In this article, I will summarize and outline what is needed and what to expect when buying or selling a dental practice.
TIME - The time it takes to sell a dental practice can be from three months to three years. A lot of the timing issues depend on the market demand in a particular area. It is interesting that those states that have opened up their borders to reciprocity generally have a much shorter turn-around time for those sellers than those that are restricted to state licensure issues.
VALUE - The first step in any transition is determining the value of the practice. I have discussed this in the previous article.
FINDING A BUYER - Assuming the value of the practice is acceptable, now you need to find a buyer. Very often, this step happens unexpectedly, and you need to backtrack to get the appraisal done. In any case, once a buyer has been identified, the negotiation process begins. This process can be simple or complex, friendly or hostile; but at some point, you will either agree on the basic terms and conditions, or you will not. Because of the dynamics of a practice sale, all of the terms and conditions will not be agreed to in the beginning because there are too many issues to resolve. Therefore, the basic terms and conditions of the transition should be agreed to, and the rest of the items will be settled one at a time as the process continues.
INITIAL AGREEMENT - The four issues that should be agreed to in the beginning are purchase price, method of payment (cash at closing, seller financing or a combination thereof), closing date, and terms of the restrictive covenant. Once these terms and conditions have been agreed to, we have a meeting of the minds on these issues. This does not mean that we have a deal; it just means that we have a solid foundation for a deal to work from. At this point, the seller and buyer should execute a letter of intent (LOI) that outlines the agreed-upon terms and conditions, and the buyer should make an earnest money deposit. It does not have to be a large sum, and it will be refundable in the event the transaction does not close. From the time of signing a letter of intent to closing usually takes from thirty to ninety days, although the timeline can be stretched if necessary. During this time, all of the other terms and conditions of the transaction will be worked out and the financing commitment procured. Generally, the financing and acquiring of insurances can be the longest part of the process. The buy-in partnership or solo group structure will take significantly longer because the buyer has got to be established and generating significant production before he or she can afford the buy-in. The documentation required is also totally different and more complicated than for the straight sale. However, the same initial process should be followed. There should also be some form of projecting at what point, production wise, the buyer can afford to buy into the practice, and with this projection, a general time frame during which it seems practical that the buyer can achieve this goal. In general, this process is about 6 months to one year.
DOCUMENTS - The documents required for a transition depend on the type of transaction.
- An outright sale will require a purchase and sale agreement (PSA) or an asset purchase agreement (APA), restrictive covenant and/or non-solicitation agreement, lease, bill of sale, and closing statements.
- A buy-in to a corporation will require a stock purchase agreement, revision of the corporation shareholder agreement, minutes reflecting the action of the board of directors, and employment agreements with each of the dentists of the corporation.
- A buy-in with a defined buyout would require the same documents as the buy-in, but would also provide for the obligation, options, or rights of first refusal for the buyout. These provisions may include formulas or actual numbers for the purchase price, time frames, payment terms, and so on. Usually at the buyout, the buyer will again pay a nominal fee for the stock (for tax purposes), which will include the tangible assets (they will most likely be owned by the corporation) and the balance of the purchase price allocated to the personal goodwill of the selling dentist. The buyout will be a cash transaction because the buyer will be able to get financing by collateralizing the entire practice. The buyout will still be a win-win transaction because the seller will receive capital gains treatment for the entire sale price, and the buyer will be able to amortize the value of the goodwill over a fifteen-year period.
- The solo group requires an initial agreement with the entire process defined, including the way each dentist's patients will be transferred and identified, protection of each dentist's individual goodwill, the purchase price (dollars or formulas), and approximate time frame
- for the buyout point. The buyout point is established in the beginning of the relationship and is projected as a function of the income and expenses of the practice as well as the number of active patients, the
- number of new patients, staffing requirements, and the facility. At the buyout, the same documents as for an outright sale are required since, in fact, there is an outright sale of goodwill and a fifty percent undivided interest in the tangible assets (equipment and supplies).
DEFINITION AND FUNCTION OF THE DOCUMENTS:
It should be said that all mechanisms and advisors of the transition should be facilitated by an individual that specializes in the dental industry. The dental industry is very unique and has nuances that are specific to the industry of dentistry.
Confidentiality Agreement
A confidentiality agreement, or non-disclosure agreement (NDA) is often required by the seller or the seller's advisor or broker before identifying a practice and providing the proprietary information about the practice. This agreement is a legal and enforceable agreement that can have serious financial implications if damage occurs to the practice because information is distributed that should not be made available to the public at large.
Letter of Intent (LOI)
A letter of intent is usually a nonbinding agreement that describes the basic terms and conditions of the transaction. As mentioned above, it should include the agreed-upon purchase price, method of payment, restrictive covenant parameters, and closing date, and it should be accompanied by a refundable earnest money deposit by the buyer.
Purchase and Sale Agreement (PSA)
The purchase and sale agreement will identify all of the terms and conditions of the sale, including the allocations of the various assets, the payment terms, restrictive covenant parameters, closing date, and indemnification language. It will be av a very comprehensive document and should be drafted specifically for the sale of a dental practice, not a generic agreement used for any business transaction. There are issues that are very dental-specific that should be included in this document, therefore requiring someone with knowledge of your state dental act requirements to make sure that the required issues are addressed.
Restrictive Covenant
The restrictive covenant will restrict a party to the transaction, usually the seller, from practicing dentistry or associating with a dental practice in any capacity within a certain area and for a certain period of time after leaving the practice. The time and distance criteria are jurisdictional, meaning that every court jurisdiction will have set acceptable standards of time and distance that they deem reasonable. In the event the restrictions are challenged or breached, and the issue ends up in litigation, the court may determine whether the restrictions are too severe. They may also disallow the covenant altogether or revise it to meet the acceptable reasonable standard set by the jurisdiction. Though the restrictive covenant time and distance is usually defined in the purchase and sale agreement, a separate restrictive covenant agreement should be attached to the purchase and sale agreement as an addendum, which makes it part of the purchase and sale agreement. The restrictive covenant agreement should be a complete, stand-alone agreement that is comprehensive in nature and defines all of the terms and conditions of the restrictions agreed to, including the penalties and remedies for breach of the agreement.
Reverse Restrictive Covenant
A reverse restrictive covenant is appropriate in the event the seller is financing all or part
of the transaction. The reverse restrictive covenant protects the seller in the event the buyer defaults on his or her payment obligations and restricts him or her from practicing in a competitive area in order to protect the seller's practice.
Promissory Note
A promissory note is the legal document that obligates the executer of the note to pay the holder of the note the money owed. Usually, the only time a promissory note is involved between a buyer and seller is if the seller is financing the transaction. A buyer will be executing a promissory note with whomever he or she has borrowed the money, whether the seller or a commercial lender.
Security Agreement
The security agreement is the document that secures the promissory note. It reiterates the terms and conditions of the financial obligation, the terms of payment, the collateral supporting the value of the note, and the penalties in the event of default on the note. A security agreement should always accompany a promissory note so that the holder of the note will have adequate recourse in the event of a default.
Closing Statements
The closing statements, usually one for the seller and one for the buyer, identify the way the money in the transaction was disbursed. Closing statements are necessary for determining tax issues when the tax returns are filed and should be signed by all parties to the transaction, verifying that the money that was disbursed to the buyer, seller, and third parties, was, in fact, agreed to by all the parties to the transaction. An escrow company can facilitate this aspect of the transition.
Employment Agreement
Any time there is an entity, such as a corporation, LLC/LLP, or partnership, there should be employment agreements with each of the principals in the entity. This includes the solo dentist that is incorporated. The employment agreement should, at minimum, include a job description and compensation provisions. When there is more than one dentist in an entity, it is imperative to have employment agreements that define the obligations of each dentist to the corporation and the corporation's responsibilities to the dentist, including compensation and benefits. There should also be provisions for termination in the event of violations of "moral turpitude" (dishonesty, illegal activity, immoral behavior, etc.), the loss of license, or disability to the extent they cannot practice.
Independent Contractor Agreement
In some cases, an independent contractor relationship is engaged; however, the definitions for a true independent contractor relationship are very specific and clearly defined by the IRS. The reason the IRS is involved in defining a true independent contractor is because
the independent contractor relationship is too often established to avoid paying payroll taxes. Some of the requirements that identify a true independent contractor are no longer applicable. Therefore, independent contractor relationships are becoming more popular. Please consult with your CPA.
Shareholder Agreement
The shareholder agreement is, or should be, a part of the corporate documents in a Cor Subchapter 5 corporation. The shareholder agreement defines the ownership in the corporation, the operating conditions in the corporation, and the dissolution provisions, including insurance requirements and buyout agreements between the parties. It is not infrequent that the shareholder agreement is either found to be incomplete with respect to all of the necessary terms and conditions of the parties' agreements or is woefully neglected and never updated. Along with the corporate minutes, which should be, by law, updated every year at the annual shareholder meeting (which is also often disregarded), the shareholder agreement should be updated and revised to meet the expectations of the shareholders. In some cases, the agreements are not even signed, which renders them invalid in the event of a litigious dissolution.
Operating Agreement
The operating agreement plays the same function in the LLC/LLP as the shareholder agreement in the corporation. Once again, it should be updated regularly and contain the
provisions that the members of the LLC/LLP desire as far as ownership, operating
relationship, and dissolution provisions.
ADVISORS - The advisors that are a must in any of these transactions are:
- Attorney
The attorney chosen to represent you in these transactions should be a deal maker, this is a transactional sale not a litigious one. They should have experience in dental practice transitions, including the state dental act requirements and the tax laws. There are several attorneys in the country who specialize in dental legal services and do an excellent job for their clients. Beware, however, of those attorneys who do not specialize in dental practice law who want to totally rewrite the agreements or renegotiate the deal. This will kill a transaction faster than anything else.
- Accountant
Usually, the seller has an established relationship with an accountant or CPA. Often, the buyer does not. Accountants are usually engaged to prepare financial statements and prepare taxes. The sale of a dental practice is totally different and requires a different approach and often, different tax knowledge. A good accountant is also being as creative as is legal to reduce your net income for tax purposes, therefore potentially impacting the value of the practice. Most accountants are very easy to work with, but again, once in a while, there will be one who defies all the experts and demands certain structures that may severely impact the transaction or the tax
consequences of the transaction. Remember, you are employing your attorney and accountant. They are not employing you! You should be able to tell them that this is the deal that you want to do and ask them to point out to you any issues that they might be concerned about. But you, ultimately, should make the decision, not the attorney or the accountant.
- Brokers and Consultants
Like any professionals, there are very good and very bad brokers and consultants with a lot of mediocre ones in between. There are very honest and ethical brokers and consultants who can be of incredible value to you in your transition, but you should spend the time to seek them out. As is often said about lawyers, "The most expensive lawyer is a cheap lawyer." The same goes for brokers and consultants. You will get what you pay for and the industry is small enough that it does not take much investigation and inquiry to find out who does a good job and knows their business and those who do not. Dentists do not like paying a commission to a broker or consultant, but choosing the right advisor will more than pay for itself, not only in the quality of the service that you receive, but also in actual dollars you save and/or receive for the services rendered. One of the most accurate ways to identify a good broker or consultant is to talk to colleagues and industry vendors who are involved with dental practice sales. They do business with most of the brokers and consultants and will provide you with references they do business with. Remember, they are lending a lot of money in these transactions and need to do good deals that are successful. They know who they can trust when it comes to quality and integrity. Also ask for references of their former client/dentists who they have facilitated a sale for.
- Lenders
As a buyer, at some point in the process, you will most likely need to borrow money, and as a businessperson, establishing a relationship with a reputable third-party financial institution will be essential. The initial relationship when purchasing a practice is important because it will determine the terms and conditions of the loan, which include the interest rate, the time over which the loan will be paid back, the amount of money that can be borrowed, and the availability of working capital and the future availability of money for growth and/or expansion and new equipment. To establish this partnership with the right lender is important. Lenders are not all the same, and some seem very willing to make the loan as easy as possible for you by extending the term out or even deferring payments. It is not prudent to borrow more money than is needed nor to extend the loan period longer than is required.
It will only cost you more than necessary in the long run. Remember, lenders make their money by lending it to you. The higher the interest rate and/or the longer the loan, the more money they make. Because you can save total interest charges by paying the loan off quicker than scheduled, the lender may impose penalties for early payment to assure that they make the amount of money they want to make. One of the biggest mistakes made by borrowers is overreacting to the interest rates. Remember that a practice acquisition loan is not collateralized like a home loan. In other words, if you default on your house payment, the bank can sell your house to recover their money. With a dental practice, however, the majority of the value is in the goodwill, and therefore, the only thing the bank can really sell is the equipment, which is usually valued at a fraction of the whole practice value. The good news is that very few-less than 0.05%-of dental practices fail, and therefore, the lenders are on pretty solid ground when they lend for the purchase of a practice. The other thing to remember is that this is a business loan and not a home mortgage, so interest rates are going to be higher. Often, the first-time buyer of a practice is surprised by the interest rate because they are familiar with the home mortgage rates and assume them to be the same. We talked about cash flow earlier, and you will remember that debt service (the loan to purchase the practice) was one of the components. When cash flowing a practice (overhead, officers' compensation, and debt service), our practice is to amortize the loan (the period of the loan) over a ten-year period. If it can be paid off earlier, that is even better, but for cash flow purposes, we use ten years. If it has to be stretched out for a longer period of time, either the price is too high, or the interest rates are too high. Some lenders want to provide you with a period of six to twelve months on the front end of the loan with no payments due. This will create negative amortization, which is nothing more than interest being charged on interest, which in the long run can significantly increase the total amount of interest you pay for the money you borrow. Remember, any practice will cash flow if the loan is extended out long enough! But, like credit cards, if the minimum due is all that is paid it might take forty years to pay off the present existing balance.
DISSOLUTION PROVISIONS - Just a comment about dissolution provisions:
Regardless of the model that you choose for a multi-doctor relationship, the "stepchild" of provisions in the documents, whether it is a partnership, a corporation or an LLC/LLP are the dissolution provisions that kick in when the relationship dissolves. All relationships ultimately dissolve! Whether because of retirement, disability, death, or personal conflicts, all relationships ultimately end. It is therefore critical that the dissolution provisions covering any and all contingencies be defined in depth before the fact and not at the point of dissolution. As mentioned before, these provisions should be re- evaluated and assessed every year so that the necessary changes can be made and incorporated into the documents. For sellers, it is very probable that if you think through your goals and objectives, understand your retirement requirements, evaluate honestly your practice and your exit strategy, and-most of all- use advisors who understand dentistry and the transition process, you will experience a successful and profitable transition. For buyers, find the best and most experienced consultants and brokers and trust their knowledge and expertise. By surrounding yourself with the best advisors and listening to their advice and counsel, you will not make a mistake. Remember, for both buyer and seller this is a life decision, and it should be taken very seriously.
The above outlines are general broad strokes from beginning to end and is not designed as a complete blueprint on how to transact a transition. This is one of the biggest events in your life and can have severe consequences if not done well.
