For the last twenty years, I seem to be at odds with the valuation methodology used when assessing the true value of a smaller dental practice.
Somewhere along the line, someone said practices need to be valued using an EBITDA multiple only to discover the true meaning of EBITDA is complicated. Yes, maybe it fits practices whereby they are over a certain size in generated fees and surgeries, say $2+M or three-plus chairs.
But what about the other 70% of practices between one and two chairs and family-run or maybe two partners or one owner, one associate or a sole proprietor? Why should they be appraised in the same way?
In my experience, if these smaller practices generate more than $700,000 in fees, they can be more profitable than their larger cousins.
Why, might you ask?
Calculate their financials like a larger practice, i.e., add back expenses not attributed to the practice’s running, remove interest and depreciation, and allocate commissions or wages to arm’s, length associates. The Net Profit will be positive.
At this stage, if you allocate a 40% commission to the principal based on their contribution to the generated fees, it blows the Net Profit to pieces, thus rendering the practice unsaleable in most cases.
Using EBITDA Multiple Method
Let’s say there was $80,000 of Net Profit at this stage, and based on a fictitious multiple of 3 times EBITDA, the value is approximately $240,000,
So there is no value for plant equipment or goodwill. Either way, you want to look at that
- Net Profit $80,000
- Multiple of EBITDA 3 x 80,000 = $240,000 sale price
Using Owners Taxable Income Method
In my experience, most principals contribute at least 65% of the generated fees or more, so based on $700,000 fees, our principal has produced $455,000 and allocated 40% commission = $182,000
- Net Profit $80,000
- Owners’ allocated commissions of $182,000
- The owner’s taxable income is $262,000
- Multiple of Taxable Income: 2.5 x $262,000 = $655,000 sale price
So for argument’s sake, if we sold this practice with a taxable income of $262,000, it would be paid off in less than seven years, making for an attractive deal.
So the bottom line looks like this:
- Multiple of EBITDA calculation value 3 x $80,000 = $240,000
- Multiple of Taxable Income calculation value 2.5 x $262,000 = $655,000
Please don’t believe that all practices are valued equally. They are not. We have many profitable practices approved for finance using the taxable income methodology.
