by Terry D. Watson, DDS, and Frank Brown, JD, LL.M (Taxation)
A significant number of dental careers begin with the purchase of a practice. This purchase is one of the most important financial decisions a dentist will make in his or her professional career. If you are entering into an arrangement to purchase a practice, whether now or in the future, you are entitled to the information you need to make an informed decision.
Most practice sales are immediate sales. The owner transfers complete ownership to a purchaser and, after a short transition, leaves the practice. There is also a growing trend toward structured or delayed sales leading to complete or fractional ownership (partnership) after a period of association. Delayed sales add a layer of complexity, and accordingly, require a greater amount of preparation and exchange of information.
More than one prospective purchaser has entered a practice as an associate without a clear understanding of the terms of the future buy-out/buy-in. Unfortunately, negotiating purchase terms after the period of association often ends in failure. After investing significant time in the practice and likely signing a restrictive covenant not to compete, the associate’s future is suddenly in jeopardy. This can be avoided by sharing information early in the process.
Regardless of whether it is an immediate or a delayed sale, a prospective buyer should expect to be furnished with preliminary practice information including the applicable business points for the intended association, purchase, and partnership.
The preliminary information should include, but is not limited to, the following:
- Practice appraisal. Regardless of whether you plan to purchase the practice immediately or in the future, the first step is to have a qualified party perform a practice appraisal.
- Cash flow analysis. The practice must be able to generate enough cash flow after operating expenses to service the debt associated with financing the purchase and still provide a reasonable income. The projected income should be supported by historic practice numbers and not unrealistic future projections.
- Fee evaluation. Determine whether the fees are in line for the area.
- New patient numbers. An indicator of practice vitality.
- Three years of practice financial records (tax returns and financial statements). This is essential to obtain an accurate picture of the practice’s financial performance, including overhead and profit.
- Patient chart audit. Verify the number of active patients and the number of patients on recall. Charts should have complete treatment entries, current patient information, and easily discernible treatment plans.
- Facility evaluation. Is the décor up-to-date? Is the dental equipment in good condition or in need of replacement?
- Lease evaluation. Examine the lease terms compared to the surrounding market. A lender will require a lease for at least the length of the note if third party financing is involved.
- Treatment mix. Does specialized treatment comprise a significant portion of the practice? Are you trained to provide this treatment?
- Payer mix. Carefully evaluate all sources of income and any insurance plans in which the practice participates. Can these plans be transferred?
- Recall. Ideally, 22 percent or more of the total production in a typical general practice is derived from hygiene production.
- Compare major expenses to industry standards. The percentage of total practice income for major expenses (typical general practice): rent 6 to 6.5 percent, lab 8 to 10 percent, dental supplies 6 to 6.5 percent, office supplies 1.5 to 2 percent, and total staff expenses 30 percent or less.
Association business points
The following points should be addressed if considering an association:
- Practice income. The practice should have the ability to provide an additional dentist’s income.
- Facility. Be sure the practice facility is large enough to support an additional dentist.
- Staff. Be sure you have the total support of the staff.
- Business relationship. Define the relationship between the owner/seller and associate/purchaser. The association can be either an employer-employee relationship or an independent contractor relationship.
- Termination. Delineate the termination policy. Specify the causes for involuntary termination and the notice period for voluntary termination.
- Compensation. Compensation should be clearly defined. Compensation based on a formula is typically a percentage of production or collections that may include a draft against future earnings. Alternatively, compensation may be set up as a base payment plus incentive bonuses. Ask for an illustration of the calculation for compensation.
- Service parameters. Define service parameters. Specify whether the associate will devote all professional time to the practice, or whether he or she will work limited days or hours.
- Expense allocations. Specify who will be responsible for the cost of professional licenses, dues, continuing education seminars, health insurance, malpractice insurance, benefit plans, dental and office supplies, laboratory expenses, and staff salaries.
- Time off. Outline a time off policy. How many days will be allowed for vacation, personal time, or attendance at continuing education seminars? How much advance notice will be required for time off?
- Covenants. Agree on any covenants. Restrictive covenants, such as non-disclosure of confidential information and non-compete clauses, are typically included in associate agreements. A non-compete clause may have a different effective date than the associate agreement.
Purchase business points
The following points should be addressed if considering a future purchase:
- Practice value. It is not enough to know the current practice value if the purchase price will be different in the future. Agree in advance on exactly how the value of the practice will be determined in the future.
- Assets. Identify the assets of the practice. All assets of the practice being sold should be identified. Assets excluded from the purchase should also be identified.
- Asset allocation. Determine how assets will be allocated. The purchase price must be allocated among the assets and reported consistently by both the seller and purchaser. This decision has tax consequences for both parties.
- Leased and licensed assets. Determine what assets are leased or licensed. If certain assets such as dental software are leased or licensed, determine whether the leases and licenses are assignable. If there is a fee for transfer, specify who will be responsible for the fee.
- Closing and transfer dates. Determine when the closing and transfer will occur. The transfer of physical ownership and control of the practice may take place at the time of closing, or at a specified date in the future. A closing date different from the transfer date is commonly used in a delayed sale.
- Accounts receivable. Determine how accounts receivable will be addressed. The accounts receivable may be purchased or retained by the seller.
- Covenant not to compete. The seller will be expected to agree to a non-compete agreement containing reasonable time and distance terms.
Partnership business points
The following major areas should be addressed if considering a future partnership:
- Decision-making authority. When matters arise that require input and approval from partners, they must usually be approved by a predetermined percentage of the owners. Depending on the matter, certain management decisions may require a simple majority, super-majority, or unanimous consent. Matters requiring different voting percentages for approval should be delineated.
- Succession planning. What happens if one of you dies, becomes disabled and unable to work, becomes divorced, or decides to retire? Determine in advance the mechanism for the sale of a partner’s interest for each situation. It is usually preferable for a buy out at death or permanent disability to be funded by insurance.
- Profits and loss distribution. Partners should reach an agreement on how profit and loss will be distributed. Distributions may be made several different ways: pro rata to each partner’s production, by ownership percentage, or by a combination of the two. Some partnerships choose to use a detailed expense allocation to each partner’s individual revenues to determine each partner’s income.
As you can see, the scope of critical planning that precedes a purchase is linked to how complex the path to ownership is. Choosing the best path depends on each set of circumstances, but the ultimate success of a purchase rests on the ability of those involved to make well-informed decisions early in the process and progress to legal documentation.This information is not intended to be comprehensive - it is a greatly condensed overview. As always, the devil is in the details. It is wise to seek professional advice from an experienced practice transition expert who can help with the acquisition and analysis of the information.