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.