Posted on Apr 23, 2012
Image Credit: © Dreamstime.com
Posted on Apr 23, 2012
By Randon Jensen, Larry M. Chatterly and Susannah Hazelrigg, CTC Associates
In our last article: Making Sense Of Dental Practice Valuations, Part One, we discussed the income-
based approach to dental practice valuations.
The market-based approach is similar to a real estate appraisal. It relies on the comparison of the dental practice for sale to similar practices in the area that have sold recently. Market-based appraisals often use some form of ratio for applying that comparison, such as the ratio of the sales price to the average annual gross collected revenues. For example, assuming the same $800,000 in average annual gross collected revenue, the actual sales price of practices with similar characteristics in the area would be analyzed. Assume that such research yielded an average price to gross revenues ratio of 60 percent . Applying that ratio to the subject practice would generate a value of $480,000.
So, furnished with these two numbers, $508K and $480K, what would be the probable selling price of the practice? Based on our experience, the eventual selling price is usually the lower of the market approach or the income approach. Why? Of all the factors influencing practice value, few influence it more than prevailing buyer perception. In other words, a practice is only worth what a buyer is willing to pay for it. And a buyer’s perception of value will be influenced by all of the practice characteristics mentioned above as well as general market and economic conditions. Regardless of what the seller may feel it is worth, the final price is determined by what the market can bear.
Conversely, even if the market can bear a price higher than the value generated by an income approach, a buyer may not be able to pay more than the income-based value since that value will account for the buyer’s ability to service the debt and meet personal financial needs. Furthermore, most practice acquisition lenders have criteria regarding cash flow which limits the amount they willing to lend for the acquisition of any going concern practice. If the proposed purchase price falls beyond those limits, the lender is unlikely to approve the financing.
Sometimes conflict arises between perceptions and reality, for both buyers and sellers. Adjusting one’s perceptions to match reality can be difficult, resulting in frustration, anger or discouragement. As a dental practice appraiser, we recognize that practice valuations are a mix of science and perception, and we walk the line between merging the two to arrive at a fair market value. Even after having appraised more than 1,400 professional practices, we find it is still a challenge to help some clients reconcile the two.
Simple. Complex. Perception. Reality. The science of appraisal is a science of blending the two. The final value of any practice is a function of buyer perceptions, supply and demand, financing parameters and the opinion of an experienced, credible third-party appraiser. Armed with some additional knowledge of these approaches to practice value, the advantages and limitations of general-rule formulas and factors influencing value, hopefully will make sense of dental practice appraisals.