Making meaning of dental practice valuations during the viral pandemic

October 7, 2020 News

by Bruce Bryen, CPA, CVA

As the pandemic continues and more and more dental practices are suffering financial and emotional losses, owners of these practices are being subtly forced into selling their offices.  The trauma of day to day ownership and its worries about employees, patients, cleanliness of the office and the monetary fallout from these problems have created in their minds, a “no win,” situation for many of these owners.  Having reached the point of no return for the dentists, they now are looking to sell their practices and hope for the highest price and best terms that they may be able to get. Their own dental CPAs and other financial advisors are probably requesting that the dentists retain an expert to prepare a dental practice valuation in advance of meeting with any potential buyers.  Having the valuation assists in determining the price for listing the practice with a broker as well. This report would give them an idea of what their practices are worth.  The evaluator will be preparing a report that will probably be like no other that he or she has ever written. The main reason is the substantial reduction in gross revenue and earnings that the dental practice is experiencing because of covid-19 and the effect that the virus has had on the financial results of the dental practice.  The analysis of the dental practice’s past operations is an important factor that must be taken into consideration when the valuation is being prepared.  The methodologies used in the valuation are critical when the computation of value is being undertaken. The present situation should be explained in great detail and should not be so heavily weighted that the actual value is reflected solely by the most current year’s results.  The pandemic has substantially reduced the most recent reports of operations compared to the past.  Relying on this year is most likely a grave error on the evaluator’s part and undermines the real value of the practice.  A potential buyer is almost always interested in whether the operating profits will pay for the acquisition debt as well as leaving enough cash flow to allow for a comfortable life style for him or herself.  An improper reporting will dramatically affect the seller on a long term basis.

What meaning should be made of the results of the valuation? 

Without understanding what the actual net earnings of the dental practice at issue are, it is almost impossible to know whether the valuation is accurate. Without that information, understanding what a transition price should be is a guess. The “normalized earnings,” of the office are one of the most important items to understand as it is the benchmark for almost all of the other calculations and ratio comparisons in the valuation. Comparing the dental practice valuation to other similar practices for gross revenue, net operating profit, goodwill and the like will reveal how the practice under consideration will fit into those transition plans for the buyer and seller.  It will let the buyer know whether the practice has a strong possibility to prosper by regaining its profile before the virus struck or to continue to struggle.  Not adding back charges unnecessary to operate the practice will reflect lower net earnings for repayment of the acquisition debt. It will also limit the potential purchaser from seeing what he or she will have to support the expected lifestyle assumed from the acquisition.  The offering price and the acceptance of that price depends a great deal on the results of the valuation and those add backs of expenses paid and written off by the practice but not necessary to operate it.  The ratio comparisons of the valuation will be distorted compared to other similar practices that have sold with comparable characteristics but without adding back unnecessary overhead to profit.  Examples of practice expenses that are not needed for a successfully functioning practice include salaries to family members that may or may not be actually performing the duties satisfactorily in their job descriptions.  There may be excessive owner salaries paid to reduce the taxable profit of the dental practice.  Retirement plan expenses to family members and excessive payroll tax liabilities are additional expenses not necessary to operate the practice and should be added back to increase the “normalized profit,” of the dental practice.  Sometimes excessive rent is paid to the owner to reduce his or her social security taxes.  There may also be unnecessary seminar and educational travel expenses for the owner and family that are written off by the practice but are not needed to support its growth or success.  These items can substantially increase the profit of the practice which in turn increases the value of the practice and the subsequent transition price. 

Evaluating the dental practice with the covid-19 results included but not weighted so heavily as to misinform a potential buyer and the seller:

Using methodologies that reflect what has occurred at the practice but taking into account the trends from previous years is an attribute that the experienced dental practice evaluator understands.  If the operating results of the dental practice for the last few years have shown an upward trend in gross revenue and normalized earnings, the problems caused by the pandemic must be considered to be an anomaly for the results of operations.  On the other hand, if the normalized profits and gross revenue have been on a downward trend, it may be that covid-19 and the financial results caused by it could have occurred anyway under normal circumstances.   A lower dental practice valuation because of the effects of the virus is probably what all valuations will present during the 2020 year’s results of the financial affairs of the practice.  By delving into the valuation and its reporting, methodologies and presentation about the past, the lower value will not be looked at as the end of the negotiations for the transition.  The seller will be able to report the findings in the report and offer the upside of what had occurred during the normal times.  That upside should assist in overcoming the results of the virus and its effect on the dental practice.