I am going to answer this in two different ways: one is philosophical, the other mathematical.
The philosophical answer depends on what you predict for the future value of orthodontic practices. If you are planning on selling in the next few years, it is probably safe to assume that the market will not be dramatically different than it is now. However, if your practice sale date is decades in the future, it is hard to estimate what your practice production will be due to possible competitive pressures and uncertainty regarding fees. Even if production is constant, practice values may change. However, I think it is a mistake to assume that your practice will hold no value, especially as it pertains to your ability to take risk in your investment portfolio. For instance, assume that at some point in the future you sell your practice and you can live off the proceeds for 5 years. That extends your window for your other investments to grow before you need to access them and this may change your asset allocation in a significant way.
The mathematical approach begins with assigning a value to your practice. One way that is new to our industry is to look at EBITDA or earnings before taxes, interest, depreciation and amortization and apply a multiplier. This is a little beyond the scope of today’s discussion, but the important thing to remember with EBITDA is that the multiplier is applied after the doctor is paid and usually makes more sense for multi-location practices. The more traditional way of valuing your practice is as a multiple of production or collection or profit. The multiple can vary depending on many factors, but for this discussion, let’s say you can sell your practice for 75% of the average of the last 3 years collection. The next step is to pay any capital gains taxes due at the sale. To find what you owe, look at your balance sheet. The difference between your sale price and the book value of your assets, not including cash will be taxable. If you just purchased your practice, you probably haven’t depreciated much. If you have owned your practice for many years, the depreciation and amortization you have enjoyed over the years means you have a larger tax exposure. Long-term capital gains are currently taxes at 20% in the top bracket. Finally, you need to subtract any debt you are carrying on the practice.
So let’s say you have a practice collecting 1.3 million dollars. You hope to sell it for $1 million. You have depreciated the assets to a book value of $500,000 meaning you owe taxes on the remaining $500,000 at 20%, which is $100,000. Finally, you have $200,000 of debt remaining on a practice loan. So you can estimate the sale of your practice would add $700,000 to your liquid net worth.
There are infinite variations on this example, depending on the specifics of your practice and the structure of the sale, but this is a good place to start. If you have any questions, let me know!
