THE ADA PRACTICAL GUIDE TO VALUING A PRACTICE 5 The following are main premises of value used by experts: 1. Going concern assumes that the business will continue running normally using all of its assets to produce earnings. 2. Assemblage of assets assumes that the business assets have been assembled in place but are not currently used to produce earnings. This occurs with businesses or divisions that are winding down or starting up. 3. Orderly disposition assumes the business assets will no longer be used to produce earnings, and the assets are to be disposed in a timely and orderly manner with sensitivity for market value. 4. Forced liquidation assumes the business assets will no longer be used to generate earnings, and the assets are to be disposed of in a very quick manner with little sensitivity for market value. For most purposes, a dental practice’s value should be viewed as fair market value of a going concern. The Buyer’s Perspective Since a dental practice cannot be sold unless there is a buyer, it is important to understand fair market value from the buyer’s perspective. When purchasing a practice, the typical buyer expects to be able to meet all practice related expenses, draw some reasonable salary and service the debt to buy the practice (principal and interest) from the expected revenue generated by the practice. In addition, a buyer should be able to retire the debt incurred to purchase the practice in a reasonable period of time. If a buyer perceives that there is a good probability of accomplishing these things, in light of a specified asking price for the practice, this price should be viewed as fair. If, on the other hand, the buyer cannot see that all of these things can be accomplished, he or she would probably conclude that the price is too high and is not fair. Overhead is of great interest to buyers and is an extremely important concept when developing a fair market value. Buyers generally won’t pay much for a practice with an extremely high overhead rate, especially if there is little the buyer can do to reduce overhead. When purchasing a practice, the typical buyer expects to be able to meet all practice related expenses, draw some reasonable salary and service the debt to buy the practice (principal and interest) from the expected revenue generated by the practice. For example, if a practice had gross revenue of $600,000 per year and was to be sold for 100 percent of gross revenue (an inappropriate rule of thumb that will be discussed later), with an accompanying overhead rate of 65 percent, only 35 percent of gross revenue would be available to split between the buyer’s salary and servicing the debt incurred to purchase the practice. It important to note that a rule of thumb is helpful in making very quick and generalized decisions, but should never be used in making a final determination as to a practice’s value. Assuming the $600,000 price, $30,000 (five percent) down payment, ten percent interest rate, and a six- year payment period, the debt service alone would be $10,560 per month or $126,720 per year. The annual amount required to retire the debt represents approximately 21 percent of the gross revenue, leaving a projected salary for the buyer of only 14.5 percent of gross revenue or $84,000 per year. In this case, a price of $600,000 (one year’s gross) would obviously not be fair. It would be unacceptable for the buyer to use $126,720 per year to service the debt to buy the practice and receive only $84,000 (before employment and income taxes) when he or she is expected to generate $600,000 in revenue and manage the practice.