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Ontario Dentist - November 2001
by Timothy A. Brown, A.L.A.
The curious nature of humans has proven that we always want to know what something is worth. We often seek information leading us to an indication of value for the items we possess, including our homes, stock portfolios - and for dentists, the fair market value of a practice.
An example of our constant curiosity about value is the real estate market. When a home is put up for sale in our area, many people will search the real estate advertisements in the newspaper, or call a real estate agent to find out the asking price. Another example is our propensity to look up daily stock quotations for the latest prices. These items are very easy for us to appraise due to the abundance of reliable information available in the public domain. Therefore, it is simple for us to gain an understanding of current fair market value by ãself-appraisingä our homes and stocks.
Unfortunately, similar methods cannot be used to ascertain the fair market value of a dental practice. Sales data for dental practices is closely held by a few privately-owned companies and is not published in a public, accessible domain. This data is not made available to the profession at large for several reasons, primarily that of the dentistâs desire to keep the financial information confidential.
So, how then do we find out what a practice is worth?
First, appraisals do not usually include a projection of future fair market value, as the prevailing thought in the appraisal industry ÷ along with that of accountants and banks ÷ is that appraisers rely upon fact only, not projections of future income. This is because the reliance upon future incomes may artificially inflate its value. Therefore, a proper appraisal should state fair market value, as of the date of appraisal only; although this immediate time-dating of the report, in turn, necessitates the need for periodical updates.
Many of our clients ask, "During what time period will an appraisal remain valid? Should an appraisal be updated and if so, how often?"
As with most situations, the answer is "Maybe." In the event of sale, an appraisal should be updated immediately; yet in some circumstances an update may not be required for several years.
Prior to offering advice about when, if ever, to have an appraisal update performed, the most controversial issue to consider is the volatility of the marketplace. In the example of stocks, they can change dramatically from day to day. House prices tend to follow a seasonal or annual valuation trend.
The dental practice marketplace is much different, and predicting its price variations is something that evokes much discussion. Purchasers are hoping for a downturn in values, and vendors are very pleased with todayâs "seller's" market, especially those in the most popular Ontario cities. Market prices will indeed fluctuate, mostly in the larger cities, but not at a pace that is easily tracked on an annual basis.
If we look back to the 1970s when goodwill was selling for minimal prices ÷ roughly $10,000 or less ÷ and consider that today, goodwill in the average Ontario practice is at least 10 to 20 times that figure, it is easy to prove that price increases over time. The next question is: how long did it take for prices to increase to this level and how long will it take before they decrease? Our observations of the last 25 years worth of transactions prove that it takes three to five years before meaningful market changes occur. Our firm predicts it will take this long before the downturn will appear, but appear it will. One thing of which we can be absolutely certain, is that the market will go up and down. All we need to know is when it will turn, not if it will turn.
Assuming that a practice is unlikely to experience significant change for the foreseeable future, and the key value indicators remain more or less the same, the appraisal could be valid for three to five years, in a stable market. Therefore, there is no need for an appraisal update solely for the purpose of measuring market changes, as they are minimal in the short-term.
However, as with all advice, there are exceptions. If your practice is in a rapid period of growth or decline, its value can change quickly. The two most important factors affecting goodwill are gross and net incomes. Minor variations of three to five per cent have a minimal effect on goodwill value. A larger variance may alter value, and in such cases you should consider an appraisal update.
I appraised a practice recently that had completed a few very large cases that increased gross income by over 15 per cent in one year. When asked, the owner admitted is was unlikely this production level would continue. We took this into account for the final appraisal. Dental practice values are influenced by the historical, year-over-year trend, not just a few good months that may increase gross income.
Another issue to consider is that your tangible assets (equipment) will decline in value by three to 10 per cent each year, depending on the type and quality of equipment you own. On the other hand, your goodwill often stays the same, or perhaps even goes up somewhat if your gross income increases. The overall net effect is that the actual total fair market value of your practice will stay thesame. In most instances, goodwill becomes a larger component of total value and tangible assets become less. If you purchase new equipment after the appraisal date, simply put a copy of the invoice with the report and cross out the item(s) replaced, if applicable. When a thorough appraisal update is performed in later years, the appraiser will take this into account, along with the recent financial and procedural changes.
If you have had your practice appraised in the past, we highly suggest that a copy of the report be kept with your will or valuable documents. If you have never had your practice appraised, we advise you to have one performed. There are usually several firms specializing in dental practice appraisal services at the ODA's Annual Spring Meeting. The convention is a great opportunity to quickly meet two or three individuals, or appraisal firms, making your choice easier.
In short, I urge you to save yourself and your family the hassle of sorting out dental practice affairs in the event of a crisis. I have written before about the needless loss of time and money just because the dentist did not leave written notice that ãABC Dental Practice Appraisersä are the people to call in an emergency. This is so simple, yet I would estimate that over half of Ontario dentists leave no written instructions regarding the appraisal and/or sale of their practice. If you have any doubts about this advice, speak with your lawyer or accountant.
Once your appraisal is completed, you should then attach a letter or note addressed to your advisors, estate or family that instructs them what to do with your practice in the event of your sudden death or disability. The name and phone number of your chosen appraiser and/or broker should be stated. Otherwise, loved ones could spend weeks trying to figure out what to do and who to call. In effect, you are leaving a will for your practice.
Any reputable firm can supply you with a Letter of Direction that will ensure your practice is protected with the assistance of a locum while the appraisal is updated and the practice is then offered for sale, if necessary. A significant loss of value may be avoided with some common-sense planning.
My advice is that an annual update of your appraisal is optional, not mandatory, and should be undertaken only in the event that some significant change in the practice has occurred. Otherwise, I suggest you forego the cost of regular updates. Save your energy and spend more time focusing on the most important aspect of your practice: your patients.
Dental practise is primarily a human relations business, not a numbers business. If we focused upon this crucial element, would a practice be more valuable in the end? I think so.
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