The contribution of the hygiene department can influence both the tangible and intangible aspects of the value of a dental practice. Obviously, a well-established, long-standing relationship between patients and staff certainly increases the transferability of patients to the new owner. It’s understandable why purchasers and their consultants are often impressed by this abstract incalculable value. The doctor’s role in a transition often is transferring the loyalty and support of the staff to the new owner. Therefore, the doctor’s selection of the right purchaser becomes more than just a monetary decision.
Many of the clients I deal with often overlook the specific and measurable manner in which their hygiene department contributes to creating value in their dental office. This article will show by comparison specifically and measurably how a thriving hygiene department affects the cash flow asset value of 2 practices.
|Table. Common risk factors to consider when evaluating a practice.
- Practice productivity trend
- New patient flow
- Years in practice in the area/years at location
- Overall office appearance
- Age/quality of equipment
- Existing or future lease and terms
- Seller/bank financing
- Local economic outlook
- Other practices for sale in the area
- Perceived transferability
PRACTICE VALUATION METHODOLOGIES
There are many formulas and methodologies used in the valuation of any dental practice. The Institute of Business Appraisers, of which I am a member, has established acceptable standards of evaluating any business you wish to sell. The accepted standards give specific guidelines for valuations of closely held private companies. These guidelines are tried- and-true methods of appraisal and take into account market driven methods, cash flow methods, and the summation of all business assets.
The hygiene profitability of a dental practice influences the (capitalization) cash flow of the business exponentially. Today, mortgage companies make the majority of all dental loans, and it pays to position the practice to impress these cash flow lenders. Lending institutions vary in their way of determining the amount of money they are willing to lend. A well-documented appraisal will evaluate the business from various perspectives, and based on the type of institution, the available loan amount is determined by underwriters. Banks are collateral lenders and will lend money based on the value of the collateralized assets of a dental practice. Mortgage companies known throughout the dental profession base their loan amount primarily on cash flow and less on collateral asset value. This makes the capitalization method of valuation very important if the selling doctor does not wish to finance a major portion of the sale of the practice.
The market-driven methods encompass most of the rule-of-thumb types of appraisals. These are the formulas that dentists often discuss at their local meetings. These methods are simplistic and vary from 2 x net to 1.2 x net, net being defined as the profit of the practice, including expenses for the doctor’s retirement plan, automobile, depreciation, and the doctor’s personal medical and life insurance. Another rule-of- thumb method that is often used in the transition field is a percentage multiplier of gross collections. These rule-of-thumb methods make great conversation but often confuse the issue in the actual sale of the practice. The other concern with this particular method is that it varies from as low as 45% to as high as 80% of the last year’s gross production of a general practice. This can drastically change the price paid for a practice. The national average is around 65% of gross collections.
VALUE OF THE HYGIENE DEPARTMENT
The hygiene department of any dental practice plays an ever-increasing role in its appraised value. In fact, any department of the dental practice that is a profit center, apart from the doctor actually doing the work, plays a huge role in the capitalization method of valuing the office. Capitalization methods of appraisal take into account such things as elements that increase the risk of purchasing a particular practice (see Table).
These factors will either decrease or increase the value of the practice. Most risk factors associated with the purchase of a professional practice versus the purchase of another type of business are generally low, and the risk tolerance of each individual investor is to a large extent a personal matter. If a particular purchaser desires to be in a certain area, and an established practice with sufficient cash flow is available in that area, risk factors such as the number of practices in that same area or the age/quality of the existing equipment may become negligible factors in the mind of the purchaser.
The capitalization method is used by anyone looking at the cash flow of the practice and primarily takes into account the profit of the business due to ownership, not doctor/owner production. When you compare the value of a dental practice with other businesses, the purchase of a dental practice is usually a much more profitable business investment. The profit made in a dental practice, compared to investment capital, is substantial and is usually much higher than any other business. Cash flow lenders make the vast majority of all dental sales loans and are the ones most impressed with the capitalization of the dental practice. These are the people buyers and sellers need to impress in order to finance the purchase. Many business owners hire a manager to run day-to-day office procedures and are absentee owners. There are only a few dental practices across the United States that are absentee owner-managed.
The office hygiene department in most practices I have worked with produces between 18% and 30% of the gross practice income. Many consultants look at this figure to determine if the doctor is undercharging for hygiene or if the doctor is not productive in determining needed treatment from hygiene exams. If the hygiene department is producing roughly 18% of the gross practice income, the hygiene arm of the practice needs to see more patients, or more periodontal treatment might be performed in the hygiene chair.
Let’s look more closely at these percentages and see what is actually happening in the office on a daily basis and how this 18% or 30% influences the value of the practice. Does this number include x-rays taken in the hygiene room? Does it include work performed by a hygiene assistant? If a soft-tissue management program is in place, is it separated from the routine recall production? Does the hygienist see new patients prior to the initial exam by the dentist? The answers to these questions can impact the actual production percentage of the hygiene department. The most successful practices have exceptional staffs who see their influence directly affecting the productivity of the office. If the doctor and the hygienist can implement a program where the hygiene arm of the practice is one of its most productive arenas, the practice’s value can increase exponentially.
COMPARING PRACTICE X WITH PRACTICE Y
How does a measurable increase in hygiene production influence a specific valuation of a dental practice? Practice X and Practice Y had been delivering dental care for 20 years in a freestanding building just outside a large metropolitan area. Total collections for Practice X was $690,000, and the doctor worked 4 days each week. The production by procedure report revealed that he had a restorative practice with emphasis on crown and bridge. He referred out about 50% of endodontics and all oral surgery. Children made up only 10% of his practice, and most of his patients were over 45 years of age.
Practice Y had yearly collections of $567,000. This practice was 50% restorative and a balance between routine repair dentistry and crown and bridge. Fifty percent of all endodontics and 100% of third-molar extractions were referred out. Routine surgery was performed in-house.
In both practices, collections were 98% of production, and neither office accepted PPO or DMO patients. The true practice net percentage of collections for each practice was essentially the same (within 2 percentage points). The percentage of hygiene collections for Practice Y was 34% while for Practice X it was 18%.
Let’s look at how the difference in hygiene production influenced the capitalization appraisal value of each practice. When the capitalization method alone was used, Practice Y appraised for $15,000 dollars more than Practice X, even though Practice X produced $123,000 more than Practice Y. The capitalization method was not the only method used to determine the final value of these practices. The concluding tabulation of practice value for each office was essentially the same after utilizing the other accepted industry methods for appraising dental practices.
As you can see, hygiene production had an enormous affect on the final appraised value of the 2 practices noted above. Clearly, it pays big dividends to tune up the hygiene aspect of your practice years prior to any transition.