Whether you are buying or selling a private business, establishing its market value is critical to a successful transaction. Depending on which side of the transaction you are, you may need business valuation for these reasons:
- Determine a reasonable selling price
- Support your asking price
- Screen businesses for sale to select promising acquisition targets
- As a reality check in a business acquisition negotiation
Finding the right business selling price
In the minds of business owners, the best selling price is what meets their personal or business goals. It may be a retirement package or cash needed to get into a new venture.
The point to remember is the actual value of a business has nothing to do with the owners’ goals. It is an economic concept that rests on the business financial and operational outlook. Even historic performance is of little value except as a guide for estimation of the business future prospects.
If your business valuation disappoints, there is work to be done before the business goes on the market. You would need to review the key business value drivers and see what you can do to increase the valuation in order to meet your exit strategy objectives.
Increasing business earnings, putting a professional management team in place, or reducing key customer concentration can all go a long way toward increasing your business worth as well as making the company a more desirable acquisition target.
Is the asking price right?
No other piece of the business for sale puzzle causes more contention than the asking price. Sellers want the highest price possible, while buyers look to get the business on the cheap.
In a business sale, a reasonable price and terms will make or break a deal. A solid business valuation is your ticket to getting the negotiation off on the right foot. A business selling price that is backed by careful analysis is far more likely to lead to a successful deal.
Screening business for sale targets
One way to avoid the frustration of endless haggling is to screen business for sale listings. Doing this quickly and efficiently is the sure way to avoid fruitless debates with the sellers who refuse to budge. You can run quick valuation calculations, comparing the target companies to the actual selling prices, or estimating the multiple of discretionary earnings the seller expects.
If the target looks overpriced, consider moving on to more attractive opportunities.
Price justification – the reality check of business selling price
If you ever saw a business offering memo prepared by a good business broker, the suggested price and terms are usually included. The question is whether the deal matches the needs of both the buyer and the seller.
Such deal checks are important as they let both parties know what terms are acceptable. Regardless of the business valuation result, a business sale must address the needs of the actual buyer and seller. No two buyers have the same expectation of return on their investment, the same skill set or ability to recruit key employees. In addition, financial strength of the buyer can make a lot of difference as to the amount of down payment or ability to raise a loan to fund the business sale.
If you are considering a dental practice appraisal, here are some interesting industry statistics:
There are over 133,000 privately owned dental practices in the US alone, classified under the SIC 8021 and NAICS 6212. Dental practices are a large part of health services and generate around $104B in annual revenues growing annually at 11.6%.
Yet an average dental practice is a small service business – employing a staff of 6 – 7 and producing some $787,000 in annual sales. Revenue per employee is about $119,000. Dental practices employ some 882,700 staff.
Dental practice valuation methods – comparable practice sales
Practice sales happen regularly so there are plenty of comparable data to use for valuing a dental practice. There are a number of valuation multiples to choose from, each giving you a different way to determine the practice value. Here are the top ones most often used to price a dental practice for sale:
Surprised by this list? Well, the traditional way to assess a dental practice value has relied upon the net sales or gross annual revenues. However, the market for dental practices is quite dynamic and pricing trends change over time.
We keep an eye on the spread of actual practice selling prices from the average. This is handily captured by the coefficient of variation – the smaller this number the tighter the selling prices cluster around the mean. If you want to estimate your practice value, use the valuation multiples with the smallest coefficient of variation first. This means that practice buyers out in the market rely on these multiples more often when pricing acquisitions.
Recent dental practice sales data show that the gross profit based valuation multiples can give you the most accurate estimate of current practice value. In fact, its coefficient of variation is just 0.39 compared to 2.39 for the net sales based multiple.
Example: How to price a dental practice using multiples
Consider an average private dental practice generating $300,000 in annual net sales, having a gross profit of $275,000; discretionary cash flow of $100,000; and market value of all invested capital, which includes the practice assets and long-term liabilities, of $85,000.
Let’s take reasonable values of the respective valuation multiples for use in our value calculations:
- Sale price to gross profit: 0.7.
- Sale price to total invested capital: 2.
- Sale price to net sales: 0.6.
- Sale price to discretionary cash flow: 1.7.
Applying these valuation multiples gives us the following practice value estimates:
- Based on gross profit: $192,500.
- Based on total invested capital: $170,000.
- Based on net sales: $180,000.
- Based on discretionary cash flow: $170,000.
This gives us the average practice value of $178,125.
By convention of professional practice appraisals, the value includes all tangible assets and practice goodwill. It does not include cash, accounts receivable, liabilities or real estate. The value of earnouts set aside as a contingent part of the selling price, if present, is also excluded.
Recent sales of private dental practices are an excellent source for estimating your practice value. See how to value a dental practice based on its gross revenues, net sales, profits, EBITDA, cash flow and assets.
See Example »
Other methods for dental practice valuation
As in other health care practice valuations, the value of a dental practice is driven by its earning capacity. You can use a number of income based valuation methods to determine what your practice is worth. Both Multiple of Discretionary Earnings and Discounted Cash Flow methods are frequent choices in dental practice appraisals.
For an established practice, consider using the Capitalized Excess Earnings method that lets you estimate the value of practice goodwill. This may well make up a large part of the overall practice value.
In the real world comparisons rule. We compare products, services, features and prices all the time. Price per square foot is the yard stick used by the real estate industry to compare properties. In a world of substitutes it seems there is always the next best thing out there.
But how about this: can you compare a one of a kind painting by a famed artist to somebody else’s work? Probably not. Reason is simple: a work of art is not the same as another. There are no substitutes for the real thing.
In business valuation, the situation may be quite complex as well. While many companies can be compared to their industry peers, some businesses are unique enough to defy comparison.
Imagine, for example, comparing Google to figure out its value in the early 2000’s before the company went public. There were no other businesses who offered the kind of search engine technology Google became famous for. If you tried to use market comparisons, you’d be matching the proverbial apples and oranges.
Indeed, professional appraisers know that market based comparisons may be misleading. After all, each business is unique. It is precisely its specific value set of drivers that determine its true value. Things like technology, business relations, skills of the company’s staff, and relationship with its customers tend to play a significant role in how it competes. No two businesses are ever the same.
Yet market comparison is based on the simple assumption that businesses operating in the same industry are interchangeable. If you know the selling price of several companies out there, you can estimate the value of your firm. Well, yes and no.
Market comps are good for initial business value estimates. It is easy to see how valuation multiples you get from sold businesses can be applied to your company’s revenue, asset base, EBITDA or net income to figure out what your company may be worth.
Market evidence is also useful if your business valuation comes under fire. Examples are legal disputes, or challenges by the tax authorities. If you can furnish proof of companies’ selling prices, your business value analysis gains support from the actual market place.
However, as the saying goes, there are lies, damn lies, and statistics. Market valuation is based on statistics collected either by yourself or someone else. The stats may be very misleading, depending on who and how collects and analyzes the market data.
Private business sales data is a case in point. Usually, such data is collected on a voluntary basis by business brokers. Only a fraction of the actual business sales ever get disclosed to the business sale data vendors.
Business people and brokers are not required to report private company sales to anyone. Most of such sales never get reported. Business owners may consider their acquisition strategy highly competitive. Brokers may view their knowledge of the market place as a key advantage and keep their deal statistics to themselves. What you see is just a sliver of the actual deal flow.
In addition, most business brokers are not financial reporting experts. Be wary of the financial numbers as they are not reviewed, let alone audited by a financial accounting professional. That is one reason private business financials require adjustment or normalization before you can value a company.
For these reasons, many business appraisal experts tend to approach the market valuation methods with caution. One way to get better quality data is to examine small cap public companies or private company acquisition deals done by public firms. Such transactions must be reported to the authorities, such as the US Securities and Exchange Commission, under law. In addition, the financial numbers must comply with the standard GAAP format and be audited by licensed accountants.
So your comparison is more likely to be “apples to apples”. But what about the difference between the public and private companies? Business appraisers use the discount for lack of marketability to adjust the valuation multiples from public company sources. Fortunately for your business valuation, the difference is visible in the market place – just check the prices of restricted company stock and freely marketable shares of the same firm. This measure of price reduction gives you an idea how much the investors discount the value of assets that have limited marketability.
Remember that market comparison is but one approach to business value. To uncover what your company is really worth, you need to apply the various methods under the income and asset approaches. In particular, the income valuation helps you delve into the value drivers that create business value. This type of analysis is as unique as the company itself.