There are three phases in transferring practice ownership: finding the buyer/seller; negotiation and documentation; transition. The “finding” phase can take months to years, the second phase generally takes two to four months (longer in a buy-in) and the transition phase can last weeks, months or even years. Therefore, a seller should allow sufficient time for each phase. For instance, in a general practice, the seller should begin about one year before he wants to be out. In a more difficult sale (a less desirable area, specialty practices or home offices), the seller should begin a few years in advance. For buyers, it is quite simple. You should begin when you are ready to own a practice. This typically occurs about two to four years into practice.
There are numerous ways to find prospects: internet, professional journals, suppliers, newspapers, referrals from other professionals, brokers, residency programs and schools. Practice brokerage has become much more common due to the complicated nature of the process. Using an experienced professional is the best way to locate buyers or sellers. If you decide not to use a broker, be aware that finding a prospective buyer or seller is just the first of many steps.
There are numerous methods of transferring ownership in a practice: complete sale; associateship leading to complete sale; associateship leading to partnership and eventual buy-out; seller becomes the associate; delayed buy-out; sale of a portion of a practice; merger; sale of charts. There are pros and cons for each of these methods. The starting point is for the seller to decide how much longer he plans on working and whether he intends to cut back during that time frame. If the time frame is less than two years, then in most cases the complete sale is the method of choice.
The answer depends on a number of issues. If the situation is a general, solo practice, the answer would be no in most cases. If the practice is large enough to support more than one doctor or if it is a specialty practice, then the answer might be yes. Practices can be successfully transferred without the buyer working in the practice beforehand. If there is going to be an associateship phase, the details of the eventual transaction should be negotiated upfront (preferably even before the associateship begins).
Surprisingly, many transitions are quite short. The keys to a successful transition are a good letter (introducing the new doctor which should be sent right after settlement) and a staff who will carry over from one doctor to the next. In many general practices, the transition lasts only until the owner finishes the cases that were in progress as of settlement. If the practice can afford more than one doctor and the seller would like to stay on, then the transition can last however long as both doctors agree to. In specialty practices, the transition may need to be longer to allow time for the referring doctors to meet the new doctor.
DSO’s have become a significant factor in the dental market. They have been buying up practices across the county. Although they might offer a higher price, there are a number of factors to consider. Some of the price will probably be held back until the seller completes the transition. A portion of the price may be paid over a number of years based upon future productivity. Some of the price may be paid in the company stock. The seller usually has to commit to staying for at least one and in most cases two to three years. DSO’s are often times not interested in purchasing the real estate and they require more due diligence and documentation. Thus, a seller has to consider all these factors if thinking about selling to a DSO.
The value of a practice has two components: tangible and intangible. The tangible assets include equipment, furniture, supplies and instruments. The intangible portion of the value (commonly referred to as goodwill) is defined as value a buyer is willing to pay over and above the value of the tangible assets. It is based on many factors, but most importantly the cash flow and the desirability of that particular practice. A buyer will evaluate many factors (e.g. location, patient base, staffing, fees, etc.) and the more positive those factors are, the more he will be willing to pay for a cash flow. As a general rule, the intangible portion of the value is about two-thirds to three-quarters of the overall value. Be very careful about trying to use a rule of thumb to value a practice. There are many of them and none is sophisticated enough to value all practices in all situations, other than to demonstrate averages rather than specific values. It is advisable to have a professional who is knowledgeable about the dental marketplace do an appraisal of the practice.
The money can come from any or all of three sources: the buyer, the seller or a bank. The seller should decide before the practice is put on the market whether or not he wants to finance part of the sale. There are both advantages and disadvantages to seller financing. In cases of a complete sale, sellers are often reluctant to hold a note. If they do, there should be a sufficient down payment along with appropriate legal documents and insurance. In a buy-in, since the risk is significantly less, the majority of the purchase price is frequently paid over time to the original owner. Over the last few years, many banks and finance companies have entered the financing field. Typical terms in a complete sale are 100% of the purchase price plus working capital, with a seven to ten year payout at prime plus one to plus two. The better financial condition the buyer is in, the better the terms he will get. The two most critical issues the banks review are the credit rating of the buyer and the cash flow of the practice. They need to be sure there is sufficient revenue to pay the overhead, the debt service and the personal needs of the buyer.
For the buyer, in most cases there are no taxes to be paid. The buyer is looking for write offs. Generally, the entire purchase price can be written off. Supplies are an immediate expense, equipment can be written off over five to seven years, or expensed via IRS 179 in the year of purchase. The intangible assets (the goodwill can be subdivided into restrictive covenant and patient records as well) are a fifteen year write off. Therefore, the objective of most buyers is to classify as much of the price as possible into tangible assets. The seller will pay taxes on any of the profit from the price. For equipment, there is no tax up to the basis, ordinary income up to the original cost and capital gain over the original cost. For the intangible, goodwill and patient records are taxed at capital gain rates and the restrictive covenant is taxed at ordinary rates. C corporations have the additional tax complication of a tax at the corporate level and then the personal level. In these situations, goodwill should be classified as personal to get it out of the corporation. As with any tax issues, check with your tax advisor before proceeding with any transaction.
Both seller and buyer each should have their own attorney. In most cases the seller’s attorney should prepare the initial set of documents which will be reviewed by the buyer’s attorney. In a complete sale, the primary document is the Agreement of Sale (also referred to as an Asset Purchase Agreement). In a buy-in, there may be five (on average) documents: Stock Purchase; Stock Redemption; Shareholder’s; Employment Contracts for each partner. The attorneys generally should become involved once the business aspects of the transaction have been agreed upon. Choose an attorney who has some experience in dental practices (or at least in business sales). The fee will be based upon an hourly rate and each transaction differs in the amount of time it takes to be completed. Check with your accountant and colleagues for referrals. If you are using a broker, he should be able to refer you to an attorney.
If the seller owns the office space, it will either be sold or leased to the buyer. Therefore, this will be an additional negotiation. Some buyers would prefer to lease the space initially with either a right of first refusal or option to purchase. It will be easier for them to purchase the real estate once they have their feet on the ground in the practice. If the building is sold at the same time as the practice, it will take longer to complete the transaction and the buyer will probably need some of his own money for a down payment on the real estate. If the seller leases the space, he should talk with the landlord as soon as the practice is put on the market to be sure there will be no problems with a new doctor coming in. Lease complications with disinterested landlords (they generally have little or nothing to gain by a tenant transferring his business) can sometimes be a major roadblock to getting a practice sold. Once a transaction reaches a certain point “contracts are being prepared”, the buyer should then contact the landlord and discuss either an assignment of the lease or a new lease. Remember, if a bank is involved, they will insist that the lease run at least the length of the loan (initial term plus renewal options).
There are a number of key ingredients in negotiating a successful partnership. Of course, the first assumption is that the doctors have been working together for a while and are compatible. The ingredients include: the percentage of the practice being sold, the price, the terms, how the income will be split, management of the practice and a method to value the practice for an eventual buy-out. A common issue is the determination of a fair price for an associate to pay for a buy-in. Generally, they want a discount for the revenue they generate. In many cases, a price reduction is done in order to complete a buy-in. The most important issue, however, is not the price but the income splitting. There are numerous methods of splitting the income. In many cases, the more successful methods have two elements; production and percent ownership. Owners of practices have dual roles: they are providers and should be compensated for their efforts at chair side; they are also owners of a business and should share with any other owners some of the residual profit in the practice. Approximately 50% to 80% of the profit can be split by productivity and the balance by percent ownership. Of course, during the buy-in period, the cost to the new partner will need to be deducted from his share of the profit (assuming the entire price was not paid up front).