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When Is a ‘Valuation’ Not a Valuation? Why it’s Important Know the Difference

The question of “do I need an appraisal” often comes up when working with clients, whether sellers, buyers, clients entering into partnerships, mergers or litigation, or for estate planning.

First, let’s define what an appraisal is. An appraisal is a formal opinion of value based on all the pertinent information available about the subject– in our case, a dental practice. There are many factors that go into “all the pertinent information,” including gross income, net income, fee schedule, staff information, PPO, HMO and Medicaid insurance participation, total number of patients, number of new patients, specialties and procedures, demographics, market issues, etc. Valuations can be oral or written, but must be based on all of the information, not selective pieces.

Some practice transition specialists and consultants often offer a “Free Appraisal” or “Free Valuation” of a practice when seeking to represent a seller. Unless specifically indicated, it is most likely that this will be an “Opinion of Value” based on a Rule of Thumb approach, not a “Valuation”. So what’s the difference?

Using a Rule of Thumb
A Rule of Thumb uses some information and then usually applies an arbitrary multiplier to that information to arrive at a value. The most common Rule of Thumb we hear is, “The practice is worth 70% of gross revenue,” or “The practice is worth one times net income.” Neither of these Rules of Thumb is an accurate representation of the
practice value.

An example: Two practices each collecting $1,000,000. One has an overhead of 50% and the other an overhead of 70%. Using the “70% of gross revenue” Rule of Thumb, each practice would be worth $700,000. In reality, the first practice is significantly more valuable than the second because of the larger profit. Similarly, if one practice has state-of-the-art equipment and technology and a second has 20-year-old, non-digital, out-of-date equipment, it is obvious the first practice is worth more (but how much more?).

A Formal Appraisal
A Formal Appraisal includes all the relevant information and provides a formal written report. The report can be a Comprehensive Report, usually from 50 to 70 pages of information plus supporting documentation; or a Limited Report, usually from 2 to 4 pages plus supporting documentation. Both reports have completed the same analysis, the difference being that significantly more data and discussion is included in the Comprehensive Report, where the Limited Report is a summary of the information without much in-depth discussion of the data or findings. Both formal reports must be signed and dated by the appraiser.

Transition Specialists Use Different Methods
Unfortunately, there are transition specialists, brokers and consultants who will tell a seller what he or she wants to hear in order to engage a client. If the seller thinks the practice is worth $500,000 but an official valuation suggests it is really worth $350,000, the seller is going to be more inclined to engage the broker who tells him the practice is worth $500,000, even if the transition specialist knows the practice will end up selling for $350,000. AND, the broker has a contractual period, usually a year, during which the seller will be obligated to work with the transition specialist.

An honest transition specialist is going to tell you what the market value for your practice is and, by doing a valuation analysis, give you a realistic selling price that you can count on. The valuation does not have to be in the form of a written report, either Comprehensive or Limited, but the analysis that the transition specialist does comprises all of the pertinent information that would go into a formal written report.

Why might you need a formal valuation at all?
Some banks that finance the transaction will certainly want the same information that the transition specialist or consultant has used to arrive at a sale price as a requirement for financing. In the case of litigation, partnerships, mergers or estate planning, it is probable that a comprehensive written appraisal report would be required.

For doctors who are veterans in practice, since your practice is one of your most valuable assets, doesn’t it make sense that you would want to know its true value? We encourage all dentists to periodically have their dental practice appraised as an element of their net worth, their exit strategy planning, and for estate planning purposes. Not only does it give you the peace of mind to know what your practice is worth, the process can turn over rocks and open shades that could allow you to be more effective, efficient and profitable, now and into the future. Not only does that help you in the short term and allow you to sleep better at night, but it could be a long-term plus for you, your family, and your retirement.

For younger doctors, since purchasing a practice is probably one of your most valuable decisions, doesn’t it make sense that you would want to know its real value? Knowing the difference between “appraisals” and the information and terminology they use can make all the difference.

Are you wondering about the value of your practice? Contact us today at 888.445.8041 or info@ADSflorida.com and we’ll be happy to discuss the different options in more detail so to best fit your needs.

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