Understanding and Evaluating Associateship Opportunities
Normalization

Course Author(s): David G. Dunning, MA, PhD;Robert D. Madden, DDS, MBA

Normalization

A thorough practice valuation will include normalization of the overhead. Normalization involves identifying and removing from (or possibly adding to) a practice’s overhead numbers based on the business perks available to an owner, perks which a new owner may or may not have. These perks may include, on the one hand, legitimate but optional business expenses claimed on taxes by owners—for examples, charitable contributions given through the practice, retirement contributions and expensive continuing education trips to exotic locations. On the other hand, an owner may have a spouse working in the office without compensation or with below market compensation. Whether a legitimate expense or an avoided expense, an appraiser will adjust the overhead of the practice by removing legitimate but optional business expenses or potentially adding back into the overhead realistic but avoided costs. A specific line-item to evaluate as part of normalization is the lease/rent expense. An owner may also own the building in which the practice is housed and the building will most likely be owned by another corporation formed by the owner such as a limited liability company. The lease/rent may be lower or higher than the market would typically bear depending on the owner’s tax strategy, in effect, paying a lease/rent to him/herself.

Just as real estate values depend on the old adage of “location, location, location,” a practice’s value and loan approval will hinge in part on cash flow, cash flow, cash flow.42 In the end, a lender will require a practice valuation to be reasonable based on revenues, cash flow and profitability. As previously mentioned, if the practice does not generate sufficient debt-to-service ratios (enough money for the would-be owner to cover his/her personal/family budget, make the loan payments, and have a decent cushion of additional money), the loan will not be approved. For owners and potential buyers, dental supply companies may be willing to provide an estimated value of the tangible assets such as equipment and supplies. As a final comment, as with real estate, the listing/asking price for a practice may include a “fudge” factor for negotiating toward a final sales price.