The sale price of dental practices has been on the rise over the past twenty years. While there are many methods for assessing the price of a practice, some common metrics include using gross revenue (often 150% to 200%) or a multiple of earnings (often 6x – 8x) to determine a value. Note: These general guidelines are simply a starting point for discussion, and are not a substitute for obtaining a thorough evaluation by a reputable party. Prices can vary widely, and the purchaser needs a documented valuation to obtain bank financing.
There are many factors influencing the rise in practice values, but most industry professionals would agree that these increases are attributable to low-interest rates and greater competition for patients. Although interest rates are starting to rise, they continue to hover near all-time lows which keep practice values elevated, and the doctor-patient ratio is expected to contract further, adding more upward pressure.
Dentists often ask whether it is better to buy an existing practice or open a new location. Perhaps the greatest advantage of buying an existing practice is simply that cash flow already exists. This is crucial to covering the overhead expenses as well as the loan repayment. On the other hand, a start-up may have the best chance of success in a new neighborhood with a growing population. We often see the initial investment to equip a new office reach hundreds of thousands of dollars. While the banks will finance these new locations, that is a lot of debt to repay for a practice that has no cash flow from the outset.
For these reasons, purchasing an existing practice with predictable cash flow is often a more attractive business decision.
Time and time again, clients approach us with the desire to purchase a dental practice. For many, the ownership of a practice is the culmination of long years of study and real-life experience. With a valuation in-hand and a vision of the future, they wish to know whether they can afford it.
Despite rising valuations, the purchase of an existing practice is affordable. Generally, the valuation reflects the cash flow of the business. A practice with good cash flow and a healthy bottom line will command a higher price. If cash flow is poor, the valuation will decline. Ultimately, the valuation of a practice will settle at a level which is affordable to own. It is simply a natural law of the way money works. Banks are willing to lend for periods of up to 12 years, and repayment can often happen faster as production increases.
Let’s look at an example to get a better idea of how the finances and repayment of debt would work. In this example, let’s say total production is $1,000,000 and that the purchase price is $1,600,000. The purchase is 100% financed by the bank, to be repaid over a 12-year period.
Let’s further assume it’s an average practice with 60% annual expenses. That leaves $400,000 leftover for other use. The interest on the loan must also be included, so we’ll estimate $48,000 at today’s interest rates. Finally, the new dental owner will receive a salary of $160,000 per year.
After the expenses above, the profit after-tax would be $169,000, leaving plenty of cash flow for the annual principal payments of $133,333. The remaining cash flow of $35,667 is needed to satisfy the bank’s lending requirements; they wish to see a surplus of at least 25% of the principal amount to ensure a sufficient buffer for the loan repayment. In time, the extra cash flow could be used to pay down the debt faster or provide higher compensation to the owner.
The cash flow and profitability of the practice make it affordable to pay off the debt within a reasonable period, while affording the dentist reasonable compensation and appreciation of goodwill at the same time.
The value of the practice and cash flow each year really starts to accelerate after the repayment of the debt. With prudent management of the cash flow and careful attention to tax planning, a dental practice is the engine that will allow one to achieve long-term financial goals. The extra income earned by a dentist from immediate ownership often justifies the price to purchase an existing practice. However, the sale of a dental practice by itself is typically not enough to achieve one’s retirement goal. Additional savings through RRSPs, an Individual Pension Plan (IPP), or corporate savings is often needed to achieve one’s “Financial Independence Target Number,” or FIT# TM. A solid financial plan can provide the confidence needed to achieve these long-term goals.
To learn more about how you can align your dental practice with the achievement of your long-term goals and dreams, contact our office at 905-361-8004 or firstname.lastname@example.org to set up a complimentary one-hour initial consultation.
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