Dental Practice Finance:
Negotiating Practice Value with Cost of Capital

Once you’ve understood the term Cost of Capital, you can use it to derive or justify a valuation for a dental practice. Let’s work through an example.

Let’s say your practice brought in $200,000 of Net Income (NI) this year and is expected to bring in a similar NI next year. You just received an offer for $2,500,000 and will sell your practice debt free with the buyer being responsible for their own financing. Should you take the offer?

Reviewing our list of valuation formulas, we are best off using the perpetuity valuation formula since our NI is not expected to change:

$$ \text{Valuation} = \frac{\text{Next Year Net Income}}{\text{Cost of Capital}} $$

Given our NI, the implied Cost of Capital from the offer can be calculated by solving:

$$ \$\text{2,500,000} = \frac{\$\text{200,000}}{\text{Cost of Capital}} $$ $$ \Rightarrow \text{Cost of Capital} = 0.08 = 8.00\% $$

As Cost of Capital is a number driven by negotiation, its value is driven foremost by industry benchmarks. Since we are selling the practice unlevered (that is, with no debt), we should look up an industry average Cost of Equity as our CoC. In a 2016 report from NYU Stern, we find that the national average CoE for healthcare facilities to be 7.19%. Remembering that a higher Cost of Capital implies a lower valuation, the implied CoC is higher than the national average, and offer seems to undervalue your practice.

Using the numbers, we’ve collected, we are able to justify a higher valuation.

$$ \text{Valuation} = \frac{\$\text{200,000}}{7.19\%} $$ $$ \Rightarrow \text{Valuation} = \$\text{2,781,641} $$

Opening using this justification, we can reasonably justify a higher price around $2,750,000 for the dental practice. That said, there may be particulars about location, patient pool, or more that could further justify downward deviation from such price, but you can leave it to you prospective buyer to build such case.

Remember, great negotiation starts with clear communication between a buyer and seller. By using best practices and Cost of Capital in valuing a dental practice, both a buyer and seller can feel confident in one of the most significant transactions of their life.