How Dental Practices Are Valued

Whether you are buying a practice, selling one, bringing in a partner or simply planning for retirement, the question eventually comes up: what is the practice worth? There is no single formula. Value depends on the earnings the practice can be expected to produce for a new owner, the risk of those earnings and what similar practices sell for. This guide explains how appraisers approach it, walks through a simplified example, and shows what you can do to support a fair number.

What “value” means

Most valuations aim at fair market value: the price at which a business would change hands between a willing buyer and a willing seller, neither under pressure to act, both with reasonable knowledge of the facts. That definition, from IRS Revenue Ruling 59-60, is widely used by appraisers. A specific buyer may pay more or less than fair market value, for example a neighboring dentist who can merge patients into an existing office, or a DSO with its own return targets.

The purpose of the valuation matters too. A report for a sale, a bank loan, a partner buy-in, a divorce or an estate plan may use different standards and assumptions, so tell the appraiser up front what it is for.

The three approaches

A credentialed appraiser normally uses more than one approach and explains how much weight each gets. Be cautious of any “valuation” that is a single multiple applied to one year’s revenue.

Normalized earnings: the starting point

The income approach starts with what the practice earns before the owner is paid, adjusted to reflect what a new owner would actually experience. Typical adjustments include:

• Adding back the owner’s salary, benefits, personal vehicle and other discretionary items.
• Subtracting a market-rate salary for the dentist work the owner performs, since a buyer would have to pay for it.
• Adjusting rent to market if the owner also owns the building.
• Removing one-time items such as a lawsuit, a remodel or an unusual equipment repair.
• Adding back interest on practice debt the buyer will not assume, and non-cash items such as depreciation and amortization.
• Adjusting staff pay to market if family members are paid above or below what the job would cost.

These adjustments are only as reliable as the books behind them. Read how to read a dental practice P&L to see where owner items commonly hide, and how dental practice owners pay themselves for why owner salary and distributions need to be separated.

SDE vs. EBITDA: two ways to measure earnings

You will see two earnings measures in valuation reports and buyer offers. They differ in one main item: the owner dentist’s pay.

Because adjusted EBITDA is smaller than SDE for the same practice, any multiple applied to it is larger. Quoted multiples are meaningless unless you know which earnings figure they apply to and how it was adjusted.

A worked example: from P&L to value

The figures below are round illustrative numbers for a general practice collecting $1.2 million a year. They show the mechanics, not typical results or market rates.

In a capitalized-earnings method, value is normalized earnings divided by a capitalization rate. The rate reflects the return a buyer needs for the risk of those earnings, adjusted for expected growth; the appraiser supports it with market data and the practice’s own risk profile. To show how sensitive the result is:

Moving the rate five points shifts the value by well over $100,000, and so does a $30,000 change in the clinical-pay assumption. That is why buyers, sellers and lenders argue about the adjustments and the risk factors rather than the arithmetic. A discounted cash flow method works the same way in principle but projects several years of earnings, which lets the appraiser model a practice that is growing, shrinking or about to lose an associate.

Percent-of-collections rules of thumb

Brokers and buyers often quote dental practice prices as a percentage of annual collections. You will hear ranges, and they vary widely by market, specialty, profitability and who is buying. Consider two practices that each collect $1.2 million. One runs at 55% overhead and keeps $540,000 before owner pay; the other runs at 75% overhead and keeps $300,000. A percent-of-collections shortcut prices them the same, yet the first produces nearly twice the cash for a new owner. Use these rules only as a sanity check on a real analysis. Our dental overhead calculator shows where your own overhead sits by category.

Rules of thumb also miss specialty differences and the effect of an associate. A practice where the owner produces most of the dentistry carries more transition risk than one where an associate who plans to stay already sees a large share of patients.

Who is buying changes the number

For an individual buyer, the lender’s question is whether the practice can carry the debt. Using the example above, a buyer who does the clinical work keeps the $240,000 clinical pay plus the $290,000 adjusted EBITDA, or $530,000 before debt service and taxes. A $1 million loan over 10 years at an illustrative 8% rate costs about $145,600 a year, leaving roughly $384,000 before income taxes. Lenders run their own version of this test; see dental practice loans.

A higher headline offer is not always worth more. Compare offers on cash at closing, what is deferred or contingent, how long you must work afterward and on what pay, and what happens to any equity you roll over.

What raises or lowers value

Payer mix matters because it determines how much of production turns into cash. See PPO write-offs and fee schedules for how to measure it. A strong recall program supports value because it shows patients return without the seller.

Asset sale or entity sale

Many dental practice sales are structured as asset sales: the buyer purchases the equipment, patient records, goodwill and other assets, usually through a new entity, and the seller keeps the old entity with its cash and liabilities. In an entity (stock or membership interest) sale, the buyer acquires the seller’s company, including its history and any liabilities, and generally does not get a fresh tax basis in the assets. The structure affects taxes, liability and how the price is negotiated, so decide it with your attorney and CPA before signing a letter of intent.

Goodwill and how the price is allocated

In most dental sales, the largest part of the price is goodwill rather than equipment. In an asset sale, the buyer and seller each report how the purchase price is allocated among seven asset classes on IRS Form 8594, attached to the tax return for the year of the sale. Value is assigned to each class in order at fair market value, and goodwill and going concern value take whatever is left.

The allocation affects both sides’ taxes. A buyer generally recovers the cost of equipment through depreciation and the cost of goodwill, a non-compete and other Section 197 intangibles through amortization over 15 years, as described in the Form 4562 instructions. For a seller, IRS Publication 544 explains that a lump-sum business sale is treated as a sale of each asset separately, and that gain on depreciated equipment is ordinary income up to the depreciation previously taken, so equipment written off quickly can produce a larger tax bill than expected. Publication 544 also notes that a written allocation agreement between buyer and seller is binding on both unless the IRS finds it inappropriate. Agree on the allocation in the purchase agreement, with both CPAs involved, rather than leaving it for tax season.

What an appraiser will ask for

• Three to five years of business tax returns and year-end P&Ls and balance sheets, plus the current year to date.
• Production and collections by provider, and production by procedure code.
• Accounts receivable aging, including insurance and patient balances.
• Active patient count, new patients per month and hygiene recall figures.
• Payer mix and current PPO fee schedules.
• Staff roster with roles, pay, benefits and tenure.
• The office lease, any equipment leases and loan statements.
• An equipment and technology list with approximate ages.
• A list of owner and one-time expenses run through the practice, with support.

Having these ready speeds up the work and reduces the chance that a missing report gets filled with a conservative assumption.

Buying, selling or bringing in a partner

• Buyers: the valuation is the start of due diligence, not the end. Use our due diligence checklist and compare against starting a practice instead.
• Associates buying in: partial-interest valuations raise questions about control and minority discounts. See buying into a dental practice as a partner.
• Sellers: two or three years of clean books and stable trends do more for value than any last-minute adjustment.

Choosing who does the valuation

Look for an appraiser with recognized business valuation credentials and experience with dental practices specifically. Ask which approaches they use, what normalization adjustments they made and why, and whether the report would hold up for a lender, a partner dispute or an estate plan. A broker’s opinion of value can be helpful for marketing a practice, but it is not the same as an independent appraisal.

Common business valuation credentials include the Accredited Senior Appraiser (ASA), Certified Valuation Analyst (CVA) and Accredited in Business Valuation (ABV) designations. Credentials are only part of the picture: ask for a sample report, how many dental practices the appraiser has valued, and whether they have testified or prepared reports for lenders. If buyer and seller each hire their own appraiser, expect differences, and focus the discussion on the adjustments rather than the final number.

Value versus price: deal terms matter

The appraised value and the final price are not always the same, and the terms of the deal can matter as much as the headline number. Points that commonly affect what a seller actually receives and what a buyer actually pays:

• Accounts receivable. Sellers often keep their AR and collect it after closing, but some deals transfer it at a discount.
• Transition period. How long the seller stays, and in what role, affects how many patients stay.
• Restrictive covenants. Non-compete and non-solicitation terms protect the goodwill the buyer is paying for. See non-compete clauses for dentists in Virginia.
• Financing. Lender requirements, seller financing or earn-outs change the risk for each side.
• Real estate. If the seller owns the building, it is usually valued separately from the practice, and the lease terms offered to the buyer affect both the practice value and the property value.

Each of these should be reviewed by an attorney and CPA before signing a letter of intent, not after.

Preparing your numbers

A valuation depends on financial statements an appraiser and a buyer can trust. Cisor’s dental accounting team helps owners clean up and normalize several years of financials, and the Cisor Metrics analysis shows which operating factors are holding value back. Request a practice analysis or call (703) 345-0606.