The Reality of Determining
Practice Value

A common denominator among late career dentists is a concern over the value of their practices as they approach retirement. Due to vast changes occurring in the health care industry, many dentists are beginning to take a more in-depth look at the "future effects" of present day decisions on the value of their practices.

As health care providers, we have spent most of our careers striving for excellence in the clinical arena, taking good care of our patients and, hopefully, developing our business into one of our most valuable assets.

For well over a decade, dentists have been experiencing the effects of reduced dental insurance benefits, fee concerns from patients, and rising overhead costs. Only recently have we come to grips with the reality that managed care is having a major impact on dentistry. As we become more informed of the effects of this new and controversial health care delivery vehicle, we will certainly be faced with more and more difficult choices to make in the future. The decisions we make today in relation to managed care will greatly affect our ongoing profitability as well as the value of our practices in the future.

In order to make the right decisions to preserve and protect the income and the value of your practice, it is important first to understand the basic concept behind the valuing of a practice, as well as the actual process of practice valuation.

A Most Valuable Asset

The potential value that lies within a dental practice is a major driving force affecting every practice expansion and transition direction a dentist will consider during the course of his or her career. Unlike the value of many other small businesses, practice value for most dentists remains in a "locked" position until retirement. Unless preparations are made for the successful transfer of this value to one or more successors, this value lies in jeopardy! Due to an increasing desire on the part of the profession to "unlock" and protect part or all of this value, dentists are now exploring new transition options that were literally unheard of in the past. Creating, maximizing, preserving and "cashing-in" practice value have all become high-priority missions for many dentists today.

"Cashing-in" This Perishable Value

The actual processes involved in cashing-in practice value will differ from one dentist to another. Some will choose to sell fractions of their practice value at various pivot points throughout their careers. Others will sell their entire practices in one large transaction years in advance of or upon retirement. Dentists who carefully plan this process in advance will enjoy peace of mind while reaping the financial benefits of this now "unlocked" value. Those who fail to plan will become progressively uneasy about the future as time passes, while severely diminishing the value of the practices they have taken decades to build!

How the Market has Changed

In years past, dental practices had very little value beyond that of the used equipment and supplies. There was almost no demand for any of the goodwill value that had accumulated in the practice because it was still relatively easy to set up your own practice and become well-established in a brief period of time. However, as competition among dentists increased and the level of dental disease decreased due to better education, etc., it became much more difficult to set up a dental practice from "scratch." Because of this, the goodwill value of a dental practice has skyrocketed, something that was literally "worthless" two decades ago!

Knowing When to Determine Your Practice Value

Many situations will arise in your practice career where knowing the value of your practice will be extremely important just as important as knowing all the other "numbers" of your practice, or knowing the present and future value of your retirement fund. It is my opinion that today's dentist should always be in "position" for the possible sale of part of all of the value of the practice, becoming part of the dentist's strategic plan of "positioning for transitioning." Once you are properly postured, you can then take advantage of various transition opportunities that may come along in the future. In addition, you will be building your "fortress" in the event of death, disability, or other urgent situation that might demand a quick transition.

Prior to a Practice Sale

It is not difficult to understand the importance of having a practice valued prior to selling. Without such a valuation, the selling-dentist is literally "groping in the dark" to arrive at some dollar figure from which to base future negotiations. A practice valuation will not only help justify the price of the practice, but also will help to eliminate doubts in the mind of the purchaser that occur whenever the seller merely pulls the price of the practice "out of the air" (or when the seller's CPA "calculates" some value that does not reflect market reality.)

A practice valuation also helps to determine what terms would be necessary to make the purchase an economically viable investment. The practice valuation then becomes part of the overall practice-sale marketing package, showing the true value of the practice and not just the price. This package will, at some point, be reviewed by prospective purchasing-dentists and their tax and legal advisers, as well as any lending institutions that may be involved in the purchase financing. If you are not able to show the true value of your practice, its price often will "blow away" the average purchaser.

Prior to Forming an Associateship

I firmly believe that all associateship arrangements should be structured with the long- term potential of a partnership in mind. Having an eventual partnership as a goal allows the associate to buy-in to part of the owner's practice at some point, thereby creating an ownership position as opposed to a permanent employee-only position. I feel it is an absolute necessity to have all the terms and conditions of this future buy-in scenario spelled out up front, so that there are no misunderstandings or issues to negotiate down the road. Such issues include the buy-in price as well as what fair compensation to the associate should be, based on the overhead of the particular practice.

What Can You Sell Your Dental Practice For Today?

Now that we have addressed a few of the different situations in which a practice valuation would be necessary, we will look at the components that make up the value of a practice.

The two basic value components are:

Tangible Assets (Hard Assets) Intangible Assets (Cash Flow Assets)

The tangible component of your practice value is made up of assets you can actually put your hands on and clearly identify. Tangible assets would include equipment, furniture and fixtures, supplies and leasehold improvements. This category would also include any cash assets of the practice that the selling-dentist might be transferring to the purchasing-dentist upon the sale. These assets would include cash-on-hand at the time of sale, as well as any collectable accounts receivable.

The intangible, or cash flow value asset category represents the goodwill or "going concern" of a practice and is usually calculated by measuring the income that the practice has generated over the past three years. The cash flow value in most dental practices in now worth significantly more than the value of the tangible assets. This relative value scenario is a total reversal of what existed in years past.

Unlike the value of the tangible assets (which is relatively stable), the value of the intangible assets is very unstable. Due to this fact, this value component can rapidly disintegrate in the case of death, disability or loosely structured associateships. (We refer to these and other circumstances as "practice value destroyers.") This is why it is crucial for today's dentists to plan ahead for the eventual transfer of this perishable asset to a successor. Otherwise, tens or even hundreds of thousands of dollars could be lost!

Practice Valuation Methods

A "sea" of theories and methodologies exist in the area of practice value determination. Choosing one valuation method over another, as well as how the terms of the purchase are to be structured, will dramatically impact the final selling price of a practice. Knowing the right valuation methods and purchase terms to use in a given situation combined with actual "market" knowledge, are extremely important and almost always will justify the use of an experienced dental practice appraiser. Once this value has been determined, various methods can be explored for "cashing it in."

Some of the more common "formal" practice valuation methods used in the industry today include capitalization, discounted future earnings, excess earnings, and asset summation. All of these methods should be balanced with real market knowledge, i.e., what are practices consistently selling for in a given area under similar circumstances.

Rule-of-thumb formulas became popular years ago when dentists were seeking simple methods for determining the value of their practices. Each rule-of-thumb method presents its own unique challenges to the user, so you will need to be extremely careful when using these methods without consulting a skilled professional in the field of practice valuation.

In the final analysis, purchasing-dentists and their advisors inevitably will base their decision on whether or not to purchase your practice on the present, and to a certain degree, the potential net income that could be generated by the practice.

To consider the practice a viable investment, the purchasing-dentist must feel certain the practice will generate enough net income to first pay the existing overhead. There must then be enough remaining net income to cover the debt service of the purchase price, which is the total of all payments on the practice including any loan for down payment financing. The net income remaining must support a reasonable lifestyle for the purchaser, while paying off the debt. With the average debt service payout period being between seven and ten years, it would be unreasonable to expect a purchasing- dentist to live the lifestyle of a pauper until the time the practice is paid off.

The Impact of Managed Care

Currently, practices with a large managed care base are selling for far less than similar size fee-for-service practices. This is due largely to the following: 1. Most purchasing-dentists today are seeking traditional fee-for-service practices, not managed care practices. That fact, in and of itself, has the greatest negative impact on the value. 2. The perception, on the part of most purchasers, is that little if any goodwill exists in a managed care practice. 3. Managed care profit margins are usually much less than well-managed fee-for- service practices. (Why produce $500,000 to make $100,000 on managed care patients, when you can make $175,000 to $200,000 with fee-for-service patients?)

Here is an example of the impact of managed care on practice value: A client of mine owns a managed care practice near a famous resort area in Florida. The practice currently nets over $250,000 in income for the seller-dentist. This practitioner is working 4 days per week and takes approximately 13 weeks off per year for vacation. (Doesn't sound too bad so far, huh?) This practice has been on the market for over 1.5 years, is priced 20-25% less than a similar fee-for-service practice, yet not one purchaser has even inquired further once they heard that it was a managed care practice!

A purchasing-dentist must consider the variances in managed care pay schedules, increased patient flow in order to generate the same income (which requires more staff support), associate dentists working long hours for less pay (hired to provide services for the managed care patient base), etc. The bottom line is that most purchasing- dentists feel that managed care practices are unstable and could end up being a "revolving-door" of associates and patients.

What can we expect for the future? Good question. Managed care has been well- entrenched here in the state of Florida for more than 10 years. During that time, we have seen no change in this negative value perception from potential purchasers who, by and large, will avoid looking at managed care practices.

If you are currently considering participation in a managed care program, weigh the costs of how it will affect your practice value. If your mission is to increase your patient base, consider expanding your practice through an associate (who will eventually buy- in) or through a practice merger. If you are already participating in a managed care plan, seek the advice of a trained transition specialist to help you develop a plan to protect the value of your practice and to help you make the appropriate choices for your future.