This article is the first in a series of four articles examining the valuation process of a dental and an optometric practice. This article will explore the three most commonly used methods of practice valuation. The following article will examine dental practice valuation followed by optometric practice valuation. The final article will compare and contrast dental and optometric practice values. I bet you will be surprised by the conclusions – stay tuned.

A well-executed practice appraisal is more than just a financial evaluation—it’s a strategic tool that shapes decision-making and drives future growth. Unfortunately, appraisals are often overlooked or not given the attention they deserve. Understanding the actual value of a practice extends beyond buying and selling; it plays a vital role in assessing performance, setting goals, planning for growth, determining compensation, and shaping long-term career and exit strategies. A comprehensive appraisal provides valuable insights that empower professionals to make informed decisions and maximize the potential of their practice. In the current marketplace, there are several different approaches to preparing a practice appraisal, some better than others. We will examine the pros and cons of the three most prevalent appraisal methods.

Most dentists and optometrists have some guesstimate of what their practices are worth. They may have a preconceived notion based on any number of “Rules of Thumb,” most of which are likely to be seriously misleading. If an appraisal is based on flawed reasoning or parameters, it can lead to undervaluation or overvaluation, either of which can carry significant consequences.

To understand if an appraisal is suitable for your use, it is essential to understand the methodology used in preparing it. Three different methods are commonly used to prepare dental or optometric practices. These are:

1. The Comparative or Relative Value Method (often referred to as the Market Comparative Method
2. The Asset-Based Valuation Method
3. The Earnings or Cashflow Methods.

In a perfect world, all three of these methods would provide a similar conclusion, however, that is most often not the case. 

The Comparative or Relative Value Method (Market Comparative Method)

The Comparative or Relative Value appraisal method of practice valuation involves assessing the value of a practice’s tangible and intangible assets compared to the corresponding assets of similar practices that have recently been sold. Where the practice being appraised has “superior” assets (e.g., more patients) than the previously sold practice, the value of the practice being appraised is adjusted upwards from the sale price of the comparative practice to reflect the difference. Conversely, if the practice being appraised has “inferior” assets (e.g., fewer patients) than the previously sold practice, the value of the practice being appraised is adjusted downwards to reflect that difference. The degree of the adjustment is usually a subjective adjustment the appraiser makes.

Some of the advantages of the Comparative or Relative Value method include the following:

1. Current Market Conditions: To the extent this method uses actual market transactions, it should reflect current market conditions.
2. Simple & Easy:  This method is simpler and faster than the Asset-based or Earnings/Cash-flow-based methods.
3. Small & Medium-Sized Practices: This method is well suited for small to medium practices if they have relatively stable revenue and profit indicators of value.
4. Widely Recognized: The comparative approach is generally widely recognized, familiar, and accepted, particularly in the United States.

Some of the disadvantages of the Comparative or Relative Value method include the following:

1. Limited Availability of Information:  The details of dental and optometric sales transactions are not usually made public, and thus, the availability of comparative information is generally restricted to information from the appraiser’s own files. This can lead to self-perpetuating misrepresentations.
2. Practice Variability: Dental and optometric practices tend to vary in their comparables, including revenue stream source, making it difficult to always find a suitable match for comparison.
3. Goodwill:  Goodwill is difficult to measure and compare across different practices. To the extent that Goodwill tends to be the most significant practice “asset,” there is a potential for material inaccuracies.
4. Subjectivity: Comparative adjustments are subjective and can introduce bias or errors in valuation depending on the appraiser’s experience. This also makes it challenging to reliably assess appraisals from one appraiser to another.

The Asset-Based Method

The Asset-Based Method of valuing a dental or optometric practice entails determining the individual value of the practice assets, including tangible and intangible assets. To the extent that these practices are typically sold “free and clear,” they do not include any liabilities, and as such, liabilities are not usually included in the valuation process. If a practice included material liabilities, the amount of these liabilities would be deducted from the total value of the assets. The tangible assets usually include equipment, leasehold improvements, inventory, and occasionally prepaid expenses. The intangible assets generally include only Goodwill. The appraiser determines the fair market value of each Asset or asset class and adds them up.

Some of the advantages of the Asset-Based Method include the following:

1. Easy to Understand:  This method is straightforward and includes inventorying the practice assets, determining their fair market value, and adding them up. The valuation of tangible assets can be identifiable from various sources, primarily the Internet.
2. Start-ups and Tangible Asset-Rich Practices: A significant aspect of this method is its identification and valuation of tangible assets. Start-ups typically have no or very limited Goodwill; therefore, the value of their tangible assets tends to be the actual value of the practice. For the same reasons, liquidation scenarios with limited, if any, Goodwill are well suited for an asset-based appraisal.
3. High-tech Practice Values: To the extent that tangible assets are individually inventoried and valued, the Asset Based methodology suits practices with a significant investment in expensive high-tech equipment. This aspect is significant for buyers interested in acquiring high-tech-oriented practices. This is a benefit in the transition of both dental and optometric practices.
4. Liquidation Value Estimates: The asset method is particularly good for valuing practices being liquidated as these practices typically sell just their tangible asset values. Fortunately, the liquidation of a dental or optometric practice is a rare occurrence. However, this highlights the central aspect of the asset-based methodology.

Some of the disadvantages of the Asset- Based Method include the following:

1. Difficulty in Valuing Goodwill: There is no “built-in” methodology for determining Goodwill’s value, making it difficult to arrive at an objective Goodwill value. Most appraisers using an asset-based methodology use their own usually very subjective methods, based on individual expertise, to determine a value for Goodwill. Given that Goodwill is usually the most significant value component of either a dental or optometric practice, if valuing Goodwill creates a problem, then that seriously impinges on the accuracy and usefulness of the overall appraisal.
2. Service-Based Valuation Issues:  Dental and Optometric practices are largely service-based businesses whose value comes not just from physical assets but also from the service providers’ skills. The focus on assets, which is a “point in time” valuation, does not always adequately capture the value of future earnings growth.
3. Static vs. Dynamic Perspective: The value of an asset at any one time is made from a static perspective. Most appraisers will obtain an equipment or other asset value from their privately used equipment catalogue, or they will look up the value on the Internet. Either way, this ends up with a static value estimate. Dental and optometric practices are not static; they are very dynamic, something that an asset appraisal will likely not account for.

The Earnings or Cashflow Methods

An Earnings or Cashflow methodology of valuing a business, including a dental or optometry practice, is based primarily on the practice’s ability to generate future income or profits. This approach is widely used in service-oriented businesses, where the value is driven by the ongoing cash flow or profits the practice is expected to produce. Of the three valuation methods addressed in this article, the Earnings or Cashflow Method is the most complex, requiring the appraiser to have a better than average understanding of valuation and accounting principles.

Some of the advantages of the Earnings or Cashflow method include the following:

1. Reflects True Earning Potential:  This method is based on a practice’s ability to generate current and future earnings and cashflow. In a situation where the practice is being transitioned, having a sense of future earnings and cashflow is critical to ensure that the purchaser will have the financial resources to service their income tax and bank debt obligations.
2. Accounts for Growth Performance: Two common strategies for an Earnings-based appraisal exist. These include capitalizing cashflow or EBITDA and discounting projected future cashflows. The discounted cashflow strategy is based on projected earnings (usually ten years), which should reflect justifiable growth. Purchasers of any business are not buying past performance; they are buying future performance; thus, it is essential to have a valuation methodology that recognizes justifiable future growth. (A secondary growth related component is that most acquistions are financed with a payback term of at least ten years so a ten year cashflow analysis helps ensure that the practice will generate the cash required to service it’s ten year after tax debt requirements.)
3. Widely Accepted: Earnings-based valuations, especially using metrics like EBITDA and Net Cashflow, are commonly accepted and understood by buyers, sellers, lenders, and investors. Lenders often prefer earnings-based valuations because they highlight the practice’s ability to generate sufficient cashflow to service acquisition debt. This is particularly important in an environment where banks typically finance 100% of the acquisition price.  
4. Risk and Return – ROI:  There are two parts, to the Risk and Return metrics (ROI or Earnings Multiple) used in the Earnings/Cashflow. The Earnings Multiple is a function of adjusted interest rates (the return) and the risk assessment (the likelihood of receiving the “return” as well as the initial investment) of the practice. The earnings/cashflow (both the Capitalization and Discounted Cashflow) methods allow for ROI (Earnings Multiple) adjustments based on the practice’s risk profile. Established practices with steady maintainable income, low-risk factors and positive KPI’s may be valued with higher multiples or lower discount rates, resulting in a higher valuation. This approach can be adjusted to reflect current market conditions including interest rates, competitive pressures, and patient demand, making it more flexible and responsive to economic factors.

Some of the disadvantages of the Earnings or Cashflow method include the following:

1. New and Unprofitable Practices:  The earnings methodology is based on maintainable earnings and cashflow. New dental and optometric practices often have limited or no earnings history. Thus, this method will likely be unsuitable, as there are no reliable earnings on which to base projections. Practices currently experiencing financial difficulties or low earnings due to temporary issues may be undervalued if there is no way to project the potential of future profitability reliably. In both cases, a valuation using the earnings method would not be appropriate.
2. May Require Complex Financial Analysis: Earnings-based valuations require a reasonable degree of complex financial, accounting, and income tax expertise. To be properly prepared, these valuations will require determining a practice’s risk profile, preparing reliable future earnings forecasts, and accounting for potentially complex income tax ramifications and prevailing market conditions. Earnings-based valuations tend to be the domain of Chartered Professional Accountants (CPAs), Chartered Business Valuators (CBVs), and other highly trained professionals.
3. Market Volatility:  The earnings-based method may not adequately respond to market fluctuations and external economic conditions. Covid and spiking interest rates are good examples of how external market conditions affect practice values. Economic downturns, regulatory changes, or dramatic shifts in patient demand can negatively impact future earnings, leading to lower valuations. These changes can usually not be anticipated, resulting in an appraised value that does not effectively represent the current marketplace. This was the case with both Covid and the interest rate increases. During the period from 2020 until early 2024, the external marketplace for dental and optometric practices was definitely not steady, making it very difficult to provide reliable values.

Conclusion

With the possible exception of the Comparative or Relative Value method, both the Asset and Earnings methodologies have their place in dental and optometric practice valuations. I am a Chartered Accountant and have some specific training in business valuations. I have been preparing lender-approved appraisals for over forty years and prefer an Earnings-based methodology. I understand the methods and believe sophisticated stakeholders, such as accountants and lenders, prefer them. However, if an Asset Based methodology has an acceptable way to determine the value of Goodwill, it can also be appropriate. I have prepared many “Second Opinions” on appraisals with the Comparative and Asset Methodologies. In many cases (mostly Asset cases), my values are materially similar to the subject appraisals – sometimes a little higher and sometimes a little lower. The real question is, can a purchaser buy a practice and, in its acquisition state, be able to pay his or her income taxes, satisfy debt service, and have something left over at the end for themselves? (Many practices have unrealized upside potential; however, the value of that potential should primarily belong to the party that turns it into actual revenue.)

Whether buying, selling, or just planning, a current practice appraisal is a very valuable tool. Don’t hesitate to get in touch with me if you would like an appraisal of your optometry practice or a second opinion of a third-party optometric or dental practice appraisal. You likely review your financial operations annually with your accountant. Similarly, you should always have a current appraisal on hand to establish your operational and value baseline, identify your unrealized potential, and monitor the growth of your practice. For more information, contact me, Derek Hill (derek@derekhill.ca), or review my website at www.derekhill.ca. I am always happy to chat.