Earnings before interest, taxes, depreciation, and amortization (EBITDA) is referenced frequently in practice valuations. As a caveat, this number can be subjective (over normalized), and misappropriated as a solitary value determinant. But when compared to other practices in a similar region and in the same economic climate (interest rates), a large enough sample size of practices can provide more accurate intel as a comparative value measurement than hand selected practices chosen by a valuator. This is no different in science when case studies are mis-used to guide evidence based clinical decision making versus randomized control trials or meta-analyses. The smaller the results pool, the more cautious one has to be in making generalizations. As the saying goes, “A little bit of knowledge is dangerous.”
To state the obvious, EBITDA should really be reserved for practices that generate significant earnings after all doctor compensation. For example, if a practice is able to demonstrate a profit margin of $250,000 after everyone and everything has been paid, the profit demonstrates potential opportunity and investment return as a business acquisition. For some practices, where clinical care is provided mainly with a solo dentist and the hygiene team, using EBITDA after doctor compensation to guide any conversation around value is often irrelevant. In these cases we want SDE.
SDE stands for “Seller’s Discretionary Earnings”. This is what a buyer can expect to earn before costs of financing are added, if all things remain consistent with current operations. Some valuations refer to SDE as “EBITDA” or “EBITDA before doctor’s compensation” but the distinct delineation of these terms is important and creates more clarity in the conversation.
Using SDE in practices that are being sold by solo practitioners who want to sell to other hands-on owner solo practitioners makes the conversation of value and intended use so much clearer. A practice being purchased for profit generating purposes is a different practice, in a different market, with different sellers, and different buyers. An astute valuator will consider the intended use of the practice being sold, the current operations of the practice, and the financing considerations required for the kind of buyer the vendor wants when determining the value.
As most selling dentists practice dentistry and sell to dentists who also treat patients, SDE can offer a far more relevant metric and be applied to demonstrate maximum value compared to EBITDA.
It should be noted that what doesn’t work is taking a high-EBITDA practice and consolidating all the dentistry into a single provider to obtain SDE. Recently I supported a purchaser who was reviewing a valuation that combined more than 5 dentists’ earnings into a single provider to generate SDE for the practice. This is not true SDE. This is consolidated cash flow that can never be actualized. If it’s not possible in the operatory, it shouldn’t be possible in the valuation. It takes a lender moments to disqualify valuations that use this approach, leaving the seller with an expensive sales brochure that fails to attain results.
Understanding who you want to buy your practice and how these two metrics can vary in the determination of value of your practice can make you more knowledgeable and your practice valuation more accurate.
