Dentist Appraisals: Legal Issues
Please note that the information provided herein is not legal advice and is provided for informational and educational purposes only. If you need legal advice, contact me (Michael Carabash) or David Mayzel.
What is an appraisal?
A dental appraisal involves a person giving a monetary value to a dental practice. That person is typically a professional valuator (e.g. ROI Corp, or Professional Practice Sales) or an accountant. They examine the assets of the dental practice (irrespective of whether the owner of the dental practice is a sole practitioner, a partnership, or a dentistry professional corporation). They will specifically look at things like:
- goodwill (e.g. trademarks, proprietary systems, dental records, patient lists, etc.);
- leasehold improvements;
- equipment and furniture; and
- inventory and supplies.
When are appraisals needed?
Buying and Selling a Dental Practice
Appraisals are needed in order for parties to buy and sell a practice. The buyer wants to know what exactly they’re getting themselves into. The seller typically engages a professional valuator to review the practice and come up with the price. Purchasers, however, should be cautious about relying upon what the appraisal says: it was paid for by the Seller and for the Seller’s benefit (i.e. to get the best possible price). In fact, if the appraisers are also brokers, then they will have an incentive t put down the highest possible price. Purchasers should conduct their own diligence about the appraisal and get a chance to review the practice, its assets, and particularly its goodwill (i.e. dental records and patient charts).
Transferring assets to a Dentistry Professional Corporation
If you are a dentist and you want to transfer dental assets (e.g. lease, inventory, equipment, tools, supplies, leasehold improvements, etc.) which you owned personally into a dentistry professional corporation, you may want to get an appraisal done. You can’t just assign any old number for the asset purchase agreement when doing these kinds of deals. The Income Tax Act allows you to elect to transfer assets from your personal to your corporation on a tax-free basis (although there may be HST payable), but only if the price paid for the assets is FAIR MARKET VALUE. If the Canada Revenue Agency ever reviews the transaction, they may say that the value of the assets being transferred into the corporation and the shares taken back were below or above what the fair market value should have been. Hence, an appraisal (coupled with a price adjustment clause in the Agreement of Purchaser and Sale) may make sense here.
Adding Partners / Shareholders
An appraisal will be needed when a new dentist partner or shareholder is being admitted into the dental practice. How much should they contribute? How many units or shares should they take back? This all depends on what the dental practice is worth. Hence, the appraisal.
Appraisals could also be required when a dentist is going through a divorce. Absent a marriage contract, prenuptial agreement, or separation agreement to the contrary, the dentist will be required to calculate their net family property (i.e. generally the increase in wealth of a married spouse during the course of the marriage) in order to ultimately get to an equalization payment. I’ve blogged extensively about net family property and equalization payments here.
Once again, it is worth mentioning that the appraisal will be made by a professional for their client’s benefit. If the husband, for example, wants to reduce the value of their net family property (so they end up paying a lower equalization payment), then there will be an incentive for the appraisal to be on the lower-end of scale.
The case of David v. David,  O.J. No. 5022 is illustrative of how different appraisers can arrive at different figures. In that case, a wife sought an equalization of net family property. The wife was a homemaker and the husband was a dentist. When it came time to value the dental practice on the date of separation, both the wife and the husband had their own expert appraisers (the husband used Graham Tuck of Professional Practice Sales and the wife used Timothy Brown from ROI Corp.).
For his part, Mr. Tuck (the husband’s expert) examined the husband’s dental practice in detail. His 23 page report (excluding appendices) included the following information:
- description of the practice
- treatment policy of the practice
- patient flow
- appointment and recall system
- market data
- personnel and professional services
- office hours
- facilities design and use
- fees, payments, collections and prepayment plans
- systems and records
- income, expenses and earnings
- basis of valuation and valuation analysis
- summary of current market values.
The appendix to the report included a list of dental equipment, practice financial statements, copy of lease agreement, photographs, information on area and demographics. Mr. Tuck had personally attended the practice, interviewed the husband dentist and his staff, reviewed patient charts, and conducted a patient chart count. He also compared the value of the husband’s practice with 8 similar practices sold that had an ethnic composition in the same geographic vicinity. He ultimately found that the dental practice was worth $212,000 – which included $65,000 of goodwill.
For his part, Mr. Brown (the wife’s expert) provided a 2 page limited scope forensic letter of opinion only and relied solely on the appraisal prepared by Mr. Tuck. Mr. Brown concluded that the goodwill could have been about $139,500 for the dental practice – much higher than Mr. Tuck’s opinion.
Now, just keep in mind that the wife (a homemaker) had been accusing her dentist husband of diverting income. Clearly, the wife wanted the value of the dental practice to be relatively high, while the husband wanted it to be relatively low.
The Ontario Superior Court of Justice ultimately fixed a midpoint value between the two opinions at $102,500 for the goodwill and a total value of the dental practice at $249,000 at the date of separation. In coming to that conclusion, the court took into consideration: the age and location of the dental practice, the patient base, the management style and office protocols of the dental practice, data from another similar practice which the dentist had previously sold, a commonsense and market comparison capitalization rate (i.e. the yield of income to capital).