipment, 2) the original cost of equipment, 3) the current age of the equipment, and 4) its residual value at the end of its expected life cycle. Functional life valuation methodology can also be used for furnishings and business office equipment.
2. Item-By-Item Appraisal. In this process a list of dental equipment items is reviewed by a person or company (most often a dental supply and equipment dealer) who then attempts to estimate the value of each individual item on the list based on what he/she thinks each such item would sell for in the used equipment market. Faith in this process originated years ago when dental dealers did frequently deal in used equipment, and therefore did have some working knowledge of used equipment sales to serve as a basis for estimating used equipment items’ values. Today, dental supply and equipment dealers sell very little used equipment, and therefore have no significant exposure to used equipment sales that is adequate to keep them abreast of used dental equipment transactions and values. There is no other highly active market for the sale of individual used dental equipment items. There is no “blue book” or database of dental equipment sales to which one can turn for the current sale prices or values of individual used dental equipment items. Therefore, today, be it by a dental equipment dealer or anyone else, any attempt to value dental equipment item by item, based on its likely used market sale price, is by necessity largely “guess work” and highly speculative. Because of this, we avoid the utilization of this method when the equipment cost and purchase date information supplied by the practice owner is adequate to allow the use of Functional Life Equipment Valuation.
Sources Of Practice Sale Data
In regards to the appraisal process, we’re often asked what sources of practice sale data we utilize. The data that we utilize in each appraisal project comes from one or more of the following databases.
1. Goodwill Registry. In addition to being a source of information on transactions in other healthcare fields, it provides a dental practice sale and valuation result database maintained by and available from The Health Care Group, Inc., 140 West Germantown Pike, Suite 200, Plymouth Meeting, PA 19462-1421. It contains sale and valuation related data on a large number of dental practice sales and valuation reports that are useful in establishing the fair market value of a specific practice. Information in the Goodwill Registry database related to dentistry has been collected from dentists, CPAs, practice brokers, and other sources over a period of many years. It reports certain basic financial data for each dental practice reported along with the sales price or valuation result organized by dental practice specialty and general dentistry. Date of the sale, purpose of valuation, state of location, component of goodwill value, and other distinguishing characteristics are reported for each entry. Data maintained in the Goodwill Registry typically dates back 10 years.
2. George D. Stollings and Associates, Inc.’s Proprietary Practice Sale & Valuation Database. Within our office we have maintained records on dental practice sales of our clients in the most recent years. In almost all cases, our records for each sale include an array of valuable information such as the sale price, the practice’s annual collections, the practices taxable income, copies of tax returns, and information on the style of practice, location of the practice, etc.
Data from the above sources is compiled and statistically analyzed by George D. Stollings and Associates, Inc.
* The term “Appraisal” is commonly used to describe the process by which a practice’s value is determined. We commonly use this term because our selling clients are familiar with this term. However, the term “Valuation” is more correct.
George D. Stollings, DDS