How are dental practices valued?

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Valuing a dental practice is one part science and one part emotion. The science is the numbers—what the bank sees and uses to calculate the amount they will loan. The emotion part is everything else—the location of the dental office, the condition of the equipment, the patient base, the recall program and many other factors. As mentioned in a previous post, because banks make 100% loans for dental practices you can reasonably assume that Loan Dollars = Purchase Price; i.e. the selling price is generally close to whatever the bank will lend. This makes understanding how banks approach valuations extremely important and how the emotion piece factors in with buyers.

Rarely do bankers visit the practice in person. Typically, bankers review profit and loss statements, tax returns and production reports to make their decision, and the emotion piece rarely factors in. In doing their assessment, banks try and determine what the true income and expenses of a dental practice will be for the buyer. This process requires them to strip out certain income and expenses that the buyer will not earn or incur. They call these income and expenses “add backs”. For example, if a dental practice received $50,000 in government stimulus (e.g. PPP loans) and it shows on the profit and loss statement under income (collections), they will reduce income by $50,000 since that is NOT recurring, expected income in the future to the buyer. Similarly, they will go line by line through the seller’s financial statements looking for expenses that the buying dentist or, more specifically, the dental practice will not have to pay.  These often include things like the selling dentist’s salary, associate pay if the buyer is going to cover the associate’s production, loan interest, depreciation, travel, cell phone, auto, kids on payroll, etc. Once the bank has generated a profit and loss statement with add backs, they can then apply their underwriting formulas to the collections and profit to determine the amount of the loan. A general rule of thumb for the banking formulas is 85% of collections and 2.2 times the profit. Where these two formulas intersect is approximately the value of the practice…at least in the mind of the bank. And more specifically, banks calculate a “Global Debt Coverage Ratio.” This ratio is calculated by taking the expected net profits of the dental practice and dividing it by the sum of (1) all debt payments in the practice and (2) all debt payments outside of the practice. If the buyer does not have a home loan, the bank will impute an estimated rent. If the net cash flows are at least 1.25 times the global debt payment requirements, then they will generally commit to that loan.

Now, it is not entirely accurate to suggest that dental lenders are mere robots with simple inputs and outputs. They do consider other factors such as the total amount of debt the buyer has and whether the buyer’s clinical skills and production matches those of the seller. Do they care if the chairs are new from A-dec or used from 1976? Not so much. This is where emotion comes in. I call it emotion, but it is more the characteristics of the dental practice that motivate buyers to want to buy it.  For example, would you rather have a 3-op practice in a rural area or a 6-op practice in Coronado? The characteristics of the dental practice also play into value, not so much on paper, but in the actual process of selling it. These are the things that generate tours, get people talking, motivate dental buyers to write offers and compete for the opportunity. More ops, nicer equipment and better locations allow me to push value while fewer ops, older equipment and tertiary locations sometimes leave me wondering if the practice can even be sold. In special cases with special dental practices, I have even had buying dentists offer to pay more than the bank will lend. Why? Sometimes good practices are hard to find and when you are trying to be picked as the buyer it makes sense to write a check.

To sum up, valuing practices can be both scientific and emotional. Understanding how each play off the other and results in a final practice value takes understanding, practice and time. If you are a dental practice seller, consider ways to increase your collections, reduce your expenses and spruce up the office.  These efforts will increase your value and hasten the selling process. If you are a dental practice buyer, you will rely heavily on your banker to help you know what to offer, but keep in mind there is more to it than what the banker sees, and you are likely competing against others who want the same thing you do. Being aggressive and building a relationship with the seller will be key to winning. Good luck out there!

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