Practice Valuation: How Much Is Your Dental Practice Worth?

At a glance:

• The main takeaway: At some point in your career, you likely will need to seek out a dental practice valuation, even if you aren’t sure when or if you will sell your practice in the future.
• Impact on your practice: There are three widely used valuation methods, but the right approach depends on your purpose and your current and future goals.
• Next steps: Aprio’s dental CPAs and CVAs are here to help guide you through the valuation process and strategize your path forward.

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The full story:

What is your dental practice worth? If you don’t know the answer to that question, you’re not alone. It can be hard to quantify the value of a business that has grown from years (possibly even decades) of blood, sweat, and tears. But, at some point in your dental career, you likely will need to seek out a practice valuation, even if you aren’t sure whether you will sell your practice in the future.

Here is a thorough explainer on the key questions and factors you need to consider when it comes to practice valuation.

What is the purpose of a dental practice valuation?

To open the conversation, it’s important to know the purpose your practice valuation will serve. For most of our clients, practice valuation comes up when a dentist is contemplating a long- or near-term sale. The exercise can serve as a catalyst for the dentist to either move forward with putting their practice on the market or invest a little more work into building its value.

Dentists who are not particularly focused on a potential sale may request a valuation out of curiosity or other need. For example, they may use the valuation process as a business case for making certain staff, technology, or infrastructure upgrades.

Regardless, the key point to note is that your purpose determines the valuation methods your professional advisors will perform to arrive at the magic number.

What valuation methodologies are applicable to dental practices?

Before we dive into methodology, it’s essential to state that when we talk about valuation for the purpose of a transition, we are talking about the concept of fair market value.

IRS Revenue Ruling 59-60 determines the basis of fair market value and states that it is, “The amount at which the property would change hands between a willing buyer and willing seller, when the former is not under any compulsion to buy, and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”

The first type of valuation report is what most valuators call a calculation of value, or “a limited scope valuation.” The limited-scope valuation focuses solely on a practice’s collections (revenue), estimated cash flows, and comparable sales if applicable and does not account for broader market factors and future earnings potential. This valuation will often utilize information such as the practice’s profit and loss statements, tax returns, adjusted earnings, certain practice management reports, and recent comparable sales information if applicable.

In many cases, limited scope valuations come in handy when a practice is considering or entering into a merger and acquisition (M&A) transaction.

The second type of valuation report is the conclusion of value, or “a full scope valuation.” This method is less common in the dental practice transitions world because the purpose is relatively unique and may require 50-60 pages worth of report narrative. This valuation report includes narratives about the dental industry, as a whole (including economic factors), as well as geographic and demographic information.

We commonly see valuators perform full scope valuations for situations that involve complex tax reporting (i.e., in the case of income tax filings for gifting or estate purposes) or divorce and litigation proceedings. Some dentists may require a full scope valuation if they plan to gift all or a portion of their practice to their heirs. The main differentiator is that limited scope valuations may be used for myriad reasons, while full scope valuations often serve a very specific purpose that is unique to the dentist or individual.

In other words, valuators typically use the same metrics to calculate value under both limited-scope and full-scope valuations; the difference comes down to the purpose of the report.

Approaches to calculating practice value

Valuators will typically consider three primary ways of calculating the value of a dental practice. It is up to the valuator to determine which approach(es) is the best representation of the dental practice. These include:

1. Income approach: The income approach to valuation looks at the revenue, collections, and cash flow of the practice. Most of today’s dental practice valuators rely on this approach. When someone commits to purchasing a practice, a buyer is essentially purchasing the practice’s current and future cash flows. Valuators will start by reviewing the practice’s financial statements and tax returns and then adjusting to normalize expenses across all years (this exercise can be helpful if there is a year in which the practice had a costly, unusual expense that it doesn’t typically have). Valuators will also review personal or discretionary expenses running through the practice and normalize dentists’ compensation to fair market value rates.
   
2. Market approach: The most common market approach is the comparable sales method, similar to the method used in real estate. This approach looks at the value of similar dental practices in similar geographic areas that have recently sold; from there, the valuator will review the comparable practices to determine whether they represent a good comparison to the dental practice in question.
   
3. Asset approach: The asset approach focuses on reviewing the underlying assets of the dental practice — including the equipment, dental chairs, and the physical building — to help determine value.

Situations that necessitate a practice valuation

There are many reasons you may want to consider having an updated valuation; the most obvious and common need is the potential sale of a dental practice. We advise dentists to request an updated valuation shortly before they put their practice on the market to provide the most up-to-date measure of value when it is listed.

If you are about to engage in transition planning (for instance, retirement planning and preparation), a valuation is essential to help determine what quantifiable role the practice will serve in your future income and personal cash flow plan. If you are thinking about hiring a new associate and want to offer them a chance to buy into your practice in the future, candidates likely will ask for a valuation number to understand what the practice is worth before they consider the opportunity.

In general, it is a good idea to request a practice valuation every two to three years, or whenever you have made major changes within the practice, such as an office remodel or a staff expansion. We also recommend that our clients update their practice valuations in light of major economic or global events. For instance, if you have not requested a practice valuation since before the pandemic, now would be a great time to do so.

The bottom line

Before you start the valuation process, it is imperative to seek out the help of a credentialed and qualified professional team with experience working in the dental industry.

Aprio’s Dental Transitions Team is here to support you through the process. Whether you are ready to sell, buy, start a practice or simply start the conversation, we can provide the dental acumen, resources and comprehensive services you need to evaluate your practice and achieve optimal outcomes.

If you are ready to update your practice valuation, schedule a free consultation with our team today.

Related Resources

About Aprio’s Dental CPA and Accounting Services

Browse Dental Practices for Sale

The Top Benefits of Getting a Practice Valuation (Video)