Understanding the significance of dental practice valuations during covid-19

September 15, 2020 News

by Bruce Bryen, CPA, CVA

While always important, during the pandemic, the “buyer beware,” phrase takes on more meaning. 

Who would acquire a dental practice without some due diligence?  During the period of the virus’s economic effect on all businesses, it is especially important for the review of the dental practice valuation and the significance it plays on the soon to be made purchase.  The potential buyer will certainly have his or her dental CPA and financial advisor carefully study the valuation and have these experts offer comments about the loss of business during the virus’s turmoil and the upside that the practice has achieved in the past for comparison.  The growth record of the practice under consideration and its prior trends of revenue and operating profit will be an important aspect during the analysis and reporting of the valuation and its methodologies. The detail presented will assist the buyer in determining that the dental practice can achieve enough earnings to pay the practice acquisition debt and support enough profit for the willing buyer to see the upside to the potential purchase or an offer will not be made.  Even though the losses may have been significant during the time of the pandemic, the valuation should offer what the purchaser needs to see to be able to make his or her decision with a degree of financial certainty and confidence.   The reduced amount of patients and the speed at which the current owner has been able to lessen costs will have contributed to the most recent profit and loss statement.  The practice worth as a whole should be presented in the valuation so that past earnings and recent activity won’t distort the value of the practice for the owner or a possible acquirer.  

Some of the items that need understanding:

One of the most critical issues for a buyer to understand is the actual or normalized earnings of the dental practice.  An experienced buyer or one who is not but who has a dental CPA or financial advisor with expertise in the field of dentistry will look at the schedule of normalized profits to see what the dental practice has really earned during the last few years.  When the owner’s perks are added back to the profit, the actual earnings available for debt service and for the buyer’s income will be revealed.  Sometimes the owner will have his or her dental practice pay for personal items like telephone charges and travel to seminars that are not needed to run the practice.  If these charges are written off for tax purposes, they reduce the amount of earnings that are shown in the practice profit bottom line.  Sometimes rent is increased to reduce the social tax effect for the owner and as another way to withdraw profits from the practice. Any excess above fair market value of the rental in the area should be added back to the bottom line to increase the profit. If practice salaries to the owners’ family and himself or herself are included on a higher than normal basis to also reduce the taxable income of the practice, these excess salary items should also be added back to the profit.   Along with these excess salary amounts, the additional payroll taxes and retirement plan benefits should also be included in the normalized profit.  These and other similar items when added back to the profit of the dental practice allow a potential buyer to understand what is available from the practice for use in paying off the debt used to acquire the practice and for supporting his or her own family after the acquisition has occurred.  Any item that is not needed to successfully operate a dental practice should be included in the normalization of profit schedule for each year used to evaluate the worth of the dental practice and will almost always increase the profit and its value.

How has the dental practice evaluator presented the covid-19 results? How has the dental practice value been effected by the evaluator’s formula?  

The evaluator’s experience and understanding of debt implications are necessary attributes in the determination of which expert to retain for the completion of the dental practice valuation.  A normalization of debt and the interest charges for the potential buyer should be included where the covid-19 effect is comprehended. How much weight the report assigns to the results during covid-19 compared to the prior years operating amounts is critical to understanding what the buyer is actually buying.  As an example, if the prior years’ gross revenues were on a downward trend, an assumption will be made that the pandemic is not the only cause for the decrease in gross revenues and profits.  Since the normal operations were producing less prior to the virus appearing, a good guess would be that the lower operating results were merely continuing.  Even though a reduced value using the pandemic as a result may be a lesser overall practice value, there would have been a lower valuation result anyway based on the trends produced in the practice in spite of the virus’s effect.  Conversely, if the dental practice had consistently produced higher gross earnings and net profit as the practice was on an upward operating trend, the results of covid-19 should not have produced a substantially less attractive dental practice valuation.  These items are necessary for the evaluator who is to be retained to discuss with the owner prior to the valuation being undertaken.  The independent evaluator will answer the questions of the owner honestly but any coercion into preparing a valuation that is not independent of the owner or anyone else’s opinion is forbidden.  Even though it may be tempting for the owner to attempt to influence the evaluator’s opinion, if the result of the valuation was biased, consequences would result. If the buyer or seller ever decided to begin litigation over the results of the written report, reputations and economic losses would occur if testimony was given that the results of the valuation were not independent.