Our thoughts . . . 05-29-07

APPRAISAL METHODS

When speaking at one of our market area dental schools, study clubs or just casual conversations with practicing dentists, the subject of practice valuation almost always comes up. It seems everyone has read something, heard some speaker or knew someone who had an opinion about valuing dental practices. While this subject consumes many textbooks and professional training that can take many years to complete, let’s see if we can boil it down to its essence if for no other reason than to learn the terminology.

At EMA we start with the collection of all the pertinent data. This would include--but not be limited to-- a complete physical inventory of furniture, fixtures, dental equipment, computers and electronic equipment, supplies and instruments, three to five years of complete business tax returns, the most current P & L statement and considerable practice statistics. This data is then interpreted through the following methods of appraisal:

1.   Capitalization of earnings – a computation based on a calculated rate of return on the practice profits. The capitalization rate is determined by a combination of current market conditions, money at similar risk and database information.

2.   A cousin of that technique uses the “excess earnings” to calculate the amount of debt that can be retired. Excess earnings are defined as cash available after overhead is paid and the owner receives fair compensation for producing dentistry. Professional appraisers often refer to this method as the sanity test for their valuation decision.

3.   Summation of Assets – a build-up of values based on the comparison of the subject practice to a model practice, location and demographics.

4.   Comparable sales – EMA now has almost 200 sales in the Midwest market area along with access to the sales data of American Dental Sales and the Institute of Business Appraisers. Comparing the subject practice to other practices that are similar in size, style and location can give us an accurate formula for valuation. Common ratios include sales price to gross revenues and sales price to net income.

Be advised that the value of a practice is not just a simple average of these methods. Regional variations, market conditions and the “curb appeal” of the practice demands a blend of art and science on the part of the appraiser. Some methods may not be appropriate for all practices and in some cases the methods may be weighted. One should also be aware of certain factors that do NOT affect the value of a practice. Debt service, start-up costs and funds needed for the seller’s retirement should not affect an appraiser’s objective opinion of a practice’s value. Beware also of valuation statements from people outside of the target practice’s market area and especially from those who have not actually seen the office. Guesses—even educated ones—are not an option.

Steve Wolff, DDS
UMKC Class of 1977