Dental Practice Finance:
Cost of Capital and Valuation

So what’s better for practice valuation: a higher or lower Cost of Capital? Generally speaking:

$$ \text{Higher Cost of Capital} \Leftrightarrow \text{Lower Valuation} $$ $$ \text{Lower Cost of Capital} \Leftrightarrow \text{Higher Valuation} $$

But to really get to the heart of the answer, you have to understand the two major factors affecting Cost of Capital for a dental practice:

1. Income Sustainability:

Income sustainability factors into the concept of Cost of Capital inversely as an implied estimate of the sustainability of a practice’s income. In other words:

$$ \text{Less Sustainable Income} \Leftrightarrow \text{Higher Cost of Capital} $$ $$ \text{More Sustainable Income} \Leftrightarrow \text{Lower Cost of Capital} $$

Understood this way, a higher Cost of Capital implies that a practice must work harder to maintain its current level of income. Some reasons for a high Cost of Capital include low patient retention, high cost of new patient acquisition, contracting local market, and depreciating property.

Conversely, a lower Cost of Capital implies that a practice has an easier time sustaining its current level of income. Some reasons for a low Cost of Capital may include high patient retention, low cost of new patients acquisition, expanding local market, and appreciating property value.

2. The Availability of Alternatives:

Also embedded in Cost of Capital is the availability of alternatives. For instance, if other practices in the area are for sale, a practice’s valuation will be lower and its Cost of Capital will be higher.

$$ \text{Many Alternatives} \Leftrightarrow \text{Higher Cost of Capital} $$ $$ \text{Few Alternatives} \Leftrightarrow \text{Lower Cost of Capital} $$

Alternative availability tends to be an external factor dental practices cannot control except when buying a practice or setting up a new practice. For this reason, it’s important to factor in and anticipate alternatives by assessing the number of dentists per person in your area.

By understanding the factors behind Cost of Capital, you can better justify a deviation from industry averages. Let us help you get your best deal by reading Negotiating Practice value with Cost of Capital.