How to Value a Dental Practice: Methods & Key Factors

Understanding what your practice is worth, and what factors are driving that value, is the essential first step in making the most of the current market before conditions shift. 

Valuation Methods for Dental Practices

There are three main methods by which professionals evaluate dental practices. Each of these methods considers various elements of your practice. All three put the complete picture together to determine the worth of your dental practice.

Income Approach

This approach evaluates your practice in terms of its capacity to earn income in the future. The income approach uses either the discounted cash flow method or the capitalized excess earnings method.

Discounted Cash Flow involves taking your projected future cash flow and converting it to present day money using a discount rate between 15% and 25%.

Capitalized Excess Earnings uses your profit above and beyond what your physical assets would earn if they were operating on their own. The income approach uses the capitalization rate.

Currently, suburban general practices tend to sell in the range of 4.2 to 5.4 times EBITDA. This is changing from the older approach of valuing by revenue.

This approach is best suited for practices with more consistent and reliable income flow. Your patient retention rate and fee structure are considered in this approach because they affect your earnings.

Market Approach

This approach compares your practice to similar practices in your region that were recently sold. The market approach uses actual sales data from your region.

Factors considered in the comparison include the size of the practice, patient mix, production, and the practice’s location.

The most common multiples used in the market approach are revenue multiples (gross collections), EBITDA multiples, and the number of active patients. This method will provide you with a real-world validation of your practice’s value. However, if your practice is in a rural area or has a specialized practice, it can be difficult to find comparable practices.

Asset-Based Approach

The asset-based approach consists of adding up your tangible and intangible assets. So, your equipment, your supplies, your furniture, and your goodwill will all be factored in to give you a value.

The equipment will be based on the fair market value of the equipment today. So, it doesn’t matter when you bought the equipment or what you paid for it. Your intangibles will be your patient base, your goodwill, your location, and your employee relations.

This method will give you the minimum value for your practice. This method will be more useful to you if your practice has newer equipment or if the sale is more based on the equipment than the cash flow.

Calculating Practice Financials

Calculating the financials for your practice is the foundation upon which your practice value will be based. The main financial figures will be your adjusted net income, your EBITDA, and your normalized financial statements.

Adjusted Net Income

Adjusted net income will give you a clear picture of your practice’s income: it’s the income your practice actually makes. You can exclude owner-specific and discretionary expenditures. This will be different from your income tax returns because it will exclude expenditures that a new owner wouldn’t incur.

The adjustments will include adding back in extra owner income, personal expenditures, and non-recurring expenditures such as big repairs or legal fees.

Start with your net income from tax returns and add back in expenses like personal car expenses, inflated salaries for family members, inflated rents for family members, and anything else you spent money on for the business.

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)

EBITDA is a measure of profit, eliminating expenses like interest, taxes, depreciation, and amortization, which vary according to the business’s ownership.

Start with your net income and add back in interest, taxes, depreciation, and amortization.

Most dental practices are sold at 3x to 8x EBITDA.

Buyers like EBITDA because it’s a real measure of the way the business operates.

For instance, if you have a dental practice with an EBITDA of 500,000 and you sell it for 5x, you’ll have a valuation of $2.5 million.

Normalization of Financial Statements

Normalization of financial statements makes adjustments to your statements so they look like they would for a typical buyer.

This includes removing one-time expenses and owner-specific expenses.

For instance, you might remove unusual insurance claims and add in market rate salaries for your staff.

Other things you might add in include:

• Owner’s salaries at market rate for associates
• Rent at fair market rate if you own the building
• Market rate salaries for your staff
• Personal expenses
• Deferred maintenance costs
• Capital expenditures

Other Non-Financial Factors That Impact Value

The value of a dental practice is not just about money. Your reputation, the condition of your office, and patient loyalty all contribute to the saleability and value of your practice.

A good reputation and loyal patient base can make all the difference in the saleability and value of your practice. You want to be the practice everyone wants to own, not the practice nobody wants to own. 

Your reputation is a major factor in the saleability and value of your practice. Buyers will pay more for a practice with a good reputation and high patient loyalty. If you have a rating of 4.5 stars and above, you’ll get a premium value compared to other similar practices with low or no reputation. 

Being active in local charity events is a great way to build goodwill. Showing up to health fairs and other local events demonstrates to patients that you care about the local community and are not just focused on making money. 

Key factors that contribute to goodwill value include: Years of operation, staff longevity and their relationship with patients, membership and participation in local organizations and associations, and absence of malpractice suits and government actions.

Dental Practice Goodwill Valuation

Goodwill is the intangible value of a dental practice beyond the practice’s tangible assets. It’s an important part of the practice’s value, so you should understand how to calculate goodwill to ensure you get the highest possible sale value. 

Goodwill Valuation Methodology

There are two primary methods to calculate goodwill.

Excess Earnings Method: This method involves subtracting the fair market value of tangible assets from the total valuation of the practice, and the difference is the amount of goodwill. For instance, if the valuation of a dental practice is $1.2 million and the tangible assets are worth $300,000, the amount of goodwill will be $900,000.

Capitalization Method: This method involves capitalizing the excess earnings, which are the earnings in excess of those the buyer would have earned from the tangible assets. For instance, if the normalized EBITDA of a dental practice is $400,000 and the tangible assets would have earned 80,000 at a standard rate of return, the excess earnings would be 320,000, which will be capitalized at a market rate of return (typically 20-25%) to arrive at the amount of goodwill.

Typical Goodwill Percentages

Goodwill normally ranges from 60-80% of the total valuation for an established dental practice. This is because there’s a high value placed on the relationships, reputation, and referral base, as well as the trained management systems that come with the sale of your practice. For newer dental practices, the amount of goodwill will normally be 40-60%.

The high amount of goodwill is a major reason why it’s so important for you to develop a reputation and a strong base of loyal patients for your dental practice.

Equipment and Facility Condition

Having modern equipment will greatly benefit you in the sale of your dental practice because it will save the buyer money. Dental practices with digital radiology, intraoral cameras, and modern equipment in the operatories will attract more buyers than those with outdated equipment.

The equipment in your dental practice will greatly influence the amount of goodwill you will eventually receive for your sale. Dental equipment that’s less than five years old will add full value, while outdated equipment will detract from the valuation.

Your facility condition will also affect the buyer. If the facility is clean and well-updated, it will create an impression that the practice is well-managed. On the other hand, if the facility is old and not well-maintained, it will create an impression that the practice is not well-managed and will require additional investment to upgrade the facility.

Critical Facility Condition

ADA-compliant and accessibility features, number and layout efficiency of operatories, HVAC, plumbing and electrical, parking and building curb appeal.

Patient Retention Rate

Your patient retention rate will provide an indication of the stability of your practice and will be an important factor in predicting future earnings. Buyers want to know that patients are happy and will stay with the practice even after the sale.

If you have an annual patient retention rate of over 85%, this is a good sign. This can be calculated by dividing by the total number of active patients. Buyers are much more interested in the number of active patients than the number of patient records. Buyers want to know how many patients have been seen over the last 18 to 24 months. A practice with 1,200 active patients is much more valuable than a practice with 3,000 patients if only 800 are active.

Preparing for a Dental Practice Valuation

The foundation for an effective dental practice valuation is good preparation and understanding of the basics. These basics include professionals and disclosure of liabilities, and they provide a foundation for the accurate assessment of the value of your practice.

Gathering Essential Documents

You will also need to gather financial information for a minimum of three years, which will require gathering tax returns, profit and loss statements, balance sheets, and accounts receivable aging reports.

Include information on patient demographics, acquisition of new patients, and patient retention statistics. Your equipment inventories, including dates of purchase, should also be included. Your lease agreements, employment contracts, and vendor contracts should be readily available. Patient charts should be up to date and well-maintained, as this is an intangible asset.

Your revenue should be broken down to show types of procedures to make it easier for the valuator to understand your practice. Documentation for any ongoing litigation, insurance, and compliance issues should be readily available.

Engaging Professional Valuators

A valuator with a Certified Valuation Analyst (CVA) designation is preferred. However, if you can find one with a dental-specific designation, it’s even better. Business appraisers without dental experience can overlook critical factors such as patient retention and revenue generated from procedure types.

Interview several valuator firms to compare methods and fees. Check if they have experience with your type of practice, such as your practice size, specialty, and geographic location.

An experienced valuator should be able to explain if they use an asset-based, income-based, or market-based approach. Check for references from other dental practice owners who have utilized their services.

Ask for a timeline and how involved you need to be in the process.

Addressing Practice Liabilities

All outstanding debts, such as equipment loans, real estate mortgages, and credit lines, should be disclosed. Outstanding liabilities can kill your sale or significantly decrease your valuation.

Malpractice, patient, and staff-related issues should be addressed. Overdue vendor payments and taxes should also be included.

Employee-related liabilities, such as vacation pay and retirement plans, should be taken into consideration. Lease agreements should be reviewed, as this can significantly impact your valuation, especially if you are renting.

Common Mistakes to Avoid in Valuing a Dental Practice

The process of valuing a practice correctly involves delving into the financials, being aware of the ever-changing market trends, and being honest about the cost of running your business. If you leave out the details, your valuation will be nowhere close to the real figure.

Not Accounting for Hidden Liabilities

Hidden liabilities will erode your practice value by thousands. Outstanding lawsuits, unpaid taxes, or equipment leases will be a burden on the new owner.

Not factoring in the cost of maintaining your equipment will also hurt your practice value. If your sterilization equipment, dental chairs, or imaging machines are on their last legs, the new owner will factor in the cost to replace them.

Employee liabilities such as accrued vacation time, unpaid bonuses, and workers’ compensation will also affect your practice value. Environmental factors such as improper disposal of amalgam or lapsed OSHA requirements will also cost you a pretty penny.

A diligent buyer will uncover all the above factors. A pre-audit of all possible liabilities will give you a more accurate figure to begin with.

Not Accounting for the Current Market Trends

The current market conditions will dictate the price buyers are willing to pay. If interest rates go up, buyers’ offers will go down. Your practice will be a great deal regardless, but the offer will reflect the high interest rate.

The saturation of the market in your area will also impact the price. If there are many other practices for sale in your area, the buyers will have the upper hand. However, in a high-demand area with few other practices for sale, you will be able to command a premium price.

Corporate dental groups are buying many practices, and their criteria for a practice will vary. Insurance reimbursement in your area will also impact your practice value.

Patient demographics and local population growth can also give you hints about your practice’s future.

Underestimating Operational Expenses

Overestimation of practice value is another common mistake. This occurs when you underestimate your practice's operational expenses. This may happen when you run your personal expenses through your practice or when you're overpaying yourself.

These figures will be adjusted or “normalized” when a buyer tries to buy your practice. The cost of supplies may appear artificially low if you have special relationships or discounts that will not be available to a new owner.

Operating expenses such as labor may be based on market rates for hygienists, assistants, and administrative staff. Technology and software subscriptions are continually increasing as more dental practices become digital.

Rules of Thumb vs. Professional Valuation

Dental practice owners are often exposed to “rules of thumb” for practice valuation. These are most commonly based on a percentage of gross collections. This percentage varies between 60% and 80%.

While these are commonly used as a quick method for practice valuation, there are many factors that are commonly ignored, which can have a significant impact on practice value.

The Problem with Rules of Thumb

Rules of thumb assume all dental practices are created equally. However, there are many significant variables that impact practice value.

For example, two dental practices may have the same collections but will have very different values.

Let's say Practice A has a gross revenue of $750,000 and net margins of 40% or $300,000 in EBITDA. Practice B has a gross revenue of $750,000 and net margins of 20% or $150,000 in EBITDA.

Both dental practices will have a value of $525,000 according to the 70% rule of thumb. However, Practice A will have a value of $1.5 million based on a 5x multiple of EBITDA, while Practice B will have a value of $750,000 based on a 5x multiple of EBITDA—a difference of $750,000.

Another example: A practice with 1,200 active patients and consistent recall patterns versus one with 900 active patients and irregular attendance would have different retention risk profiles. However, the percentage of collections approach treats both practices the same.

Why Professional Valuations Are More Accurate Than Rules of Thumb

Professional valuators use several methods simultaneously: the income approach, the asset approach, and the market approach. They use this combination of methods to arrive at the most accurate valuation. They consider the local market conditions, the age of the practice, the age of the staff, and the growth potential of the practice. They normalize the compensation to the owner. They uncover the “hidden” liabilities. They consider the lease terms.

Professional valuations take into consideration several key elements that the rules of thumb completely ignore. These elements include patient demographic trends, the quality of the payer mix, the distribution of the procedure mix, the age of the equipment, the condition of the facility, the level of regulatory compliance, and the sustainability of key revenue streams.

When Rules of Thumb Can Lead the Practice Owner Astray

If the practice owner uses the 70% collections approach, they may be convinced that their $1 million collection practice is worth $700,000. However, the professional appraisal may turn out to be $850,000 because of the practice’s high margins and retention. The practice owner may be overpaying for the practice. The professional appraisal may turn out to be $520,000 because of the practice’s low overhead. The practice owner may be underpaying for the practice.

Valuation by Specialty Type

Dental practice valuation multiples vary depending on the specialty. The profitability of the practice and the recurring nature of the practice income streams affect the multiples. The demand for the specialty affects the multiples. The multiples may be higher for specialties such as orthodontics. The multiples may be lower for specialties such as general practice.

‍Specialty Notes:

Orthodontics tends to have the highest multiples because of the multiple year patient contracts with high net margin potential.  

Surgical specialties like Oral Surgery, Periodontics, Endodontics have strong multiples because of the referral-based business model and procedure-based revenue streams.  

General dental practices have lower multiples because of the overhead expenses, price pressure from the patient base, and the need to rely on patient retention in a competitive environment.  

Rural practices in any specialty will command 10-20% lower multiples compared to their urban counterparts.  

Group practices with multiple locations or practitioners will command 10-30% higher multiples because of the lack of owner dependence.