3 Critical Factors to Improve Due Diligence and Practice Valuations

Sponsored Content

There are three critical factors missing from the current due diligence and practice valuation processes, which, if properly accounted for, could significantly improve both the thoroughness of due diligence and the accuracy of practice valuations.

David James, a CPA with decades of experience as a CFO and M&A expert, has spent 15 years in the dental industry. Early on, he questioned the due diligence methods used in practice transactions and the often opaque nature of practice valuations. Over time, it became clear that several essential elements were missing from the process.

Most practice valuations follow similar methodologies: examining annual collections or profits, adjusting for non-recurring expenses, and incorporating measures like EBITDA, multiples, and ROI. Adjustments are then made for factors such as patient attrition, equipment value, operational risks, and other assets. Despite these comprehensive measures, three key factors have historically been overlooked in practice valuations due to the lack of accurate, independent, and affordable data—until now.

In this article, David highlights those overlooked factors, details the solutions developed to address them, and demonstrates their substantial impact on practices during the transaction process and operationally thereafter.

Missing Factor #1:  Patient Proximity and Dispersion

Question: If you are buying or selling a practice, what is the main asset involved?

Answer: The practice’s existing patient base. Specifically, the ability to retain the patient base.

Most traditional valuation methods apply a discount, often around 25% of annual collections or profits, to account for the risk of patient attrition. This reduction reflects the possibility that the new owner may struggle to retain the existing patients. However, this approach raises several questions. Is this discount appropriate for every practice? What data supports this percentage? How is this adjustment tailored to the unique circumstances of an individual practice rather than relying on a generalized national average? And what if the assumptions are inaccurate—how do you forecast attrition or factor in the impact of past or planned marketing efforts?

Locate Strategy addresses these concerns through its innovative Patient Proximity Report (Beta). This report provides detailed insights into patient dispersion, visualizing the practice’s patient base on a map. It offers up to six customizable radius or drive-time bands, showing the number and percentage of patients within each band based on distance or travel time from the practice.

 

How Does Patient Dispersion Change Due Diligence and Valuations? 

• We know that for a typical suburban general dentist practice, the average effective market for that practice is 12-15 minute drive time. Therefore, a patient that is 5 minutes away is more valuable than a patient 20 minutes away.  This is because the risk of retaining the closer patient is much lower and the marketing spend to convince them to stay including a coupon or other financial incentive should be much lower.  Depending on the mix, the marketing budget can change radically.

• Current valuations assign the same value per patient regardless of their proximity to the practice. There is no distinction.  That doesn’t make sense.

• The purchase price should be evaluated on a per patient basis with higher values assigned to closer patients. This can radically change the purchase price.

• A Practice with 65% of patients within a 10-minute drive time is worth more than a Practice with 40% of patients within 10 minutes.

• The map shows areas of patient concentration for focused marketing for referrals and also areas of opportunity.

• It seems to me you would want this information early in the due diligence process, especially if you are evaluating multiple practices to purchase.

• Marketing spend can be allocated based on proximity – retaining closer, lower flight risk patients might require smaller incentives with larger incentives allocated for higher risk patients.

💡Key Takeaway #1:  If you are buying a practice, knowing Patient Dispersion might be the most vital due diligence information to have – both for purchase negotiations as well as for business planning and ongoing operations.

Missing Factor #2- Competition in the Local Practice Market

Question: Theoretically, if you have two identical practices in an area with the same revenues, profit, cash flow, equipment and other assets, current valuation methods will assign them the same value.  But Practice #1 has a Competition Ratio of 4,000 and Practice #2 has a Competition Ratio of 1,500.  Which practice is worth more?

Answer: #1 for sure.  The higher the ratio, the better for the practice and its value.  The future growth potential is much higher, and the marketing spend will probably be lower and be much more efficiently used since there will be less of a need to cannibalize patients from existing practices.

Competition Ratios is the process of accurately measuring the ratio of Population to Practitioners in the practice’s market and applying the ratio to our proprietary but highly tested market saturation standards (we call them Idealratios – it’s 2,000 for a General Dentist).  These calculations are a complex, difficult process that Locate excels at and is the only Company in the industry that can provide them utilizing Census Block Groups, analysts that are experts in practitioner research (for the denominator) so all data is current and a Platform with world class technology and maps.

💡Key Takeaway #2: If you are buying a practice, knowing the Competition Ratio for that market is the second most vital information to have.

• For a deeper dive into how Locate does this in our Platform and reports, click here or to listen to a recent podcast with Group Dentistry Now, click here

For an example of how Competition Ratios work from a Locate Location Study report, see below:

 

To obtain a full sample Location Study click here

 

Missing Factor #3: Demographics in the Local Practice Market

Question: If two practices are identical in every way except that Practice #1 is located in an area with an average household income of $125,000, while Practice #2’s market has an average household income of $75,000, which practice is more valuable?

Answer: Practice #1.

The following key points emphasize the importance of demographics in practice valuation:

• Demographics involve the precise measurement of 19 critical factors, including income, age, and household characteristics, to assess the practice’s market.
• It is important to distinguish demographics from competition ratio analysis, as both are distinct but equally vital considerations.
• The Patient Proximity Report can also incorporate up to six additional demographic fields, such as age, income, race, and other factors. These can be sorted by distance or drive-time bands to facilitate deeper analysis.
• In general, practices in areas with higher household incomes tend to hold greater value and offer better future sales opportunities.
• Patients who fall within the practice’s ideal age demographic should be assigned higher value in the assessment process.
• Similarly, patients who own homes should be valued more highly than those who rent, as this often correlates with stability and long-term retention.
• Current demographic data should also be compared with 5-year projections to evaluate the practice’s potential for future growth.

By integrating these demographic insights, practice valuations can be more accurately aligned with market realities, enhancing the decision-making process for both buyers and sellers.