Are valuations insane?
"They say value is in the eye of the beholder, so is the price!"
A seller always over values their property, and buyers always want the deal of a lifetime to brag about.
Somewhere in the middle is the "market price".
As a 35 year veteran of the dental industry, I have been involved and reviewed hundreds of dental office appraisals. Here is a summary of issues that are food for thought.
A $1 Million grossing practice is selling for $2 Million....
Can you get 2X your annual gross income?
One of the first problems I see in evaluations is the lack of local market knowledge! At least in my market - there are VERY FEW practice sales to compare to. Corporations have their own formula and do not like to share the secret sauce with the general public...or their competitors.
Having relationship for so many years in this industry has afforded me the opportunity to review and understand these valuations.
How does anyone justify buying an office?
PROFIT. Anyone that is investing in a business is looking at opportunity. We usually base that opportunity on past results. Entrepreneurs use this as a "base" but can also understand the "potential" that lies in applying their formula. At the end of the day, however, profit is the basis for an offer.
If you are considering selling or buying - you MUST consider an average of the last several years of earnings and growth. Then consider what the market will pay for that opportunity.
In our community, offers are generally 7-8X earnings....which in itself is an art to disseminate from financial statements.
If you want to keep it easy, think this way. SOMEONE has to do the dentistry. That someone has to be paid "market price" which is 40% of production in Saskatchewan. This is an expense for a business owner if they are not the operator (corporations don't physically do the dentistry). A corporate buyer can only pay based on what profit is left.
Put simply - an investor might consider this scenario....
$1,000,000 gross income
Current owner makes $300,000 after all expenses are paid.
An outside investor would have to pay an associate to run this practice - and if there is only 30% left over after paying all the expenses, what is left for the investor? Only the original value of the asset? Like buying a house, there is potential for this asset to grow in value and there is opportunity to improve the asset. However, if you have to pay a dentist 40% to work for you - this is an expense so it will be very challenging to grow the value of this investment.
This type of investment is best left for an owner/operator situation, or a very ambitious entrepreneur that has a secret formula to increase cash flow.
The VALUES of these small practices in Canada has increased because this is the "starter" home. It is the most affordable scenario for most buyers. There are a LOT of buyers looking for a "starter" home - so values are STRONG! This price is NOT due to corporations bidding, it's due to an abundance of buyers and few sellers.
A practice like this, in my area, could sell for $1.2M to $1.5M. The market price being set by buyers willing to take home a little less income so they can have the opportunity to call their own shots.
A corporately purchased practice is usually based on profit left over. Here is another typical situation....
$2,000,000 gross income
The owner has an associate and 2 hygienists. The office is OLD and little is re-invested, so it appears to be VERY profitable....thus begins my challenges for those valuing clinics.
The owner gets to keep $1,000,000 a year after paying all bills. The profit sounds attractive - but the infrastructure is old. The patient base is dedicated to the very nice current owner and long team members....but what will happen for a new owner?
These types of practices offer an opportunity for corporations that simply look at cash flow. If the current owner will STAY and become an associate - they will need 40%. Let's say they produce $1,000,000 of dentistry.
The corporation says "We will pay you $4M for this practice" It's based on you staying and guaranteeing your own production. You MUST maintain profit of $500,000 per year. We will pay you $400,000 to be our associate (40% of the $1M production). If you do not meet the targets and goals, there will be consequences. You must stay at least 5 years (by which point they will have earned $2.5M of profit plus still own the current assset which has likely also increased in value)
The likelihood that a young dentist will come and fit themselves into this practice at this price can be a challenge! It will be difficult to produce the same as an experienced owner with many years of strong patient relationships and skill. It will be difficult to pay themselves so they can afford a mortgage and a car. Pay off student debt.
It would be hard, but not impossible. A practice like this can be purchased, renovated and modernized with a good transition and a smart business plan.
...a list of considerations.
#1 - Profit. Understanding that profit is NOT just free flowing cash. Understand Earnings Before Interest Tax Amortization and Depreciation is important. Just because you want to pay off your "house" in 5 years instead of 10 doesn't change the value of the asset - it only changes the free flowing cash. You have to learn to live within the means of the free flowing cash or find ways to convince investors to keep giving you more....
#2 - Market Value. Understanding that the value of a practice in Toronto is not the same as one in Saskatoon. A valuator in Omaha Nebraska may say all practices are worth 75% of the annual gross income and not a penny more. Maybe that is true in their market, but it may not be true in the market where you want to raise your family. This drives me crazy.
#3 - Affordability. Taking #1 and #2 into consideration will lead to #3. You need to decide how much YOU want to make as compared to invest. Only YOU can understand what amount of time and capital you are willing to invest, and only YOU can determine if this is worth the risk. I have seen offices sell for top end prices and the owners struggle. Other offices with similar valuations have thrived.
This is VERY DEPENDENT on the ability of the owner and the risks and abilities. The "success" rate of dental offices is very high, the difference in profitability can vary quite dramatically....
#4 - TERMS. The biggest Caveat of all. What are the terms of the sale? You hear about these prices that other practices sold for - but have no idea what the terms of the sale are! There are good deals and bad deals. It's not JUST ABOUT the money!!
When I help transition practices, the goal is for everyone to win - which generally means to me that buyers and sellers meet and discuss their goals and are transparent with each other.
There are almost endless possibilities to create the value for buyers or sellers here.
It's laughable to read and listen to dental industry pundits (myself included I am sure). We all have these huge egos. We think our way is the only way and everything we say is a fact because that has been our own "reality".
The reality is that I have been proven wrong. I have watched negotiations of sharp dentists who were able to adjust terms or sales to their strong advantage. I also have seen people on both sides of the fence get taken advantage of and regret the decisions.
You can listen to all the opinions you want, at the end of the day this is your life. Understanding yourself is the most important process of a valuation.