Dental practice valuation: the three common methods

A dental practice does not have one fixed price. Its value depends on the method used, the facts fed into it and the purpose of the valuation. This post explains the three common approaches in plain words, with sources from the IRS, the Small Business Administration (SBA) and the American Dental Association (ADA). It gives no price, no multiple and no rule of thumb. It is not valuation, tax or legal advice.

What are the three valuation approaches?

Professionals commonly use an income approach, a market approach and an asset approach. The IRS Internal Revenue Manual states: “The three generally accepted valuation approaches are the asset-based approach, the market approach and the income approach. Consideration should be given to all three approaches. Professional judgment should be used to select the approach(es) ultimately used and the method(s) within such approach(es) that best indicate the value of the business interest.”

The IRS text is guidance for its own valuation work, not a rule for dentists. It still shows how a professional thinks: look at all three, then choose with judgment. The SBA lists the same three for owners who plan to sell.

The glossary uses “cost approach” for the asset-based method. The SBA and the IRS manual call it the “assets” or “asset-based” approach. Same idea, different label.

How does the income approach work?

The income approach asks what future earnings the practice can produce, and how risky they are. The SBA says it “looks at projected revenue and accounts for potential risks.” An appraiser starts from past financial statements, adjusts them, and then applies a rate that reflects risk. The IRS manual says the appraiser “should select the appropriate benefit stream, such as pre-tax or after-tax income and/or cash flows, and select appropriate discount rates, capitalization rates or multiples.”

That sentence shows why a single published number is not enough. The result depends on which earnings measure the appraiser picks and which rate. The IRS lists factors that go into the rate, including “the stability or irregularity of earnings.” Two appraisers can reach different results with different, defensible choices. The adjusted EBITDA concept, covered in the EBITDA in a dental practice sale post, is one common way to state earnings.

How does the market approach work?

The market approach compares the practice to similar practices that sold. The SBA says it “compares your business to other similar businesses that have recently sold.” The quality of the result depends on whether the comparison sales are truly similar and recent. Practices differ in location, payer mix, equipment, lease terms and how much of the revenue depends on the owner.

Be careful with figures from brokers and articles. A percent of collections or a multiple of earnings is a summary of past deals. Ask where the number came from, which deals it covers, and which year. This post names none because no source opened for it supports one.

How does the asset approach work?

The asset approach adds up what the practice owns and subtracts what it owes. The SBA says it “subtracts total business liabilities from the total value of all assets.” For a dental practice, assets can include equipment, supplies, records and real estate if it is part of the sale. The ADA says a valuator can assess “the actual worth of the practice, the patient population, equipment and, if applicable, real estate.”

This approach tends to leave out the value of the patient base and the name of the practice unless the appraiser adds it. That unmeasured value is called goodwill. A valuator may handle it inside the income or market approach instead.

Why does the purpose of the valuation matter?

A valuation can serve different purposes, such as a sale, a buy-in or a loan, and each purpose may call for a different standard and report. Tell the valuator the purpose before work begins. Ask what standard of value they use, what date the value applies to, and what documents they rely on. The practice valuation and practice appraisal entries explain the terms.

Who should perform the valuation?

The ADA says to “assemble a team of competent professionals” for a sale, including “a dental practice valuator to assist in developing an independent and objective assessment regarding the actual worth of the practice.” It adds: “You may want to consider hiring a valuator who specializes in dental practices.” The same page lists an attorney experienced in dental practice sales, a certified accountant and a financial advisor. A practice broker may also help with listing and marketing. A broker’s estimate is not the same as an independent valuation, so ask each person what their role is and how they are paid.

What should an owner prepare?

1. The financial statements and balance sheets the ADA lists for due diligence.
2. A list of equipment, with ownership or lease status.
3. Patient and production data, such as new patients per month and referral sources.
4. The lease and any staff contracts.
5. A list of one-time or owner-related expenses to discuss with the CPA. The owner compensation entry explains why this matters.

Next step

For the full process around value, price and terms, read the valuing a dental practice guide. Then bring your numbers to a qualified valuator, an attorney and a CPA. To discuss practice transitions with Dr. Jon Copeland, DDS, a general dentist in Wildwood, Missouri, contact Dr. Copeland about consulting.