Whether you’re considering buying or selling a dental practice, you want to get fair value in the transaction. Determining the practice’s fair market value is one of the best ways to avoid making a financial mistake.
How do you determine the value of a dental practice? There’s no set way. Financial institutes may use one of several methods to determine how much value a dental practice has. This guide explains some of the more common methods and their respective benefits.
Income Approach
The income approach determines the value of a dental practice by estimating its future earnings.
To make this estimate, the prospective buyer or seller will look at the practice’s financial records. This data shows how much revenue the practice made in the past and how much money was spent on costs. Typically, those values should indicate the kind of income the practice will likely draw going forward.
Drawbacks of the Income Approach
There are two potential downsides to this method. First, past income may not accurately reflect future income if the dental practice isn’t well-established or the area it serves is experiencing population growth. Either of these situations could result in the practice being undervalued.
Additionally, this approach doesn’t consider patient loyalty or goodwill for a specific dentist. Even if there are no other staff changes, the most senior dentist will usually leave in the event of a sale. Some patients will leave with them, which could lower the value of the practice.
Market Approach
The market approach assumes that all dental practices in a given area have roughly the same value. This approach involves looking at the practice’s location, size, and services. It then compares the practice to others that have been sold previously to give potential buyers and sellers an idea of what to expect in terms of overall value.
Drawbacks of the Market Approach
The main issue with this method is that nearby practice owners may be unwilling to reveal how much they sold or purchased their practice for. While this information may be available in public records, digging it up can complicate things and limit the ability to make a good comparison.
Additionally, this strategy must take inflation into account. If a practice sold for $2 million more than a decade ago, a comparable practice today is probably worth a few hundred thousand more, at a minimum.
Asset Approach
The asset approach attempts to determine the value of a dental practice by adding up all associated assets, taking into account both tangible and intangible benefits. A list of assets belonging to a dental practice may include:
- Real estate
- Office equipment
- Office vehicles
- Client lists
- Goodwill
- Patient records
- Location
As with the other approaches, there are some cons associated with the asset approach.
Drawbacks of the Asset Approach
There are two significant challenges with this option. First, tangible assets like equipment and office space experience depreciation. As such, you must roughly calculate depreciation when employing this method.
The bigger challenge, however, is that the majority of asset value derives from intangible assets like goodwill and location. These assets may represent as much as 80% of the value of dental practice.
Because such assets can’t easily be estimated, it’s best to let an experienced dental business law attorney help with this type of valuation.
No One-Size-Fits-All Solution
Every approach to dental practice valuation has its difficulties, and often, no single approach will perfectly determine the value of a particular practice. To get as accurate a valuation as possible, consult with a dental business law attorney like the ones at Mahan Dental Law, who help clients nationwide determine the value of dental practices.
