This week, we again reached out to Chris Mayer of The Heimat Group to tap into his extensive experience with dental practice valuations. Check out his previous No Stupid Questions answer: Why (and when) should I get a practice valuation?
Question: My valuation professional mentioned three “approaches” to determining a value. What are they?
There’s no single way to arrive at a practice valuation. A valuation professional should look at all the data and determine which option best suits that particular practice. This becomes especially important when comparing two valuations, as each methodology may return a different value. Make sure you understand which methodology your valuation professional is using.
The asset approach is a balance sheet-focused method used to derive the value of a company based on the difference between the fair market value of its assets and liabilities as of the date of valuation. This incorporates dental practice appraisal(s) of all tangible assets (chairs, equipment, real estate, etc.) and intangible assets (such as practice goodwill).
Because dental practices are generally worth more as a “going concern” (meaning when they are operating day to day), and because goodwill is difficult to evaluate, the asset approach is generally dismissed for the purposes of dental practice valuation. You will occasionally see this methodology used in practices that are not currently operating (such as after a dentist’s death or unplanned retirement), or if a seller has significantly reduced production from its peak. The asset approach may also be used when a dentist is considering selling their patient list and equipment separately.
Income Approach - Discounted Cash Flow
The income approach typically includes a discounted cash flow, which estimates value based on future earnings of the practice. A discounted cash flow analysis aims to determine the value of an investment today, based on estimates of how much money it will generate in the future.
Overall the income approach - discounted cash flow method is ideal for dental practices with a proven track record, financial stability, and a clear vision for continued performance and growth. Along with the market approach, the income approach is generally utilized in a dental practice valuation.
The market approach incorporates the study of recent transactions of comparable dental practices, adjusting for differences in practice-specific and external dynamics, including financial history, facility condition, equipment, service mix, local economy, demographics, and competition. Overall, per the market approach, a valuation professional can estimate practice value by assessing the practice compared to other recent, similar practice transactions.
Comparable practice transaction data reflects differing dynamics, including nuances related to the specific dental practice. As a general rule of thumb, and supported by observing a variety of practice transactions, dental practices are traditionally valued between 60% and 80% of annual collections.
Along with the income approach, the market approach is a commonly used valuation technique for evaluating dental practices.
See two examples of how differing practice valuation methodologies hampered practice sales and check out other posts in our Real Talk series.