What is Your Practice Worth?

WHAT IS YOUR PRACTICE WORTH?

Adam Smith was a Scottish economist who is often viewed as the father of modern economic theory. In 1759 he published his first work “The Theory of Moral Sentiments”. Smith proposed the idea of an invisible hand—the tendency of free markets to regulate themselves using competition, supply and demand, and self-interest. Obviously, a lot has changed since Smith published this work, however the context that it frames remains relevant when contemplating market forces with respect to what a practice is worth.

For the purposes of this article, we will consider the ‘”value” of a practice as the dollar amount a practice could be sold for in an open market with willing participants, a phrase that is often used in valuations. This is likely not the first time many of you have seen it in print. In essence it means that the vendor is not selling under duress, standard market conditions prevail, there is no urgency driving the transaction and that all parties are willing to participate in the transaction. Typically, a valuation document would run for at least 20 pages and, in this article, we only very lightly touch on the generics.

 

Valuation guidelines

Writing as a valuer, it is important to note that valuation work is not a precise science. Rather, it produces an opinion based on a review of the underlying background information on the asset or entity being valued, and the application of valuation methodology as deemed suitable by the expert.

In the dental space there are typically four types of methodologies adopted by a valuer:

  1. Corporate Valuation (multiple of sustainable earnings; called corporate as this is typically how the large corporates value a practice).
  2. Sole Trader / Micro Valuation (multiple of principal profit).
  3. Market Comparison / Comparative Sales (info harder to glean, often used for property).
  4. Rule of Thumb.

In addition to that there are many other critical factors to consider:

  • Length of the lease.
  • Age of the equipment.
  • Quality of the fitout.
  • Location.
  • Nearby developments.
  • Access to public transport.
  • Parking.
  • Schools.
  • Patient mix.
  • Demographics.
  • Mix of clinical work.
  • Who is the purchaser & the vendor – do they align?

I will provide some very brief commentary on the general principles below.

 

Corporate Valuations

There is a lot of misinformation in the market place around how these types of valuations work and of course every practice is different. With respect to a valuation that contemplates a multiple of earnings, often phrased as EBITDA (earnings before interest, tax, depreciation & amortisation) many principals forget that EBITDA  / earnings for a corporate is calculated after market remuneration for the principal. So, let’s say the practice generates $800,000 in revenue, the standard market remuneration to the principal would be 40% of fees, less laboratory costs. For this example, let’s say that is $300,000. If the practice principal is generating take home remuneration now of less than $300,000, then a corporate wouldn’t buy the practice and it’s value would be nil – to this acquirer.

 

Sole Trader

Looking then at this same practice, at $800,000 worth of patient fees and principal total remuneration at say $300,000. We would typically apply a multiple of at least 1.5 times this amount – which would potentially value the practice goodwill at an amount somewhere between $450,000 and $500,000. Questions would of course be raised by the valuer or the purchaser: Why is the total remuneration low? Is this related to external factors and if so, which ones? How will they be affected by the business sale? and so forth. This doesn’t, of course, take into account how we would or would not deal with the physical plant and equipment. It should be noted that the value attributed to plant and equipment is usually very low; whilst the equipment has a high degree of utility (generating patient fees) it has little tangible value as a separate asset. There is virtually no second market for dental equipment.

 

Market Comparison

Practice brokers will be able to advise any potential vendors / acquirers as to what practices are trading at. The broker therefore may be able to advise that practices similar to the example “$800,000 revenue practice” have been sold in the last 12 months for a value of $x. If, therefore, several other similar practices have sold for $x, it is not unreasonable to conclude that this practice is worth a similar amount. That being said, it’s very easy to value residential units in an apartment complex based on comparative sales of essentially the same asset. These are ubiquitous assets. Every practice I have even seen is different from the others!

 

Rule of Thumb

Historically, when looking at the value of a practice (general), many advisors would indicate an approximate value for the practice to be determined from its patient fees. Or they would use various other different approaches for calculating the value. I view such general yardsticks as offering limited – if any – guidance. Every practice is different. Different practices have different values, depending on the acquirer and the vendor, and that’s before even looking at the physical premises and all of the assets of the practice, and reflecting on the intangible assets of the practice.

 

How do you Determine the Value of your Practice ?

Great starting points would be to talk to your accountant, engage with a practice broker, or talk to a friend or colleague who has purchased or sold a practice in the past few years. The most accurate position you will get is to engage with more than one source of information and guidance. Consider all of the information and, objectively (this can be hard for all of us who own a practice) consider not only the strength of your practice but the honest deficiencies as well. In a lot of the engagements my firm has with respect to valuation and practice consulting, it would be fair to say that many practices, with some fine tuning, would be worth a lot more money in 12 months’ time, than they may be as at today’s date.

A final observation, if you were selling a residential property, is that you would probably consider having the property styled, painted, new carpet laid and a raft of other minor and sometimes not so minor improvements. Consider how the practice presents, consider the patient interaction and service experience, be prepared with current, well organised information on the practice for potential suitors and put your best foot forward.

 

About the author

Heath Stewart, CA, B.Com, M.Tax, CTA, Dip.FS (FP)
Chartered Accountant and Director
Ecovis Clark Jacobs
Accounting and Business Advisers

This article first appeared in the March issue of News Bulletin, published by the Australian Dental Association.

This article is designed to provide generic information only and should not be viewed as a recommendation to act or financial advice. Individuals should seek advice from a qualified adviser to ensure their actions are commensurate with their financial needs and requirements. Whilst every effort has been undertaken to ensure accuracy of information at the time of publication, the information contained within the article may have changed prior to and subsequent to the article’s publication.

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