How Dental Practices Are Valued

Hey, everybody, it's Wes Reed here. And yeah, it's been a little while since I've come at you with a podcast on the Dental Cell Podcast. So I should probably start off with a little bit of repentance here and explain a little bit about what's going on over here at the Dental Podcast show, really a part of the Practice Orbit technology that we have recently launched and are excited about. Practice Orbit is a dental marketplace online for buyers and sellers of dental practices and their teams. Not their clinical team, their professional team, that is their dental accountant, their dental attorney, or the buyer, generally a bank is involved to all be able to operate inside of this software, this online website, and be able to navigate that sale successfully. And it's a lot of work. It is a lot of work to develop a technology, a software, and it's a lot of work to roll out that technology. And I am thrilled to announce we have a lot of users signing up on the platform and we have a lot of listings coming on the platform. I want to clarify for any listener, perhaps Practice Orbit is not attempting to be a broker. Actually not a dental broker. There are plenty of dental brokers out there. Practice Orbit is a technology platform and anybody can use the platform, including brokers, if they so wish. Many brokers sort of have their process and systems and they are not necessarily eager to change. But hey, we're humans who likes to change the way we do things. Fact of the matter is, however, technology disrupts every industry and it will disrupt the practice sale industry. I am absolutely 100% convinced of that. And that's why I've dedicated some time over the past two and a half years and some money, I might say here, to developing the software with an official development team with weekly meetings to brainstorm the client experience or the user experience for dentists who are either selling or buying their dental practice and their personal professional team to make for a much better experience. And right now, when a doctor sells a practice, it's sort of, who do you know? How do you find that associate? And if you're an associate, how do you find all the opportunities out there? You just have to talk around, you have to go on listing sites, you have to go on, try to go on aggregator sites, and you got to go to your study club, your dental societies, and just it's old school. It has not changed since the 1980s. And so brokers, typically the ones with the biggest Rolodex, tend to be the ones who can make that market, that is make the introductions for a sale and also help them through the sale. And brokers have been able to play, I think, an important role for a lot of buyers and sellers. And I think that in spite of the role that they play, I think technology can help facilitate this for everybody. See, here's the problem. Everybody. In dental practice sales, as in all small business sales, but in dental practice sales, uniquely, there is no multiple listing service. There is no mls. It's the mls. If you don't know what that is. The MLS is what feeds Zillow, it's what feeds Redfin, it's what feeds all of the assembly line of houses coming on the marketplace for anybody to see. Now, back in the day before Redfin and Zillow and the like, brokers and agents all had access to this MLS system and therefore they could use it to see what houses are for sale and they could do showings. And so buyer agents would be able to take you around and show you the houses. Well, now it's not you don't really need an agent per se to find a house because you can find houses on the website. So you have direct access to, to the Redfin or the Zillows or the Trulius. You have access to that. However, an agent may still come in handy to help hold your hand through the process of offer letter to closing. Now, when it comes to dental, it's a little bit unique because dental practices have the same value as another asset that sales it is like a home. It may be 70%, 80% of annual collections. Let's say you do a million dollars. That practice may sell for 800,000. Now, I'm ballparking that and I'm going to get into that a little bit later today in the purpose of the podcast dental pract practice valuations. But when it comes to selling your practice, you can sell it just like you can sell a house. It's an asset worth something. And it's your reputation, it's your location, it's your goodwill, it's your recall system, it's your brand, it's your systems and processes and your team. All of that reputation, mostly in the form of goodwill that you can sell to somebody else at a really good value. Now, it's not like a technology company that sells for 10 times its revenue. It usually will sell for about 0.8 times its revenue. But, but hey, if you're doing a million dollars, that's still a lot of money. And dentists like to bank on or count on the ability to sell their dental practice as a part of their Plan to build financial independence and eventually retire. Now these days a lot of dentists are selling mid career because they're moving. Maybe they're, some are selling to the DSOs out there that'll be for other podcasts and some are partnering and sometimes people just want to get into a different type of practice. There are a lot of people buying and selling practices these days, dental practices and how convenient would it be or much more fluid to be able to have a single place where people can go and find those dental practices. Now I would love it if every broker would come on practice forbid and put their listings on there. There are so many tools to make for a beautiful listing. It's anonymous, built in legal documents, workflows, inviting team members inside of it and, and it would really help the whole system. But that may be a dream, that may not happen in the next six months. But what I can do is offer buyers and sellers a place to net to find each other organically and the tools to be able to invite their attorney and banker and accountant in to navigate that sale. Because if you have a dental accountant, a good dental accountant, not a general account, if you have a good dental attorney, not a general attorney, but the accountant and attorneys that know the terms of a dental deal, they know how to assess valuations of a dental practice. They know the contingencies, the nuances, the caveats. If they know that, then they can really facilitate the sale for the buyer and the broker from NDA to letter of intent to closing. And when I bought my house, though I didn't have an attorney, I didn't have an accountant, therefore I had an agent and the agent was fairly helpful. But in the case of a dental practice, it's a little bit different because you already have a couple professionals. So you don't necessarily have to have an agent, a dental broker or an agent in order to sell. Now if you're a dental agent or broker listening to this, you may take offense to that and I don't mean to for you to take offense to that for a long time practice cfo, which is my CPA firm on the side, had a dental broker associated with it who was great and I really cared for that person and we had, we get along great. And many sellers may want to use a dental broker and find value in a dental broker. And in no way do I want to discount the value of a dental broker. But what I want to say is there are a lot of practices that sell already without a dental broker and the ones that do so successfully are Ones where the buyer and the seller have dental specialists, accountants and attorneys helping them through that process. For example, at Practice cfo, we do a lot of buyer rep services and we have a whole process around representing the buyer, a whole workflow with checklists and all of that to make sure that the transaction moves forward and that the buyer is properly represented in that deal. And we, of course, can represent sellers as dental CPAs as well. Well, Practice Orbit is off to a great start. There's a lot of flow, there's a lot of new users signing up. There's a lot of excitement for what the features are inside of the system. And I am very optimist, or what we say in the investment world. I'm very bullish on where this is going. And I want to make something very clear. This is not a listing site. Again, this is a technology. What do I mean by that? Is Airbnb a listing site for short term rentals? Yes, but it's not just a listing site. That could have been done on Craigslist. Airbnb is, is a software now. It's a software that's housed on a website. And those types of softwares are called software as a service or SaaS. Back in the day, if you go back 15 years, 20 years, most softwares were installed on your computer and you had the icon on the bottom of your computer and you would open it up and it may have been able to connect to the Internet, but it wasn't housed on a remote server somewhere else. SaaS or software as a service is, is a software that is looks like a website, but the software is inside of it. You can know because you can open up the website and it will start with app or app dot, whatever. So if you go to Practice Orbit and you go to the homepage, practiceOrbit.com, it has no app, but when you log in, you are now in a dashboard and it will say app. And that means that you have tools inside of there, you can operate inside of there. There's activity, there's interaction, there's functions that you're operating inside of that just like any software. Think of your practice management software. That is a software. And now a lot of these practice management softwares are going to the cloud. Curve was kind of one of these earlier ones, but now you have Ascend and you have is it Fuse, I think for Eaglesoft, I could be wrong in that, but you have more and more of these going to the cloud. Open Dental, I think is in the cloud. And that's where Software has gone over the past five years or so to the cloud. One of the biggest companies to first sort of introduce this cloud concept, Salesforce. And it was their huge innovative idea. And what made them so successful at Salesforce was that they were one of the first big cloud CRMs out there. And so Practice Orbit isn't a software you download on your desktop. It's a software you log into through a web page. But when you log into it, you are definitely in a software. So, number one, how is Practice Orbit different? It's not a broker, it's a technology company. Just like Uber is not a taxi company, it's a technology company. Just like Airbnb is not a hotel company, it's a technology company. Airbnb does not own real estate. Uber does not own taxis. It's a technology company that allows the users to find each other and to transact easily, including collecting inside of that software. Now, when softwares are developed, they sometimes start small. They sometimes start with just one feature. And that one feature provides a little bit of benefit and people will pay for a little bit of benefit. And over time, it adds more features and more features. Look what Amazon has turned into. Amazon is also one of these marketplaces. Formally it's called a multi sided platform. And Amazon now has many sides to it. And now you've got Amazon Video and you can have subscriptions and you have all of these sellers and you can get books and there's so much more you can do in Amazon. It's one of the most layered, complicated marketplaces that exists on the Internet today. Well, a basic multi sided platform will just have usually two sides, a buyer and a seller. But as you add others, it becomes a multi sided instead of a two sided platform. Well, Practice Orbit is a multi sided platform. And who are the sides? The sides are the people that can log in and do something inside of the system. Obviously, the seller is a side, the buyer is a side. All right, who are the other sides? The accountant for each of them is a side because the accountant needs to get access to the documents. The accountant on the buy side needs to do financial due diligence. The accountant will need the documents on the escrow statement and whatnot to file the tax return to know how to allocate the purchase price across the assets. There are various reasons reasons why the account needs to log in and to have access to the transaction flow and data inside of the Practice Orbit software. Attorneys. Why do they need to log in? Well, attorneys also need access to documents as well. And attorneys need to communicate with the other side's attorney. Now, right now, in the development of Practice Orbit, think of software development as you're developing a way to transport yourself from one place to another. And there's an official term for this in software development called agile development. The very first release, they sometimes call it your MVP one, your minimum Viable Product one, or in the case of a marketplace, they'll call IT Minimum Viable Platform 1. Well, practice orbit has now reached and delivered and is in use, a MVP one. And it's a very strong MVP one. But this concept of agile development, if I need to go from here to the other side of town, one way I could do it is I could walk, okay? And that's going to take the most energy. Or I can grab a skateboard. The skateboard is going to help me get there a little bit faster, a little bit less energy, especially when there's downhill. And then I can go to a scooter. Well, that's even easier. A scooter, you don't have to work so hard and then you can get to someone with a bike, then you throw a little engine on that bike and then eventually you get to a moped and a motorcycle and a car and eventually you're on like a bullet train or you're on a, you're on a jet. And every one of those iterations is another release of that software. So in time, Practice Orbit will have other releases with other features that make it more and more beneficial for these sides. These individuals involved in a practice sale to work and want to work inside the system because everyone is better off that way. When I can literally sit down for three minutes and buy five items on Amazon and get up and go make my dinner and it shows up the next day, that is a very convenient feature. Now, that's not what it was 20 years ago. You could buy a book, it took more work and you had to wait three weeks to get it, but you could still do it. But agile development of a software is a beautiful thing. And Practice Orbit is out, ready, functioning, working. It's got doctors who are listing their site, their practice on the site. We have users signing up and buyers. And we are just having such a great time seeing a technology be introduced that I feel so strongly, having literally been in hundreds of dental practice sales as a dental cpa, to see this, get out there and start to provide a benefit to make this a more enjoy, I'll say enjoyable, successful experience for all parties involved. Well, that's a little update and an explanation of why I'VE been out of pocket for quite some time here on my podcast and I hope it was for a good reason because now it's launched and we are wanting to provide great education to buyers and sellers and their teams through the Dental Practice Sale podcast. So today, what I want to talk about here we are 15 minutes into it. What I want to talk about today is practice valuations. Just for a minute. And I have no guests. This is just me, Wes Reed, dental CPA and certified financial planner who have been doing in dental CPA and financial planning work for about 15 years and a lot of transaction work coming at you and in doing so I've had hundreds of conversations about what is the value of a dental practice. Now let me caveat that I am not a certified business valuation expert. There are official designations like dds, dmd, CPA for business valuations and if you feel you need a formal valuation on the Practice Orbit website, if you go to directory at the top, click on my dashboard and then you go to my directory, you'll see there is a valuation expert named Mike Seiz. He's currently our go to on this and we have no financial tie with Mike Size. We just think he's independent and he does a great job. And he'll charge 2,500, 3,500. I'm not sure right around there to get a 30, 40 page report with a lot of jargon in there ultimately to tell you what your dental practice is worth. Now do you need to get that? Maybe it depends on what the purpose is. If there's a lot of conflict or disagreement over a price, maybe you're in a divorce settlement, maybe an estate plan is being done and you need to know the value for estate purposes, yada yada. There's a lot of reasons to maybe go get a very formal report that backs up a price. However, if you in practicality, the price of a dental practice is A what a buyer and seller are willing to agree on and B what a bank is willing to lend on. Because the vast majority of time the buyer depends on a bank to get the money to lend to to buy the practice. Now the dental lenders out there at the banks are very good at assessing the value and cash flow of a dental practice. They're exceptional at it and they're very niche with it and they're willing to lend 100% of the sale price and then some for working capital cash for the buyer. I mean this is very rare. That's how low risk a dental loan is to a bank. They love you. They love you dentists because you have such a predictable cash flow business that's fairly resilient to economic cycles. That's why buyers, you guys get a great rate on your loans. Right now they're hovering right around 6%, plus or minus just a little bit. That may feel high because over the past 15 years or so, 20 years, interest rates have been next to nothing, which means the time value of money hasn't existed. Which means the time value of money is this concept that over time the dollar becomes less and less valuable. Well, really, interest rates have been so low that inflation really has not been a problem. And so it's been a great market for borrowers to get out a loan because rates were at 3%. One of my clients has rated 2.76%. I mean, that's ridiculous. Well, now they're at about 6%. They're getting closer to what historical norms have been that are still very low and very reasonable. And so buyers, that's what you depend on when you get a loan. Are you looking to buy or sell a dental practice? If you're a seller, how do you find a strong list of potential buyers? There's no MLS or Zillow for dental practice sales. In such a fragmented market, many dentists selling their practice feel discouraged. That's why I built practiceOrbit.com practice orbit is modernizing how dental practices are bought and sold. It's a platform technology. Y' all know them. Zillow, Airbnb, Uber, and OpenTable, just to name a few. These technologies practice technologies do two things. First, they help match buyers and sellers by centralizing the marketplace. Second, once the match between buyer and seller is made, these technologies help them navigate the sale to a successful close. Here are a few of the features inside a Practice Orbit users can determine a reasonable sale price for practice in just minutes. All they need is the most recent business tax return. Practice owners can use the directory to find important sales service providers like practice brokers, attorneys, accountants and bankers. Practice owners and their brokers can invite those service providers into the platform. So all parties are coordinating the sale together. Practice owners will have a beautiful digital listing of their practice, like a home on Redfin. And importantly, the listing will be anonymous. And personal information like your address, name and pictures are only released after an ending is signed and approved by you or your broker. Practice buyers can create saved searches to be auto notified when new listings come on the platform that fit their desired specialty and location. And hey, dental practice brokers, you can list all your practices on the site for free. By doing so, you'll get access to Practice Orbit's large pool of buyers, all of whom have created profiles and saved searches to be auto notified when new listings are come for sale. You can use the platform to introduce your listings to a targeted set of buyers. Additionally and optionally, you can use the platform tools such as a built in NDA, a customizable LOI, and a workflow tool to navigate the sale from LOI to closing. In fact, you can manage all your listings on the system, from listing the practice to NDA, to loi, and finally to closing the deal. Create your free account today at www.practiceorbit.com.

So let's talk about valuations. What do we do? What does a bank do? What does a dental accountant do? What does a broker do? What does Praxis Orbit do when you're determining the value of a dental practice? Let me start from the top. The value of a dental practice is really driven by by its economics. And its economics is reflected in its financial statements. In the financial statements, there are two primary financial statements. One is called your statement of income and expenses. Colloquially we call it the profit and loss statement or the P and L. Now if you're a buyer, you're going to get to hear this, I want you to know it. P and L. So it tells you your income and your expenses and your profits, which flows through on your taxable income to determine your taxable income. The other statement is called your balance sheet. And the balance sheet doesn't show your income and expenses. It shows your assets and your liabilities and the difference between the two, which is called your equity. So your assets will equal your liabilities plus your equity. In other words, it's everything you own and everything you owe. And the difference between those two, that's called the balance sheet, or more formally called the statement of assets and liabilities. So P and L and balance sheet, that's the way we typically term it. Now, when determining the value of a dental practice, you really don't need a balance sheet. And the reason why is dental practices sell as an asset sale. They sell. It's like a garage door that opens up its dental practice and sells the chairs and it sells the equipment and it sells the furniture. And it puts a value on that like you're selling it on ebay. And then whatever is above that is called an intangible asset known as goodwill. And it's an asset sell.

And the price isn't really determined by the assets on the balance sheet at all. The Balance sheet is what you bought it for less what you sort of deducted through what's called depreciation. The balance sheet does not signal what the value is worth and some people think it does. It doesn't. It's what are the profits on the P and L? What is the cash flow that the buyer is going to get from month to month in order to pay the overhead, debt, taxes and personal spending needs?

And so the P and L is the main document, it's the primary document that determines the value of a dental practice. Now you can add other things like hey, I just spent $150,000 on new dental chairs. Well, great, that might add a little bit of the value, but generally sellers, I'm not recommending you go and spend a lot of money on equipment for your practice shortly before selling it because it generally doesn't increase the value of your practice a whole lot. It's like you do a remodel on your house and you drop $500,000. It might increase the value of your house $100,000, maybe $200,000, but it's certainly not going to increase at $500,000. Why? Because the value is largely the square foot, the location comps, things like that. Same thing with a dental practice. That's why you poor buyers sometimes buy a practice and you inherit a bunch of junk inside of it that over the next few years you got to replace. But that's just the way it is and you got to factor that into your cash flow and your projections. When you go to buy a dental practice, hopefully you have a good dental cpa. I want to emphasize the need for a dental specific cpa, not just somebody who, you know, brother in law, yada yada. I'm telling you that's not in your best interest. You need a dental, you need dental specific professionals around you. It's so much more valuable. Is it going to cost you a little bit more? Yeah, but it's going to be way more valuable to you for sure. Alright, so the P and L. So what we do is we get the current year and the last three years of your profit and loss statement and we take that and we put it in a tool that shows your income or your collections for those three years. And then we put your labor, your labs, your supplies, your facility, your marketing and your admin expenses. Those six expenses, labor, labs, supplies, facility, marketing and admin facility of course is your rent and all of that, those six categories. Now within each of those you'll have subcategories like in Rent, you may have your rent, you may have repairs and maintenance, you may have grounds keeping, that kind of thing. Your labor, you might have hygienist, front office, associates, assistants, payroll taxes, benefits, all of that. In admin, you have your phone, you have your cpa, you've got continuing education, office supplies, all that stuff. But those are your main six categories. Labor, lab supplies, facility, marketing and admin. And then what we do is we. Now you haven't paid yourself anything yet as a doctor in that analysis, you're not included in your labor yet. That's your team. And you come up with a number, your collections list those six categories and, and that equals your operating income. Your operating income is a key number on your financial statements. And if you're with practice CFO or a dental specific firm, they should have something that shows you what is your operating income highlighted every month on your P and L because that's the punchline of cash flow coming out of your practice. Now from there, there's other tax deductions that are on your P and L what you're paid as an owner of your corporation. If I assume for a sec that you're a corporation, an S corporation, you have to pay yourself something because the IRS wants their Social Security, Medicare, which is only applied to wages, not pass through profits. And so they make you pay yourself something. But what you pay yourself something isn't 33% of production. It's whatever you should be paying yourself for tax and 401 purposes. That's another subject matter. But under the operating income is what you have to pay yourself. If you have your payroll taxes, any sort of personal travel, your meals, a lot of this personal stuff that you run through, that stuff that's kind of slushy stuff, but that's also tax deductible. Some of that might be toeing the line a little bit. But if you're, you know, a firm, a client, a practice cfo, we try to have as much legitimate though we may be pushing it in some areas, but we need to get as many tax deductions as we can. We don't want to cross the line, but we get a lot of that stuff in there. Other things that are on there on your P and L are these things called depreciation and amortization. I don't want to go too much into that other than to say when you buy equipment, you deduct it by leaking in the cost into your P and L for a few years called depreciation, or you can front load all of it. Through what's called a Section 179 deduction. And you get to deduct all of it through through depreciation. And if you buy a dental practice, you buy goodwill. A lot of the purchase price is in the form of what's called goodwill, which is an intangible asset. And you get to deduct that every year over 15 years through what's called amortization. So how is a dental practice valued? Now, as I've laid out the anatomy of a P and L for a dentist, how is it valued? Well, what we want to do, we want to. And I'm going to start with a private practice because the way a DSO values is going to be a little bit different. But the way a private practice is valued is we want to know what is the cash flow to the buyer before paying anything for the buyer, the true business cash flow. So you get to that operating income and you have to make sure that you've sifted out expenses that aren't really business expenses.

And that's important because that's how we determine the true profitability of a dental practice. And for a seller, this is a good thing because your profits go up. That's a good thing. Your profits go up when you have fewer expenses. And the way to sift out some expenses are to get rid of these expenses that are one time or personal. Let me list a few of these. So I already named a few of these things. We want to take out your personal auto. We want to take out any office supplies that's really Costco and Amazon. That's for your house. You want to take out your meals. That's you and spouse or kids going out. You want to take out the travel. That's you going over to Hawaii to, you know, be with your family. Although you may hook up with a friend and have a quick discussion about dental and call it therefore a business deduction. You know, some people get really aggressive with this stuff. You want to remove those expenses as if they never occurred. And that way the profit goes up because a buyer's not going to be paying for your Hawaii trip. A buyer's not going to be paying for your automobile or these pseudo office supplies. You also want to sift out or what are called add back. These are all called add backs. That's a key term, add backs. What expenses are we adding back to the profit to make the profit go up? Travel. We talked about that. Also, if you have a 401k or defined benefit plan and you're putting a lot of Money for you, the owner, that should be added back because the buyer is not going to pay for your pension expense, 401k and your defined benefit plan. Also, in a lot of states, states like California, where there's a high state tax, there's a special way to pay your state tax as a business owner that allows you to deduct that state tax payment on your 1040 personal tax return with the IRS. And that's called a pass through entity tax, a PTE tax. In California, it's specifically called an AB150 tax. That is a personal tax payment that shows up on the P and L. So we want to add that back because that's a personal, not a business expense. But you have to pay it through the business in order to get the tax deduction. So if you're a business owner, make sure that your CPA knows to have you pay your AB150 if you're in California, or your PTE tax if you're in a different state through your corporation. So you can deduct that against your federal income because that's going to save you anywhere from 15 to 37% on whatever it is that you're paying to your state. Now, a lot of states don't have income tax or they have a very low income tax and so it may not be relevant, but the states that have high income tax like California definitely want to be looking at the pass through entity tax. But that's an add back. Also, anything that's one time, like let's say in two years before selling, you bought new computers and it cost $50,000. That's probably an add back because it's a one time expense. And of course you want to add back depreciation and amortization because those aren't even cash flow items. Those are accounting adjustments. Also, if you are selling your practice and you still have debt, maybe you bought dental chairs or a CAD cam, whatever, you still have debt on your balance sheet. The interest that you're paying on that debt, which shows up on the P and L as a deduction for paying interest, that interest should be added back. Why? Because the buyer's not taking on your debt. And so that is an add back to the profit. Now the downside is that you're going to have to take the proceeds from the sale to pay off any outstanding debt you have on the practice. So once you have taken the operating income and you've sort of added some of these items back and you get to what is the true cash flow, profit in other words, if you didn't run anything personal through the business, what's the true cash flow profit? Before paying you, before paying any of your benefits, before paying your taxes, before paying your debt, before funding your 401, all that stuff, that's you. What is the cash flow profit? Another way of looking at that is what is the buyer going to get as a cash flow profit? Assuming that they can maintain your collection level so that they can pay their own debt, taxes and lifestyle needs, then the banks will take that number and they will apply it to a formula they have called the global debt coverage ratio. To see how many times does that number pay for the buyer's global debt inside and outside of the practice. And they're always looking for at least 125% of that global debt coverage ratio. And they factor things like living expenses in that and whatnot on the personal side. So I'm not going to get into that global debt coverage ratio. But just know that that's the number that determines how much the banks are willing to lend, which oftentimes generally drives what is the value of that dental practice. Now in practice Orbit, there's a very sort of back of the envelope, but also fairly accurate way of doing this. If you have a tax return, you can log in, create a free account, and when you log in, you're on your my dashboard in the bottom left it says price evaluator or price estimator. You can click on that. And if you get your tax return, if you're an S Corp, get your 1120s. If you're a sole proprietor, get your schedule c from your 1040. And if you're a partnership, get your 1065. So whatever type of business you are S Corp, sole proprietor, partnership, get your business tax return and find there's one page, that's all you need, one page. And it will tell you which boxes to enter. There's six boxes. Enter those into practice orbit and then you answer one question. How aggressive were you in running personal expenses through the practice like the ones I listed, A little bit, some or a lot. And then once you do that, click done and it will calculate a low median and high value, what your dental practice might be worth. And then from there you can put in what is the debt that you have outstanding on your practice? And it will go the next step, which I think is the more important step, what do you keep as a seller based on that price after paying off your practice debt, after paying off your taxes related to the sale, and after paying selling expenses and you can put in a percent for if you use a broker or not. And then it will calculate what is your take home. When it's all done and the dust settles, you can give that to your financial planner and say, am I ready for my next step? Am I ready for retirement? Is this going to make sense? And a lot of times it's almost discouraging to see how low that number can get, especially if you have a lot of debt and if you're in a higher tax state. So you'll put the state that you're in, by the way, and it will take a state tax. So if you're in California, you're going to see more taxes come out. If you're in Texas or Alaska, you're not going to see nearly as many taxes taken out because those don't have income taxes in those states. So Practice Orbit is a really good way to get a very. Not, I won't say perfect because the only way to get a very precise analysis would be you got to go through all of these individual add backs and be very meticulous. And every practice might be a little bit different, but Practice Orbit is going to give you a very good ballpark for what you could sell this practice for. And you can do that in minutes and you can do that for free. Okay, so that is how you come up with the value. Now let me. Well, let me say that's how you come up with the cash flow that determines the value. Now let's say how does that cash flow, that profit, translate into market value or a list price? Well, sometimes you'll hear the Practice sells for 80% of revenue or collections somewhere between 60 and 80 or 75 and 85. You'll hear that rule of thumb all the time. And to an extent that's true. But at the end of the day, what's the value? To a buyer it's going to be what is the net cash flow after the expenses? So the more relevant number isn't your collections, the more relevant number is what is the net profit after doing all of those add backs that should drive it. What the top line or revenue does. And when I say top line, I mean collections. And when I say bottom line, I mean profit after your collection is less your expenses. Top line, Bottom line. What the top line does your collections is the banks generally don't lend more than a percent of your top line. Now, the banks vary a little bit on this, but usually it's somewhere around 90%. Might be 95, might be 85 for some banks, but let's say 90%. So if your practice is doing a million dollars a year, they won't lend more than $90,000 if 900,000 is their ceiling. Now that 900,000, keep in mind that the buyer is going to need some working capital, some money in the bank on day one. So they may take 50,000 of that 900,000 that the bank is willing to lend and reserve that for the buyer's bank account to get started. In that case, the max sale price could be $850,000, assuming that the seller isn't going to require the buyer to go get money elsewhere. Or the seller could do what's called carry a loan, essentially act as a second bank. That's what the top line revenue or collections is generally used to do is to determine what's the cap that a bank is willing to lend. But ultimately what they will lend is based on the cash flow profits. And so I will usually say that the price of a practice, the value of a practice is somewhere around 2 to 2.5 times its net profits after all of the add backs, cash flow profits after all of the add backs, before paying the doctor wages, doctor benefits, doctor taxes, all that stuff 2.5 times. So if you have a million dollar practice and you have a, let's say a 400,000. Now let's say after all the overhead, you're left with $300,000. $300,000. That means you have a 70% overhead. $300,000 times let's say two, that practice would sell for 600,000. And that feels low. That's only 60% of revenue, but it's low because its overhead is high at 70%. 70% overhead is high. A standard dental practice should be somewhere, a GP practice should be somewhere around 60%, 60%. So let's say it is 60%. And so your expenses are 60% of a million dollars million dollars being your collections. Your profit therefore is 400,000. Before paying the doctor and the doctor's personal stuff and before amortization and interest and depreciation and all that stuff, you pass the renity tax before all that stuff, your true overhead, labor lapse of facility marketing and admin is 600,000. That's a 60% overhead. $400,000 profit times 2 is going to be 800,000 times 2.5, 2.5 is going to be a million dollars. So in that case, that practice 2.5 is a little bit of a stretch. I usually say between 1.8 and 2.25. If I want to be specific. And so that practice, I'd say on the high end is going to go at 900,000. That's 90%. But that's at the high end. That's at the high end. I think more likely that practice is probably going to sell between 750 and $850,000. Now, a broker may come and say, I think I could get you a million dollars. I can get you 100% of collections. Now, I mean, this is no offense to the broker, but we all, if we're a broker, what do we want? We want to get the listing. Because once we get the listing, you're locked into me. You can't go to another broker. I've got you for six months captive or a year, I've got you captive. No matter who you sell to, whether I find them, you find them. Whatever you got to pay me my 8 to 10%, my 7 to 10% upon that sale. So brokers will definitely encourage you to sign the listing. And sometimes I think if brokers are honest about this, I think they may inflate the value. Now, that's not always the case. I've definitely met brokers who are much more honest about that. And so I, you know, I highly respect that as well. The practice Orbit estimate tries to give you what is a reasonable value by essentially saying, here's what we think. A bank is willing to lend on this at some level. So I think it's a pretty honest value. And it also gives you a range. And then you get to decide what you want to list the price at, or you can get a professional valuation done. So that's how you sort of arrive at a price. The collections drives the cap. The profit drives the actual price. Now, as a seller, if you want to sell more than what the industry standard sort of benchmark is because of intangible reasons, maybe you got this beautiful location, you're on a street corner. Maybe you just bought a whole bunch of new great equipment. Maybe because they're doing a whole new development right next to your office. Maybe because you're near the beach and everyone wants to go to work with a window looking out at the waves, whatever that is. If you think you got more value than your standard dental practice, that's fine. The bank just may not be willing to lend on that. So what is your option there? Well, you got to go find someone with deep pockets, which may be a dso, but a DSO is going to have a lot of strings attached. You're going to have to work back for three to five years, you're going to have to produce more than you were producing before you sold. You now got a boss, all those things. So that may not be what you want. So if it's a private buyer, what are your options? Well, you either find a private buyer who's got money to pay the difference of what the bank won't lend in order to get the price you're asking, or they got a rich uncle, or you can say, okay, the bank is willing to lend 800,000, I want 950,000 for this. I will carry the other 150,000 and I'm in second position to the bank. So if you go under, I'm probably never going to get paid because the bank is going to take over the practice, sell it, they're going to try to get their money back. But assuming you don't go under and you make good on the payment, we're going to set up a promissory note where you're going to pay me in very similar terms to the bank, might be a little bit higher interest, but you're going to pay me over a period of time, usually the same term as the bank loan, which is typically 10 years. And so that $150,000 spread between what the bank is willing to lend at $800,000 and the price the seller wants at 950, the seller is going to act as a second bank and do a 10 year loan for $150,000 at 6% interest rate and then you pay them. Now the only problem that can introduce is that new loan to the seller that the buyer has to pay may affect the bank's willingness to lend the 800,000. Because remember, they're calculating what is the cash flow and is it enough to cover 1.25% of global debt? Well now you just added a new debt to that analysis in the equation. And now the bank may say, but now we're only willing to lend 750,000. Okay, well maybe the seller will say, okay, I'll do 200,000 carryback. But you have this sort of interplay between the seller carryback loan and what the banks are willing to lend there, that you have to find something that works. So generally as a buyer, I say that the general rule of thumb is you shouldn't be willing to pay more than what a legitimate bank is willing to lend. And you should probably go get a couple lenders to bid on this. That way you have a really good idea for what is a reasonable price for the practice. That's what I would say with the exception being if there are exceptions for whatever reason you and the seller agree upon or you feel like, then you can go ahead and allow the seller to carry back a loan. Now, there's different ways to pay a seller because a lot of times the banks don't want the seller to carry back a loan because again, it may affect their willingness to lend. So what you could do is the seller may work back and the seller can work back as an associate. This is very common, as most of you know, the seller can work back as an associate. Sometimes the banks don't like that because the seller working back eats into cash flow and the lower cash flow means less ability to pay the loan. You know, the banks are just trying to get a snapshot on day one. What happens after day one, after you get the loan and the banks go back to the next buyer, the next loan, and you're sort of now in the backdrop, the banks aren't coming and scrutinizing everything. And so let's say the seller decides to come back and work as an associate a little bit. Well, you could make up some of the price by just paying them a little bit better in their production over a period of time. I have seen it where you structure essentially a guaranteed payment for kind of consulting, where the seller consulting the buyer, maybe consulting them by making introductions and how to be a leader and how to run the practice. And you can package part of the payment through a consulting agreement that might be in addition to a associate pay if they are actually doing clinical work. And that's another way to get a little bit more out of the sale price if the practice maybe is legitimately worth more than the bank is willing to lend. The only problem there is to the seller, that consulting agreement, let's say it's $100,000 consulting agreement paid over three years. That consulting agreement is taxed at ordinary tax rates to the seller, whereas goodwill is taxed at the lower capital gains rate. So they're going to pay an extra roughly 15 to 17% on that consulting agreement than if it were packaged into just the normal sale price of the loan. So those are some sort of tricks and nuances on how to handle the sale price when it comes to determining that sale price and how to get the seller paid. So that is a top down approach to how valuations are determined in a dental practice. I will extend this into a little bonus commentary here about how DSOs will evaluate it. What the DSOs will do is they will take that net profit, that operating Income, profit. After all those add backs, what I've been calling the cash flow profit, what they'll do is they'll take from that and they'll say, okay, since we're a DSO and we're buying and we're going to own this thing. Now in some states they don't allow non dentists to owe, but they get around that through other entities. They sweep out the profits, all this stuff. But just conceptually think of it this way, the DSO buys the practice 100%. Sometimes it's the 100% of the cash flow, but they're buying the practice and they're not going to be doing the clinical work. A dentist is. Now usually that's the seller, but now the seller is going to get paid a percent of their production. Just like an employee. Just like an employee. And that might be 30% of production. Whatever it is, if you're a specialist, it might be more, might be 45%, whatever. But they're going to get paid as an employee. Well, in order to calculate a true profit to the dso, you have to subtract out from that operating profit what they're going to pay the employee doctor. Now after paying the employee doctor, they get to this number. It's famous, it's called EBITDA. Some say EBITDA, I just say EBITDA. And it's what you learn in day one, Finance 101 in college, EBITDA, which is what is the net earnings after everything of that business. So if I'm a shareholder and I own 1% of a business, you take all of the EBITDA And I get 1% of that for the year and that's my return on that investment. So ebitda. But they apply this EBITDA which is very much used in big corporate America. This is very much applied in the DSO space. And the EBITDA stands for earnings before Interest, Taxes, depreciation, amortization. Now each one of those is simply an add back. That's what it is. I mentioned all of those earlier, DA ebitda. The only difference is that a DSO has to pay you as an employee to work back or they have to pay a dentist to work back. And after paying the dentist, what is the net cash flow? That's called ebitda. And in Practice Orbit it will calculate, if you list your practice on there, it will calculate the EBITDA for you by estimating what you would pay an associate or what an associate doctor, employee doctor would get paid based on the doctor's production and what it does is it takes the total production, less the hygiene production, and it multiplies it by, I think, about 31% to say. Or if it's a GP, 31% to say, okay, what would the employee doctor be paid? And whatever's left. That's the EBITDA. And that way, if a DSO is looking at a practice, some sellers, some sellers are open to sell it to dso. I'm not going to go into the pros and cons here. It's a very specific type of sale, very different than a private sale. And there are pros and cons. A lot of times the pros are highlighted while the cons are neglected. It's important that buyers, that sellers, understand everything going on there when it comes to a DSO sale. And I've seen some of those fail horrendously. And I've seen a couple of them be like, wow, that was a phenomenal rate of return for you. Usually the earlier you are in a dso, the better you are going to be paid off if that DSO is successful. Different podcast, different time. So that's how DSOs look at it. What is the EBITDA on that dental practice? With that, I'm going to sum up this podcast by saying, hop on to Practice Orbit. Check it out. If you have your tax return and you're a dental practice owner or you're thinking about buying a dental practice and you have the tax return, just go in there, it's free. You get that valuation. Happy to jump on a phone call with you if the practice is doing more than 800,000 in collections. There's a lot of sometimes small practices. I won't say small, but their collections are sub 500. Those ones are a lot harder to sell. And I don't mean for any owner right now who's doing 500,000, $600,000 or less to feel discouraged. But that is the marketplace. It is harder to sell those. Sometimes you have to just sell your patient records to someone down the street. If you're doing 800,000amillion plus 1,020,000, 1.5, much easier to sell those practices and get these valuations I've been talking about. Happy to jump on a phone call and just assess that value for you as a dental cpa, I'm going to be doing more of these dental practice sale podcasts. I have some guests I'm already lining up to come on and talk about their experience selling or their experience buying a dental practice. We'll have some other professionals on as well. It's important that buyers and sellers of dental practices are educated on the key concepts to buying and selling or the transaction of a dental practice sale because it can really help them exit the game successfully for sellers and enter the game successfully for buyers. Hope you've enjoyed the podcast. See you all next time.