By - Jeremiah Grant
Last Updated - June 7th, 2024 2:16 AM
Jun 07
Whether you’re planning on selling your dental practice, bringing in a new partner, or acquiring a new clinic, you’ll need to know its exact dollar value. And like all business owners, your biggest question in this situation will be: How to value a dental practice?
For starters, let me tell you that there’s no one-size-fits-all formula for valuing a dental practice. After all, every business is unique despite operating in the same industry.
So, you’ve got to pick the right valuation method and apply appropriate multiples, depending on factors like your practice’s age, scale, profitability, and more.
Curious about what dental practice valuation methods exactly are and when and how you can apply them?
Moreover, some experts even argue that the value of service-based businesses like dental practice goes far beyond their hard assets.
And having valued multiple dental practices, I couldn’t agree more. That’s because the largest chunk of your practice’s value comes from your own expertise, your brand’s trustworthiness, your customer base, etc.
So, while tangible assets like facilities, equipment, etc., are key to dental practice appraisals, for an appraiser like myself the goodwill factor will be equally important.
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How to value a dental practice using valuation methods?
Now that you’ve got a fair idea about what dental practice valuations involve, let’s now jump to the million-dollar question, i.e., how do you value a dental practice?
Like all businesses, an appraisal expert like myself will deploy popular valuation methods like the income, market, and asset methods. So, there’s nothing unique to the valuation of a dental practice at least when it comes to the methods.
But that said, the valuation process itself is completely unique and involves industry-specific approaches and multiples.
For instance, the formulas for calculating your practice’s value using the income approach will be similar to any other business. However, I’ll use the latest dental practice valuation multiples to multiply your balance sheet items and derive a dollar figure. So, with that clear, let’s see how to evaluate a dental practice using the three major business valuation methods.
1. Dental practice valuation using the income methods
When I talk about the methods for valuing a dental practice, the income approach comes to the top of my mind. And for obvious reasons since this is the most common and reliable way to value service-based businesses like dental clinics.
The valuation method itself is based on a straightforward notion: Your practice’s worth is based on how much income it can generate now and in the future.
As such, the value of your business that valuation experts like myself will arrive at will be based on its expected income.
Coming to the valuation methods, there are two commonly used income-based methods thatbusiness valuation firms use, namely capitalization of earnings and discounted cash flow.
Here’s what these income methods are all about and how to use them:
A. Capitalization of earnings
This particular income method looks at your practice’s normalized earnings, also called EBIT or earnings before interest and taxes. Herein, it is your business’s operating income that is factored in for valuation.
For instance, a valuator will take your income after expenses, but before taxes, interest, and your own compensation. Then, they will apply a capitalization rate to arrive at a valuation estimate.
For instance, let’s say your dental practice had adjusted earnings or EBIT of $300,000 in the financial year 2023-24.
Now, as per the latest market figures, the capitalization rates for dental practices range between 20 and 30 percent. Also, the rate of 25 percent is standard for an established practice.
So, I’ll take your firm’s EBIT of $300,000 and apply a capitalization rate of 25 percent to derive a total value of $1,200,000.
$300,000 / 0.25 = $1,200,000
Should you use capitalization of earnings?
This earnings method is based on a capitalization rate which itself depends on the expected rate of return an investor would want from their investment.
Meaning that the riskier the business the higher the expected rate of return. And this can result in valuation for the same earnings.
Simply speaking, a new practice that is yet to build a reputation and customer base will be on the riskier side and end up with lower valuation despite higher EBIT.
B. Discounted cash flow
Yet another popular income method, discounted cash flow or DCF projects your practice’s expected cash flows for each of the next five years or more.
Thereafter, it calculates the total value of your practice by applying a discount rate to the estimated cash flow.
You see, the idea behind applying a discount rate is simple: To reflect the running costs and risks involved, among others.
For instance, you’ll need to pay for staff and equipment, among others. Also, your actual earnings could drop for a particular year due to unforeseen events.
So, the discount rate factors in these things while putting a dollar value.
So, by applying a discount rate of 22% to the expected future cash flow, I can put the dollar value of your firm at $865,289.08.
Is it a good idea to use DCF?
A valuation using DCF calls for making assumptions about future growth rates, costs, discount rates, and more. And although it’s more complex, it can provide an accurate valuation.
In fact, if your practice is new and lacks a past earnings history, this is the best way to value it.
2. Valuing a dental practice using the market approach
After income methods, the market approach is probably the most widely used method for the valuation of a dental practice. Moreover, the older dental clinics with a well-established customer base find this as a reliable way to estimate their dollar value.
Herein, appraisers like myself value your practice based on the value of similar practices that have recently sold.
So, how to value a dental practice using the market approach?
Well, to value your firm, evaluators like myself will analyze all such dental clinics in your locality that changed ownership in the last year. I’ll look at their size of operations, patient volume, services, etc., along with the total price they sold for.
For instance, let’s say, about half a dozen practices sold for around 65% of their annual revenues in the year 2024. In this case, I can apply the same percentage to your annual revenue in order to derive a valuation estimate.
Is the market approach worthwhile?
If you are operating in a large marketplace with plenty of similar-sized practices, a market approach can be quite reliable.
However, that is hardly the case for smaller practices, meaning this approach can be tricky. After all, finding accurate comparable sales data can be quite difficult.
Also, the approach assumes that there is no difference between practices, which is impractical since every business is unique.
3. Dental practice valuation using the asset approach
The asset approach is commonly used for valuing such businesses that have a high number of net assets, i.e., tangible and intangible assets. Herein, the total value of your practice is based on the fair market value of your net assets.
Speaking about dental practices, this is a reliable method given the availability of both tangible assets like clinic and equipment and intangible assets like patient databases and local reputation.
How to value a dental practice using the asset approach?
Tovalue your practice using the asset approach, you can start by estimating the value of tangible assets first. Here, you can factor in the practice’s equipment and carry out an assessment of their remaining useful life.
Generally speaking, tangible assets make up about 10 to 20 percent of the total value of dental clinics.
However, your brownie points are the patient records and charts which are invaluable intangible assets.
A common approach for valuing these assets is to assign a dollar value to each active patient record. For instance, every active patient record can be between $150 and $250.
Now, let’s say you’ve got a practice with 2000 active patients. So, if each patient record is valued at $200, the value of your intangible assets will be $400,000.
On top of that, if the value of tangible assets like equipment is $100,000, the total value of your firm will be $500,000.
Value of tangible assets + Value of intangible assets = Net asset value
$100,000 + $400,000 = $500,000
Should you use the asset approach for dental appraisals?
This asset approach can be a saviour for such practices that aren’t generating strong revenue currently.
However, it doesn’t take into account your practice’s future earnings potential, especially when compared to the income approach. So, if your practice is making profits, it’s better to stick to income methods than the asset approach.
As you can see, the question of how to value a dental practice has no single answer. That’s because different methods and approaches provide a different valuation altogether for the same practice.
So, it is essential you factor in your own unique business situation and proceed with a dental practice valuation method that gives you the best outcome.
For instance, if you’re running a profitable practice, it doesn’t make any sense to use the asset approach.
Similarly, if you’ve got a small practice with less comparable businesses, you shouldn’t use the market approach.
Curious how much exactly is your dental practice worth?
At Arrowfish Consulting, we are seasoned business appraisal experts with a collective experience spanning two centuries. And we’ve got all your dental clinic valuation requirements covered.
Jeremiah Grant
Jeremiah Grant is the Managing Partner of Arrowfish Consulting. In addition to acting as a primary liaison for many of the firm’s engagements, He primarily focuses on business valuation and economic damages expert witness assignments, in addition to forensic accounting and insurance claims analysis.
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