Pitfalls of Practice Transitions

Planning now can save your financial future.

by James R. Pride, DDS, and Hy Smith, MBA

On the morning of January 25, 2001, Dr. D., a 49-year-old dentist with a practice grossing over a million dollars per year, awoke, opened his eyes, and could not see! He blinked a few times but could not clear the distorted images from his vision. Overnight, he had developed serous retinopathy, a condition that results in a fluid build-up between the retina and the back of the eye, causing a distorted, tunnel vision and loss of all depth perception. Dr. D. had suddenly lost his ability to practice dentistry!

In 1990, Dr. R., a 35-year-old dentist on a ski trip to Park City, Utah, fell, broke both thumbs, and tore the ligaments in his hands. After several surgeries and many months of physical therapy, it finally became apparent that he would not be able to practice dentistry again. He knew he would have to dispose of his $500,000 practice.

And more commonly, Dr. C., a 67-year-old dentist, just decided it was time to retire. A close examination of his financial condition revealed that his practice was his only asset. After taxes and commissions, there was only enough money left for one year of retirement income at his accustomed lifestyle. After that, Dr. C. would have to spend the rest of his life living on a $1,350-per-month Social Security check.

Each year, hundreds of dentists unexpectedly find themselves facing an accident or illness that forces them out of dentistry; or more commonly, they approach retirement age and want to stop practicing. Many are not prepared. Are you?

In more than 30 years of selling dental practices and structuring associate/partnership transitions, we have seen very few dentists who have actually defined an "exit strategy" in preparation for their unexpected or normal retirement. And of those who have, many have made mistakes that actually jeopardized their retirement plans. In this article, we indicate some of the more damaging and recurring errors we have seen, so that you can avoid making them.

The ADA's "1999 Survey of Career Patterns" indicates that the median retirement savings of a 49-year-old dentist is $293,000. According to pension actuaries and the statistics developed in recent years by these experts, if a dentist intends to retire on an income of $100,000 per year, it will require in excess of $1.5 million in cash in a qualified pension plan for him or her to retire at age 60 and live until age 85. It is estimated that only four out of 100 dentists have pensions adequate to support them in retirement. (For more information on developing an exit strategy and financial plan for retirement, see "Ready, Set, Retire" by Pride, Hufford, and Prescott in the June and July 2001 issues of Dental Economics.)

Unfortunately, many dentists assume that the proceeds from the sale of their dental practices will fund their retirement or at least substantially contribute to it. To avoid this mistake, you should know the value of your practice. It is one of your primary assets and should be appraised formally by a qualified dental-practice appraiser. This information should be used by your financial planner as an essential part of your portfolio and should be updated regularly.

Financial planning for retirement should have started the day you graduated from dental school. Realistically, it probably didn't, but today is not too late to start. Proper financial preparedness will allow you to sell your practice when you decide to do so or if you are forced to retire. Even the biggest and most successful dental practice will not bring a sale price that will support your retirement needs! A practice grossing $1,000,000 may, at best, bring a sale price of $700,000. After the commission, legal expenses, and taxes, the net proceeds to the seller may be, at most, $480,000. This will provide just a few years of income at a dentist's customary lifestyle. After that's gone, it's just subsistence — a $1,350-per-month Social Security check! Guard against overdependence on the practice sale by effective and early planning.

At one time or another, many dentists decide it would be nice to have an associate. Unfortunately, the decision to bring in an associate is often a spontaneous, emotional one. Many times, the decision is made without a proper analysis of the profound impact that such a move can have on the dentist, the staff, and the practice.

We often see a new graduate approach practice owners because of their reputation or standing in the community, or because the practice is "exactly what I hope to have some day." The senior doctor may be looking to slow down, flattered that someone would want him or her as a mentor, or needing to solve "busyness" issues in the practice. He or she takes on another doctor without careful analysis, with a "let's give it a try" attitude. Often, after the associate works for a while, the senior doctor realizes that for some reason(s) the relationship is not working out and a change in their professional arrangement needs to be made.

Just recently, we participated in litigation between two dentists who had never entered into any kind of contract. Neither had anticipated the physical disability of the senior dentist. The senior dentist's practice was assimilated into the associate's practice by default. For all intents and purposes, the senior dentist's practice just vanished. The disabled dentist had much less to sell than he had expected, and actually had to pay the associate to move from the office and relocate. The dentist paid the associate in excess of $200,000 just to be free to sell what was left. In addition, the purchase price of the practice was less than it otherwise would have been, because the purchaser could not be certain of what he was purchasing. The practice owner lost in excess of $400,000, because there were no written agreements.

Many of these verbal agreements go to litigation and end in very bad feelings. Good contracts define relationships and protect all parties. Guard against hastiness in adding an associate by carefully analyzing the needs and growth patterns of your practice, as well as the collateral costs of the new doctor and the personality impact on you and your staff.

Friend and practice broker Roger Hill, in his Texas country humor, refers to this error as "Selling the cow and keeping the milk." After you've spent many years starting and building a dental practice, is it sensible to sell your practice to someone else and continue working as an employee? Who would really be in charge? Who would the staff turn to when problems occurred? Who will the patients want to see? Even short transitions of a month or two are usually difficult for the seller, buyer, staff, and patients.

When a dentist pays a lot of money for the ownership of a dental practice, he or she expects to be able to manage, make changes, do marketing, and, above all, reap the rewards of the practice. The lingering presence of the seller makes it difficult to transition power to the newcomer. It is impractical for the seller to be relegated into an associate's role; it does happen, but rarely without significant difficulty. Consider arranging your retirement so that you remain the boss for the time you practice, then bow out gracefully when the new owner takes charge.

When a practice becomes large enough for two dentists, the first reaction of many owners is to bring in an associate, often with the idea that the new dentist will buy into the practice. If the relationship survives and the parties decide to move into the next phase, they normally enter into a partnership. The usual scenario is for the associate to buy into the practice and own 50 percent or, if there is more than one dentist, an equal portion with the group. The problem arises when one doctor wants to retire or relocate and the remaining doctor, who in the meantime has developed a thriving practice, does not want or need to purchase the departing doctor's share.

It is nearly impossible to sell half of a co-mingled dental practice! What is the buyer buying? What guarantee does the buyer have of getting a fair return on the investment to purchase the practice? What assurance is there that the patients will accept the new doctor? Institutional lenders are very reluctant to lend money for this kind of a relationship without the guarantee of the remaining doctor and all of the tangible assets as collateral. Why would the remaining doctor want exposure to all the financial risks of guaranteeing "unknowns"?

There are methods by which the practice owner can sell a portion of a practice to another dentist and still retain the autonomy and independence of a solo practitioner. The "solo-group" is an excellent arrangement for a practice with sufficient new patients and an adequate facility to accommodate more than one doctor. Over time, a solo-group arrangement creates two independent, autonomous practices under one roof. This relationship can be advantageous in providing for the mentoring and consulting desires of the doctors, as well as providing for coverage and the sharing of some expenses. If structured properly, the solo-group can solve the "too large practice" or "I want to slow down" problems, while offering an environment that allows for the sale of either practice in the future. That future sale is made to a third doctor, with the remaining partner in the solo-group keeping his or her separate, intact practice, not being obliged to purchase a practice he or she doesn't need or want. As with any legal arrangement, it is important to understand all of the elements of the solo-group concept to avoid the common pitfalls.

One of the most unfortunate circumstances that we ever encountered was that of a father who had to retire from dentistry while his son, who was a fellow dentist in the practice, stayed on. This son felt no obligation to his parents or siblings to pay for the practice that his father had brought him into. The practice was part of the parents' estate and, as such, should have passed to them and eventually been distributed to their children. Instead, the siblings had to sue their brother to recover their legitimate portion of the estate. The suit ultimately destroyed the family. In this case, a well-defined solo-group, or at least a clear dissolution agreement, would have provided an equitable result to all parties involved.

Planning and preparation are the key elements to a successful transition. You must know the value of your practice and its place in your exit strategy. Relationships are difficult; therefore, carefully analyze them beforehand and clearly define their terms in writing and include dissolution provisions. Consider the solo-group concept, which can retain for you the autonomy of the solo practice while providing the advantages of a multi-dentist office and exit-strategy options. To protect your financial and professional future, follow these steps:

1. Plan your exit strategy well in advance of your retirement.
2. Confirm that your financial planning is going to meet your retirement needs.
3. Know the value of your practice and how it plays into your financial planning.
4. Decide how you are going to transition out of your practice.

Oh, by the way, give some thought to what you will do after retirement. When you have been active and productive for a long time, it is important to plan your postretirement life so that you can look forward to years of fulfillment, not boredom. At some time, we all want to or must retire. The secret to a successful post-professional life is proper planning during your professional career. So don't flunk retirement!