What Constitutes Value When Buying a Dental Practice?

n existing dental practice is a small business. It is made up of a number of assets that together comprise the “value” of the business. The “sale price” of the business represents the “monetary worth” to be exchanged for the “sum of the values” of these various assets. The relationship of the sale price to the value determines whether the purchase was a “good deal,” “fair deal,” or “bad deal.”

Many new dentists, unfamiliar with business principles, confuse “good

value” with “a good deal.” A good deal means the asset is acquired for less than its value. These new prospective business owners miss the point that while negotiating a “good deal,” they frequently destroy the very “value” they are trying to acquire. To avoid this loss of value, the new dentist needs to understand the value of the underlying assets being acquired, how to protect that value, and the relationship of the price to the value.

instruments are those items that while not necessarily disposable, also have a relatively short, useful life. Any leasehold improvements paid for by the practice are also part of the tangible assets of the practice.

The Assets

When acquiring a dental practice, the practice assets that comprise the value are easily defined. They are the tangible or hard assets, defined as dental and office equipment, furnishings and office décor. Additional hard assets include the supplies, consisting of office supplies, clinical supplies, and “hand instruments.” Hand

In addition to the tangible assets, best described and understood as items that one can see, feel, or touch, are the intangible assets, best described as assets one cannot see, feel, or touch. Of all the

dental practice assets, the “goodwill” of a dental practice is usually the dental practice asset with the highest value. This goodwill value is made up of many different components. First, and most important on the list, is the endorsement of the selling dentist. The value of the Seller’s referral to all patients of record, i.e., that in the future they seek the services of the Buyer, cannot be over-stated.

This referral or endorsement has the

same impact as any “celebrity” referral or endorsement we have all seen in the media for any product, service or “provider” of service. The trusted referral source (in this case “the Seller”), has a long standing and trusting relationship with the individual to whom the referral is being made (“the Patient”), and has special knowledge of the product, service, or in this case provider (“the Buyer”), that allows the Seller to attach their name, reputation and relationship history to the individual being endorsed (“the Buyer”). And it is “the value” of this most important asset (“the referral or endorsement”) that can be readily decreased or destroyed if the Seller does not feel they have been paid a fair price or has been forced to accept other less than desirable terms to allow the sale to happen. In other words, if the Buyer beats the Seller up (negotiates the price down) to get a “good deal,” the endorsement of the Seller will not be as strongly worded and in fact the Seller may withdraw that endorsement after the sale occurs, feeling, in fact, that the Buyer did not pay fairly for that endorsement and the goodwill value attached to it. In the Seller’s mind, withdrawing the endorsement is the only means available to off-set

being taken advantage of by the Buyer.

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full schedule provides) while the first day, week, and months of a new practice has multiple open hours with no patients to be seen.

In addition to the actual number of active patients, the type of patient base, i.e., are these patients who are looking for and accept comprehensive dentistry or are they patients who only seek services when they are in pain, requires investigation to determine just how valuable this patient base may be. However, any full-time active patient base provides cash flow from day one. This is the reason most lenders will much more readily lend $500,000 to purchase an existing practice versus $300,000 to finance a start-up practice-less risk to the Buyer and a greater likelihood of repayment of the bank loan.

goodwill.

Another primary component of the goodwill value is the “active patient base or count.” The purchased collection of patients (the active patient base), who frequent the practice and spend their money with this selling dentist for dental services, have been acquired by the Seller over a period frequently of 7-15 years. It is the time it has taken to build this active patient base that makes the existing practice so valuable. Certainly one can start a practice from scratch with nice new equipment at a lesser cost than purchasing an existing practice, but the first day in the existing practice has a full patient schedule (and the cash flow this

While the most valuable asset in this intangible group is the goodwill, there are other intangible assets of the practice such as the new patient flow, existing staff, current marketing system, business systems, and location of the practice. The new patient flow also adds to the goodwill value. The higher the number of new patients per month, the greater the value for this portion of the goodwill. Whether these new patients are from internal referrals from the practice’s existing active patient base or the result of an effective external marketing program, they are a highly desired asset to a practice being acquired.

And the final intangible asset of an existing practice is the Seller’s promise not to compete against the Buyer of the practice. If the Seller accepts employment and establishes a new practice in close proximity to the original practice, many of the Seller’s active patients of record will follow the dentist to the new location. If this happens, the Buyer will lose a major portion of the most important and valuable asset they have just purchased, i.e., the active patient base. This point again indicates just how valuable the active patient base and how closely this aspect of the goodwill must be protected. In fact, the value of the goodwill and the non-compete covenant are so entwined and difficult to separate, that from a taxation perspective, the IRS allows the cost

allocation of both to be considered totally as goodwill, thereby giving the Seller the more favorable capital gains tax treatment for the entire value.

Defining the Value of the Various Assets

The “asking price” for the dental practice is typically determined through an appraisal or valuation of the individual assets of the business (the dental practice). In most instances, the asking price will be at or slightly above the “fair market value” of the sum of the values of these assets. The definition of “fair market value” frequently quoted is the Internal Revenue Service definition. Per the IRS, the “fair market value (FMV) is the price for which you could sell your property to a willing buyer when neither of you has to sell or buy and both of you know all the relevant facts.” This fair market value is further defined as the price at which similar practices with similar overheads and profits are selling at this particular time in the market area the practice is located in. By setting the “asking price” slightly above the fair market value, many sellers hope this will provide some flexibility for “price” negotiation.

profit.

Determining the fair market value and

Get more patients.

In today’s market, the goodwill value for a dental practice is 50-150% of either the most recent twelve month adjusted profit or the weighted average of the last several year’s adjusted profit. 100% is the typical multiplier for a general dental practice, unless special conditions warrant using a higher or lower value. Examples of these special conditions include the practice of a deceased dentist seller which has been inactive for 3-6 months. In this case, the percentage for this goodwill would probably be 50% of the adjusted profit. In the case of an aging dentist whose personal production is in decline but whose hygiene department is continuing to maintain the active patient base, we frequently see a build-up of needed but uncompleted dental services and a higher percentage multiplier is indicated.

In today’s market, the

month adjusted profit or the weighted

average of the last several year’s adjusted

asking price for the assets is an accounting process. The current fair market value of the equipment, office and clinical supplies, hand instruments, and leasehold improvements are determined using industry data based on a number of factors including age, original purchase price, and ongoing “used” sale prices for the individual assets being appraised. To this total value of the tangible assets is added the value of the goodwill/noncompete covenant.

Regardless of the proposed fair market value or asking price, the actual “sale price” may be above, equal, or below the actual calculated “fair market value.”

Why a “Fair Deal” Constitutes the Best Value

The old saying, “You get what you pay for,” could not be truer when it comes to purchasing an existing dental practice. To preserve the goodwill of the Seller, the

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most valuable part of goodwill, the Seller must believe they are being paid a “fair price.” Nickel and diming the Seller during “negotiations,” whether on price or terms of the sale, destroys or significantly decreases the value of that portion of the goodwill. A Seller who feels they have been cheated and continues to live in the community will have no problem telling every patient they see on the street or at the corner grocery about how they view the “integrity” of their successor, and the anti-marketing impact of the local community “rumor and gossip chain” should never be under-estimated. Many of these patients have trusted everything the dentist has said for many years, so the retraction of their endorsement will also be given full credibility and attention. If the Seller feels they did in fact get a fair price and terms, the new Buyer will receive the opposite (and desired) ongoing positive marketing on behalf of their new practice.

The trick comes in determining wheth-

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er the seller is being “fair” in their asking price. Some sellers have an over-inflated idea relative to what their practice is worth and what price they are willing to sell it for. Many dental practice brokers will tell the new dentist anything necessary to get them to sign on the bottom line. It is for these two reasons, coupled with the reason to pay a “fair price” to achieve the maximum value for the practice being acquired, that the new dentist is well-advised to hire their own experienced Buyer Agent to assist in evaluating the practice, conduct the negotiations, etc. The best Buyer Agent is one who hopes to have an ongoing business relationship with the Buyer for many years to come.

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