Thumbs Up or Down? Rules of Thumb Play a Meaningful Role in Business Valuations [Podcast]

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Episode 007

Doctors Business Management Show

The following is a guest post by Ben Lane, CPA, JD  my co-host on the Doctors Business Management Show and a member of the VMDE Healthcare Team. In episode 007 Ben and I discuss the use of and methods for computing the value of a healthcare business.

In the business valuation community, a rule of thumb is a clear, quick, and easy method of communicating value. It is an instrument of calculating a value without really analyzing data. It is a short-cut approach to valuing a business. For example, beer distributors are valued at $20 per case sold, dental practices are valued at 60% of collections.

Business valuation practitioners are a group of critical thinkers with training in capitalization rates, market data, and economic analysis.   Despite the clarity offered by a rule of thumb and its ease of use, business valuation professionals have long turned their nose up at rules of thumb. As a CPA with a significant amount of experience analyzing and valuing various business, I understand and appreciate the cynicism.   After all, how can one value a business without first looking at the value of the underlying assets of the business or analyzing cash flow alongside the inherent risk of receipt?

Should a valuation discussion ever begin and end with a rule of thumb? Most certainly not, but for specific industries like dentistry, there is room in the conversation for rules of thumb. If there is any doubt, just ask a retiring dentist what his practice is worth. Undoubtedly before he exchanges his hand piece for a golf club, you will hear “40%-60% of production”. The doctor’s value perception created by the mentioned rule of thumb will become the doctor’s value reality upon sale. To explain, the retiring doctor negotiates towards his number, a number that is heavily influenced by countless articles addressing dental practice rules of thumb. These materials were collected by the doctor from colleagues, the American Dental Association, and similar trade publications. Dentists are inundated with dental practice rules of thumb throughout most of their professional career.   Upon reaching retirement, the 40-60% rule of thumb is recited from memory. The rule of thumb becoming part of the chorus of the doctor’s swan song hummed on the way to the golf course.

It is an uphill battle for a valuation professional to explain away rules of thumb.   This is particularly true in industries like dentistry, where the rule of thumb is well established. In these industries, it is important that attention be paid at the beginning of a negotiation to address the value perception created by the rule of thumb. This will ensure the rule only occupies a small part of the value discussion. At a minimum, rules of thumb should serve as a relative sanity check to a value calculated based upon detailed projections and accepted valuation methodologies. If the value perception created by a rule of thumb is ignored, it will dominate the negotiation. The ultimate result may be dollars left on the table for the seller or a practice purchased by an associate for a price the associate simply cannot afford.

Whether you are a new dentist looking to acquire your first practice or a retiring doctor looking to transition ownership, members of the VMDE Healthcare Team can help. Contact Benjamin Lane (ben@vmde.com) or Mike DeVries (mike@vmde.com) for additional information.

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Mike DeVries is a CERTIFIED FINANCIAL PLANNER ™, Enrolled Agent,  and a Certified Healthcare Business Consultant focusing on helping healthcare professionals.

Please note: I reserve the right to delete comments that are offensive or off-topic.

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