The article mentioned the specialized nature of the top paid medical/dental professions as well as the considerable educational expense required to enter the fields, but what does this article mean for you?  While you may have even more requests to negotiate your fees as families are still mired in the difficult economy (track the economic outlook at http://economy.ADSflorida.com), more wide ranging is the realism of the financial needs within the profession and how you can best position your practice to make your transition a success.  The reality is, while the “average earnings” of a general dentist was reported to be almost $159,000, for most purchasers the average simply isn’t and won’t be enough.

In life, serendipity is often sweet.  However, serendipity rarely works as a strategy for a practice transition.  Thoughtful planning and preparation will yield far better results.  So what can you do in the time remaining to make your transition a success?

0-2 years from transition
Bring in a transition expert now.  A detailed examination of your practice will probably reveal areas for improvement, but general cookie-cutter advice will not suffice.

2-5 years from transition
Review your fees and raise them wherever possible to be within the 80th percentile of local fees (contact your local ADS representative about a localized report).  Look at staff salaries to make sure they are reasonable and reflect the individual’s qualifications.  Determine whether your team members will be supportive of a transition and are not expecting to retire with you.  Look for untapped opportunities to bolster your patient base or procedures, but avoid adding specialty procedures, especially those that need special training or qualification that may not be easily transitioned.  Avoid major equipment purchases or extensive remodeling projects, but look at minor aesthetic upgrades (paint, flooring, etc.).  You may consider ‘going digital’ or paperless, but realistically assess the cost and learning curve for your practice.  Bringing in a transition specialist to do a “Coffee Stain Tour” (click here for the article) or conducting your own will yield valuable opportunities for improvement.

5-10 years from transition
Consider everything in the 2-5 year plan.  Look to reduce specialty procedures and become as mainstream within your practice area as you can be by the time you hit year five.  Ensure your practice systems and processes are running smoothly and efficiently.  If they are not (or you do not know), bring in a practice management specialist to help.  If you’ve considered digitizing or going paperless, you definitely have time and it will prove an important asset in your transition.

10+ years from transition
Consider everything from the 2-5 and 5-10 year plans.  The significant difference is that you now have time for larger expenditures to pay off.  Look at replacing major equipment or updating the office appearance.  Digitizing and going paperless is pretty much a must.  Carefully consider technologies such as Cerec or CAD/CAM as they still may not have the payoff in transition.  However, they may prove valuable to you while practicing and should be considered primarily in that respect.

While the statistics of the past predict a glut of dentists reaching transition age, recent news of new dental schools opening will change the projections of a vast disparity between retirees and graduates.  What isn’t changing is that future purchasers will need to earn more from their practice than those of the past, and the best prepared practices will not only transition faster, but for a higher value.  Cash is and will be king, so increasing your practice’s net income is important, but how a practice operates and looks is not any less important.

Remember, serendipity is not a plan.  Prepare now.

- Originally Published in Dental Economics, October 2011

2. What can increase or decrease value?
Fewer specialty services (in a general practice), less discounted fees or insurance (especially HMO/capitation), more stability, higher gross and higher net income yields higher value.  Aesthetically, though, the more visibly appealing a practice is, the more a practice will sell for.  Note, that this will not necessarily affect the appraised value, but may affect the sale price.  Importantly, some procedural and nearly all financial modifications to increase value may necessitate longer range planning (3-5 years out) to provide a return.  Major equipment or aesthetic changes most likely will not yield a justifiable return in the immediate short term.

3. Can you provide an overview of the transition process?
After finding a practice, the purchaser makes an offer which the seller can accept, decline or counter.  The offer should establish the general framework (price, anticipated closing date, restrictive covenant terms, whether there will be a transfer of real estate) for the purchase agreement that will be developed.  Once the offer is accepted, the purchaser applies for financing (if applicable) and completes the in-office due diligence.  Concurrently, purchase agreements (and lease, if applicable) are developed and reviewed by seller and purchaser’s counsel.  Once documentation is finalized and financing is secured, a closing date is set and the staff notified.  Many steps, if done incorrectly, can adversely affect future steps and jeopardize the sale, so it is important to consult with an expert.

4. What is a Covenant Not to Compete / Restrictive Covenant?
The Restrictive Covenant establishes a time and geographic area within which the selling doctor agrees to not practice or participate in another practice after a sale.  The seller is also usually restricted from soliciting patients or staff.  The area for the Covenant is unique to each practice and location, and is usually correlated to the service area of the practice (where most of the patients live/work) taking into account local and regional factors.  Time limits are often established by state law or jurisdictional court rulings and can be months (if at all) to a number of years.

5. Are Restrictive Covenants enforceable?
When properly developed and reasonable in its terms (distance and/or time), covenants are definitely enforceable in most areas.  The specifics of the covenant are very important and defined by local laws.  Since a restrictive covenant is vital to almost every transition, it is important to consult with a local transitions expert and legal counsel to verify the statutes and ensure legality of a covenant.  That said, in all states but Alabama (others does not allow them for employees), Restrictive Covenant contracts are enforceable and care should be exercised when drafting them.

6. Will the staff stay in a transition?
The staff typically is as worried about keeping their job as the purchaser is about keeping them. If they leave, they have to start working for a new doctor and with a new team with a new set of expectations, benefits and a reset on their seniority.  This amount of change sets a high incentive to stay.  With a proper transition strategy, the staff should stay in place unless the purchaser lets somebody go or somebody was already set to retire.  In the case that they were ready to retire, this should be disclosed throughout the due diligence process.

7. Will the Seller’s patients accept a new dentist?
The patients of the practice will accept a new doctor if the introduction and transition are handled the right way. The seller’s endorsement, coupled with staff acceptance and enthusiasm, is key, but the purchaser’s participation in creating a steady environment over a period of time will enhance acceptance significantly.  Generally speaking, we see that patient retention is in the mid to high 90% range knowing that those that travel from out of the area and some others may not return, but the vast majority will and give the new doctor a chance if the transition is handled correctly.

8. How do you appraise or value a practice?
No valuation is made on one year’s data alone and metrics such as percent of gross or multiple of net are not accurate appraisal values.  A true appraisal process includes evaluation of several different methods of correlating value to residual net income of a practice after reasonable expenses, including all those to produce the dentistry are deducted from the gross income.  There are methods that are generally accepted in the business valuation profession, legal community and banking industry that can be applied to valuing a practice.  Appraisals should have detailed documentation that review the methodologies examined to determine final value.

9. Does my dental practice need to be a certain size to accommodate an associate?
There are generally recognized minimal requirements for a full-time associate which include office size (square footage and operatories), production levels, available staffing, new patient flow and overall transition plans.  That list is just the beginning and a careful evaluation is really necessary to ensure whether a need or opportunity is really there and, if so, to make sure the addition of another doctor goes smoothly.  If you are contemplating this in the near term, we suggest that you contact a transition specialist to determine your needs.

10. What is Dual Representation and Transactional Brokerage?
Dual Representation is the practice of representing both the seller and purchaser in a brokered transaction and being paid by both. In many states, this practice is illegal.  Not only is it illegal, it is unethical. Transactional Brokerage is the practice of representing neither party, but rather, the transaction itself.  This usually provides shelter for a Broker whereby they minimize their responsibility for accuracy and disclosure.

– Originally published in Dentaltown Magazine, August 2011

Reasons to sell and stay
When we interview dentists who are preparing their exit strategy, the common theme we hear is they still enjoy performing dentistry and communicating with their patients, but they do not like running the business, dealing with insurance companies, and handling staff issues.

Some of the reasons that dentists choose to sell and stay on after the sale include:

➊ They are tired of being a business owner 24/7, 365 days a year.

➋ They have the peace of mind of completing their exit strategy while still practicing dentistry.

➌ We are finding dentists in their 30s to 50s who have good practices, a large debt service, and high monthly payments to the bank, but due to the high debt they find business very stressful and their earnings are not as high as they would like.

➍ Some dentists from ages 50 to 70 do not want to sign another long-term lease that commits them to a space longer than they want it.

➎ Owners with a full-time associate realize that they can switch roles with the associate and stay on after the sale.

➏ Many baby boomers have set a goal of selling their practices after they reach age 55. This strategy allows them to sell but continue earning income and increase savings to offset losses they had due to the economic downturn.

Who are the buyers?

- Dentists who see the opportunities in dentistry and choose to own multiple practices. They are able to keep the selling dentist and take charge of all of the business aspects of the practice, including responsibility for future practice growth.

- Dentists who are in a dead-end associate employee job who are willing to buy a practice now and wait for it to grow so that they can have their own practices. They may continue to work a part-time job as they grow around the former owner.

How to explore the sell and stay strategy

- Choose a transition organization that specializes in practice transitions and does not have other products and services to sell such as dental equipment, financial planning, and practice management.

- Have your practice valued by a qualified transition specialty organization that is experienced in this area.

- Decide what you want to do and what your timetable is. Plan your transition now including how long you want to stay after the sale.

For the dentist who loves performing dentistry and communicating with his or her patients, who is ready to implement a successful exit strategy, selling the practice and staying is an excellent alternative.

Most of you will grudgingly admit that you are going to die. The plan is that it will happen many years after you have successfully transitioned your practice, and that you and your family will be well prepared for the inevitable. That may or may not be the case, but we’ll talk more about that later.

What about the very real possibility that you are forced to stop practicing as a result of a disability? We have recently had clients leave their dental practices as
a result of degenerative joint disease, back pain, mild strokes, and neurological disorders. None planned or expected it to happen, and most agonized over how to deal with it.

One of the problems with a progressive disability is figuring out when to “pull the trigger.” Most of those affected are in the prime of their careers and sincerely want to get better. Unfortunately, as someone’s health declines, his or her efficiency in the office decreases. Patients and staff notice the difference.

Treatment plans may get altered or delayed and productivity slips. As revenue goes down, so does one’s quality of life, and with it, the value of the practice. To top it off, any compromise in someone’s ability to render treatment may increase his or her risk of some potential liability.

At some point the dentist may be forced to deal with some very difficult decisions, and those will be even more painful if they have not done any planning for this very real possibility.

What to do?
First, make sure that you have quality disability coverage. I understand that coverage is available on some policies until age 70. If that option is available to you, consider it, especially since the eligibility age for Social Security is creeping upward. Be sure that your policy is specific to your “own occupation” so that you do not lose benefits in the event of a future alternate occupation.

The next step is the hardest, and that is to be realistic about your future and to take action. Almost no one wants to start a new career or new practice late in life, but if your persistent health issues are eroding the value of one of your largest assets, then steps must be taken to sell or transition the current practice to a new owner.

If competent, informed medical opinion cannot provide an endpoint to your problems, or if treatment is expected to give you no better than a 50/50 chance of a full and productive recovery, then now is the time to act. Practices that have been beaten down by declining production, anxious staff, and shifting patient bases are difficult to sell for anywhere near their predisability value. Don’t make the mistake of hanging on too long. If you ever eventually recover
enough to return to practice, opportunities will present themselves.

In the worst case …
As I mentioned earlier, all of us will die. Hopefully, your death will be long after your dental career ends and you have had many, many blissful years enjoying your grandchildren and hobbies. But what about the possibility that life doesn’t work out that way? What position would you, your practice, and family be in if you were to receive a terminal medical diagnosis? While we would all hope and pray for a full recovery, immediate steps must be taken to get the practice on the market. The sooner the practice can be sold, the better it will retain its value, and more importantly, the less of a burden it will be to you and your family.

Finally, what about the tragedy of sudden death? In our office, we have witnessed the agony of families struggling with disposing of practices after doctors have died from strokes, heart attacks, choking, and motorcycle or auto accidents. You owe it to your family, staff, and patients to prepare for this very real possibility.

Steps to take
Now that you are motivated to be better prepared for an unplanned and unfortunate end to your career, what do you do? This list, while not complete or all-inclusive, should provide a starting point.

1. Have a current will, estate plan, and appropriate medical directives.

2. Obtain a quality disability insurance policy for your “own occupation” payable to at least age 65.

3. Obtain adequate life insurance that at the very least will cover any practice-related debt, including real estate.

4. Tell someone where all of your documents are located.

5. Meet with a dental practice broker. I know this sounds self-serving, but in spite of the fact that we all have attorneys, accountants, and estate executors, I feel no one is better able to quickly get your practice valued and sold. A broker who is familiar with your practice and market will be in the best position to find a buyer, and can even help in finding temporary coverage while the sale is pending.

6. Consider organizing or participating in a dental mutual aid society. John Cahill of Western Practice Sales has written extensively on the subject and has organized groups of doctors who will come to the immediate aid of a fallen comrade. A formal agreement between six to 10 doctors can provide peace of mind by knowing that your practice will be immediately covered in the event of your unexpected loss. (Click here to read an article from ADS Member John Cahill on “The Three-legged Stool” Part I — Part II can be found here)

7. Have a Memo of Direction on file with your estate attorney and the transition specialist/broker to facilitate a quick sale of your practice. This document, executed by the dentist and witnesses, makes it clear who should be contacted in the event you are not able to make decisions about the sale of your practice. A short, proactive meeting will give the broker some insight as to your wishes, and you will know what services he or she can provide. All dentists with any ownership in a dental practice (regardless of age and physical condition) should have this document on file.

8. At least annually, organize important information about your practice as if you were preparing for a sale. A good starting point is financial statements for the last three years, along with a current profit and loss statement, current lease, any contracts you are party to, and a current list of major equipment. The broker you meet with will be happy to provide you with a complete list of necessary documents.

9. Tell someone where your documents are kept. (This is not a typo — it is often the biggest reason for a delay in moving forward as no one knows where anything is kept.)

The brutal reality of sudden death or a medical crisis is something that none of us want to face. I don’t know that any hard data is available, but it seems to me that as many as half of all doctors or their families mayhave some hard decisions to make in the future A little planning now will go a long way in ensuring the continuation of your legacy.

For most dentists a good estate plan will frequently consist of a will, power of attorney, health care directive, and possibly a revocable trust (this list is certainly not comprehensive). Nevertheless, you should consult with your own estate planning attorney to be sure that your particular situation is addressed and state law is considered.

Will
A will allows you to designate where your assets will go, and who will take care of any minor children, administer your estate, establish testamentary trusts, and engage in complicated estate tax planning. Without a will, state law determines who gets your assets, takes care of your children, and administers your estate. Moreover, if you allow the state rules to apply without estate tax planning, it may cost you millions of dollars in estate taxes.

Revocable trusts
A revocable trust is a will substitute that allows you to do the same things you can do in a will, as well as avoid probate proceedings, protect your privacy, and allow for speedier distributions. Revocable trusts are especially appropriate for people who have real estate in multiple states, and for those who are approaching retirement.

Power of attorney
A power of attorney allows you to designate an individual to make financial decisions on your behalf. Without a power of attorney, if you become incapacitated, your family may have to go to court to have a conservator appointed to make financial decisions on your behalf, which is cumbersome and very expensive.

Health care directive
A health care directive allows you to designate someone to make health care decisions on your behalf in the event you are unable to make them for yourself. It also allows you to give directions regarding burial vs. cremation and organ donations. Without a health care directive, your family may have to go to court to have a guardian appointed to make decisions regarding health care.

Asset protection planning
Asset protection planning is often done in conjunction with estate planning. It involves retitling of assets, establishing asset protection trusts, examining insurance policies (property casualty, malpractice, and life), and ensuring that different pools of assets are held in different entities. All of these can provide a great deal of protection from creditors’ claims. Without even basic asset protection planning, creditors can reach the assets that you have worked very hard to earn.

Beneficiary designations
In addition to the above items, typically during the estate planning process you will change the beneficiary designations on IRAs, 401(k)s, retirement plans, and life insurance policies to dovetail with your estate planning documents. This is an essential part of the process and very important to follow through.

Those who do not have an estate plan are leaving much to chance. They are allowing state law to govern the disposition of their assets to other people, and those may not be the people they want to receive their assets. Furthermore, careful estate tax planning can save millions of dollars in state and federal estate taxes on death, which can be avoided with estate planning.

Like dentistry, proper estate planning is good “preventive medicine” for the unexpected. Naturally, we all have the expectation that these unfortunate things will never happen to us. Yet we know of friends, colleagues, and family members who have been stricken by death or disability. No one wishes to leave themselves or their family in a difficult fin nancial situation, thus a proper estate plan is one of the best ways to avoid this difficulty. Estate planning won’t solve all the problems, but it will help preserve your wealth.

The plan involves starting a new retirement program now, using cash from the sale of your practice to fund the retirement program and start living the “good life” earlier. In short, combining the sale of your practice with an employment contract from the buyer may very well produce a better result than continuing to work full-time and trying to sell at a later date.

Recent pension law changes enable a dentist to obtain the highest price for a practice while the practice is at its peak value. Much of the payment price can be deferred into a retirement plan, which will generate tax deductions for the retiring dentist. Actuarial funding levels for defined benefit plans can range from $30,000 per year to $200,000 or more per year, all fully tax deductible and all with the blessing of the IRS. The pension plan law allows the seller to make the maximum contribution without worrying about previous contributions to a defined contribution plan.

By selling the practice at its peak, the seller can obtain a much better price. The price can be negotiated so that part of the sale package includes continuing employment for the number of years needed to adequately fund the retirement benefits under the new pension plan

This is where the services of an experienced sales broker are invaluable. The broker’s task is to evaluate the practice, locate the buyer, and work out the transaction so that all parties benefit. In the long run this means less stress and more vacation time for the seller. Using an employment arrangement instead of a partnership agreement can reduce legal costs and the level of future risk. At the same time, the purchaser will gain from being involved in a mature practice instead of working to revive a declining practice.

If necessary, the retiring dentist can live on other assets while funding the maximum into the pension plan. If the seller is married, anything the spouse earns from separate employment can also be used to cover living expenses during this time. Since a substantial amount of the monies paid to the dentist will not be in the form of current taxable income, this will put the dentist in a lower tax bracket — a tax strategy the accountant will love.

Benefits that the seller accumulates in the plan will be rolled over into an IRA when the seller actually retires. The funds can be stretched out over a number of years and even past the death of the retiring dentist with minimal tax consequences.

The retiring dentist stays on the new company’s payroll. Payments that otherwise would be made to the retiring dentist for the sale of the practice go instead to fund the salary for the seller under the employment contract, and to fund the new pension plan. Since the retiring dentist is likely older than the other employees, the bulk of the pension plan contributions should be made on behalf of the retiring dentist. The result is that substantial monies go into the pension plan for the retiring dentist and are fully tax deductable by the practice.

The time to plan your retirement is long before you actually retire. Recent changes in the law now allow you to shorten that planning timetable. By taking advantage of these changes, you will be preparing for a better life for yourself and your entire family.

Emphatically, YES! Getting a practice at a great price does NOT ensure success, but getting a great value at a reasonable price does. Even the buyers who hire the best transition specialists in the industry confuse the interaction of these concepts. Let’s define each of these terms and discuss how to best deal with the problem in the process.

Price
Price is the easier of the two concepts. Price, as with any commodity, is determined by the marketplace. Currently the national average for the price of a dental practice is approximately 65% of the past year’s gross receipts. This rule of thumb value can range from 50% of gross in rural areas, to 100% of gross in desirable urban areas. Essentially, the local prevailing market will dictate the price. Individual characteristics and specific neighborhoods within a region can produce a local price variance of 10%.

Therefore, price usually falls within a 10% range of variance in the local market. Is that price variance really a make it or break it issue for the buyer?

Quick note: Net profits arguably should be a greater factor than gross receipts. However, in pricing, net profit is generally secondary to the gross receipts multiple. I believe this is the case for two reasons.

First, the gross receipt number is easily apparent, while the true adjusted net profit is not. Second, an argument can be made that each buyer will manage the practice differently, resulting in different profits from the same starting gross receipts.

The percentage multiple has not changed much in the past several years, but the calculation has changed slightly in our current economic environment. Previously, depending on the local circumstances, the price could be based on the best year of the last two or three years.

As most practices have declined in this economy, the market (essentially the banks and the buyers) dictates that the price is determined by the most recent year-end revenues (which have usually declined) rather than previous years’ average. This reality is underscored because lenders may not even finance a practice if the revenues have dropped more than 15%.

Value
This is the most important aspect of the success of any dental transition. Unfortunately, it is totally subjective and virtually impossible for even the best and most well-intentioned brokers, accountants, and consultants to measure.

Case in point: A dentist in San Jose purchased a practice five years ago, where the local rule of thumb gross receipt multiple is approximately 75%. She paid 100% on a practice that was grossing $300K a year. The three-op office was poorly designed with a lot of wasted space and had a very high rent, with equipment and leaseholds more than 20 years old.

Every accountant and advisor told her this was NOT a good transaction, but she purchased the practice anyway. Within four years, she was collecting nearly $1 million and even moved into her own office building when her lease became due!

I could also give you an example of a practice that everybody, including me, thought was the greatest deal in the universe, only to have the practice struggle and the buyer do poorly. My contention is that I could place 10 dentists in either of those situations and I would get results anywhere from bankruptcy to wild success in each practice.

Price is not the issue. Every practice will ultimately sell at its market value if it is properly vested into the market. The price will usually be within 10% of the local average percentage, and yet the ultimate success of the practice usually has little to do with the 10% variance.

Success will ultimately be determined by the “value” of the particular opportunity in the specific hands of the buyer.

Problem
Value is determined by the skill sets of each buyer relative to the skill sets of the selling doctor. Only the dentist is qualified to make that determination. Ultimately, the buyer needs to take charge and own the due diligence process to enable him or her to make the proper decision.

While I fully encourage the buying dentist to hire the best transition team, the dentist is the only person qualified to correctly analyze the pieces of the puzzle as it relates to his or her particular skill set.

Due diligence
It is impossible in a brief article to review the entire process of what is proper due diligence when purchasing a dental practice. I will try to give some guidance below on how a buyer can achieve the goal of assessing the value of a particular practice.

The ultimate question is, What will I likely produce and collect with my skill sets and philosophy after I take over the practice? While I am pleased that most buyers are seeking the advice of good dental accountants, consultants, and attorneys, I am frustrated that many are missing the mark because they are not properly interpreting the counsel they receive as it relates to the real value of the opportunity.

The starting point is the evaluation of the basic financial reports, which include three years each of tax returns, profit and loss statements, and production/collection reports.

A good dental advisor will be able to verify if an asking price is within the normal expected market price range for the area.

A good dental accountant can quickly point out issues that may be of concern from these basic financial documents. The buyer should eventually have a full understanding of any expense that is above or below the normal average for a dental practice; however, the buyer should remember that most accountants simply look at pieces of paper and not the entire picture.

Additional reports may be needed to help clarify issues out of the norm. However, asking for excessive reports on accounting minutia that do not help the buying dentist realize the value of the practice adds cost and time to the process. The dentist should be the person who directs advisors to answer the question, “What is the value of this practice in my particular hands?”

Skill sets: The determining factor
Once the buyer understands the basic financial reports on the practice, he or she should also review the many management reports generated from the practice software. My favorite report is the Procedure Code Analysis. This report generated for the last year will show exactly what procedures were done to get to the numbers that established the price. No two dentists’ skill sets are alike.

The buyer will need to determine what skill sets he or she may lack as compared to the seller. This difference might be made up by procedures not currently performed in the office. For example, it might be safe to say that older doctors seem to do more crowns compared to other procedures.

In general, many young dentists likely attempt more molar endo, extractions, and ortho. Interestingly, none of this really affects the price in a true market, but it does affect the value for each particular buyer. A doctor’s ability to present and close a difficult treatment plan can also make a huge difference in the success of a practice. Closely related to communication skills is philosophy of treatment.

We all have different opinions on how large a restoration should be before full coverage, whether an implant or a fixed/removable appliance is the desired treatment, or when to refer certain procedures to a specialist. An interview with the seller and a good chart audit to help determine who is more aggressive on treatment planning is essential.

Conclusion
Ultimately the doctor, not the consulting team, owns the decision because only the doctor can properly assess his or her clinical, communication, and managerial skills. Value is a big picture question. The small picture mentality needs to be placed in the backseat for this decision, but be allowed to take over after the transition to successfully manage the practice.

While each buyer should hire his or her own trusted team to help evaluate any practice purchase, he or she needs to understand, control, and eventually answer the most important question — Why do I think I will produce and collect similar numbers in my practice purchase?

If value can be answered in a positive way and the price is within the normal local boundaries, then negotiation on price becomes more of a sport than a determining factor in the success of the transition. I believe this process should produce a gut feeling that may be the most important factor in determining whether the buyer should pull the trigger.

Getting a practice at a great price does NOT ensure success, but getting a great value at a reasonable price does!

--
Originally Printed in Dental Economics – February, 2011

• Communication between the seller and buyer BEFORE the transition.
• Communication between the seller and staff DURING the transition.
• Communication between the buyer and staff DURING and AFTER the transition.
• Communication between the buyer and seller AFTER the transition.

Most problems that surface during a practice transition can be traced to a lack of communication on the part of one or the other party, and often with both parties.

As the transition evolves, it is extremely important for the seller to emphasize how the practice operates. It is important that the practice philosophy of the buyer be in sync with the practice philosophy of the seller. If the seller has the laid-back style common among long-term practitioners, and the buyer is very aggressive in his/her treatment planning style, then this could spell disaster for the transition.

Likewise, if the seller is very aggressive in his/her treatment planning and the buyer is more cautious and conservative, then it may very well create financial problems for the buyer. The buyer will not be able to keep up the production numbers of the existing practice.

Additionally, the buyer needs to be comfortable with the treatment procedures that are being performed in the practice. He/she should also have the experience and ability to continue these procedures after the practice transition.

Once the seller has made the decision to transition the practice, it is imperative that this be communicated with the staff, especially long-time staff members. If the staff learns about the transition from an outside source, it can create problems of trust during the transition process, especially if the staff members feel slighted in some way.

By withholding plans, the seller risks offending longterm staff members, and they might conclude that the seller did not trust them to keep the news quiet.

It is important that staff members learn of the transition from the seller. The appropriate time to tell the staff depends on the circumstances of the particular practice. I have found that in most cases it is best to inform the staff once the practice is being actively shown to prospective buyers.

There needs to be a clear vision as to the role the staff will play in the transition, and it is important for the seller to make that role very clear. The seller needs to communicate to the staff how important their role is in assisting the new doctor, and patients must be reassured that the new doctor is capable and caring.

Likewise, the buyer needs to establish communication with the staff once the seller has told them about the sale. The staff will primarily be concerned with job security, salary, and benefits packages. They need to hear from the buyer that nothing will change except the new owner/ doctor.

Once their concerns are put to rest, the buyer should tell the staff the roles he/she wants them to perform in the transition process. The staff’s role in growing the practice as it moves to the next level is just as important as the transition.

In order to guide the staff, the buyer must have a clear vision of the goals of the practice during and after the transition. Oftentimes, an experienced management consultant can be a great resource in clarifying goals for a young buyer. After the closing, communication between all parties becomes even more critical.

The seller and buyer must be sensitive to the needs and issues surrounding each other on all transition matters, but especially regarding patient re-treatment issues. The contract should be very clear and specific on this.

If a problem regarding re-treatment does occur, I suggest that the buyer discuss it with the seller by telephone or personally and not through e-mails or attorneys. Having an open line of communication between parties will resolve most differences in the least amount of time, and at a far lower cost than through attorneys.

In my experience, most issues can be resolved when the two parties sit down and openly and fairly discuss things.

The transition mantra should be: COMMUNICATION, COMMUNICATION, COMMUNICATION.

Navigating the IRS rules regarding goodwill has always been difficult. Recently, it has become even more difficult, especially for those dentists who formed a C corporation. Historically, many dentists were advised to organize their practices as a C corporation due to favorable retirement plan and fringe benefit tax advantages.

Over the years, those benefits became available to all entities, causing C corporations to fall out of favor and S corporations to become the entity of choice. Although C corporations are used less frequently today, many dentists now reaching retirement age and considering selling their practice still operate as a C corporation.

For those of you who practice through C corporations, the sale of your corporation’s assets are double taxed — 35% at the corporate level and 15% at the individual level. Since 1998, advisors have minimized this double tax by taking the position that your goodwill is a personal asset (personal goodwill) and not part of your practice’s assets (corporate goodwill).

They did this by relying on two 1998 favorable tax court cases. Based on those cases, goodwill that is characterized as personal is taxed on only one level at the favorable capital gains rate — currently 15% — and a double tax is avoided on the largest part of the sale, the personal goodwill.

However, this favorable case history is now under attack. In a recent case, the court held that when a dentist (a Dr. Howard) sold the assets of his C corporation practice, the goodwill was not personal, but rather a practice asset (corporate goodwill) resulting in a double tax.

What made the difference? In the two favorable cases, the shareholder-employees did not have a covenant-not-to-compete with the corporation employing them. Unfortunately, Dr. Howard did, and the court ruled against him.

The Howard case
Dr. Howard began practicing in 1972 and incorporated his practice as a C corporation in 1980. At that time, Dr. Howard also entered into an employment agreement and a covenant-not-to-compete with his corporation to obtain favorable retirement and fringe benefits. The restrictive covenant was in effect during Dr. Howard’s employment with his corporation and for three years thereafter.

In 2002, Dr. Howard sold his practice, with his corporation selling the practice assets and Dr. Howard selling his personal goodwill. Of the total purchase price, small amounts were assigned to the tangible assets and Dr. Howard’s covenant-not-to-compete with the purchaser, and the lion’s share to Dr. Howard’s personal goodwill. In challenging the allocation, the IRS recharacterized the sale of Dr. Howard’s personal goodwill as a corporate asset, resulting in a tax deficiency and interest totaling almost $75,000.

Ruling in favor of the IRS, the court concluded that the goodwill was not personal goodwill because Dr. Howard’s corporation earned the income and paid the taxes based on the 1980 employment agreement.

The court also concluded that because Dr. Howard was bound by the covenant-not- to-compete after he sold his corporation, he could not have earned income from a competitive practice within the restricted area. The court noted that even if the goodwill had belonged to Dr. Howard personally, it would likely have very little value because the restrictive covenant radius would discourage patients from following Dr. Howard to a new location.

Lessons to be learned

1. Plan for the sale. Authorize your attorney to review your corporate records to ensure that the goodwill belongs to you and not your corporation. If you currently have an employment agreement with your C corporation (irrespective of, but especially if it includes a covenant-not-to- compete), terminate it — and the sooner, the better!

The covenant-not-to-compete in the Howard case should have been terminated long before the practice sale. This leads to an interesting question: How long before the sale of your practice must a covenant be terminated in light of the shareholder’s ability to terminate it at any time prior to the sale? The court raised the point that Dr. Howard’s covenant-not- to-compete was in effect from 1980 through 2002, and during that time, the goodwill was a corporate asset and not personal goodwill.

Applying the same concept to the sale of your practice, suppose you have a covenant-not-to-compete with your C corporation for 20 years and you terminate it five years before the sale. If the value assigned to your personal goodwill is $500,000, the value could be reduced by four-fifths: i.e., $500,000 to $100,000.Authorize your attorney to review your corporation’s proceedings of incorporator (which should be contained in your corporation’s record book) to ensure that your goodwill was not transferred to your corporation at the time of its formation.

In addition, it may be very helpful to have corporate minutes designating that the goodwill is owned by you personally. This is not bulletproof, but perhaps useful in the event of an IRS challenge.

2. Consider converting to an S corporation. Consider converting your C corporation to an S corporation if you plan on practicing 10 or more years; seven years for practice sales in 2009 and 2010, and five years for sales in 2011. S corporations that have never been C corporations — and C corporations that have been converted to S corporations within the applicable time period prior to the practice sale — avoid the double taxation problem. However, the conversions have complexities, particularly relating to avoiding a double tax on accounts receivable.

3. Authorize an appraisal of your personal goodwill versus any corporate goodwill. The Howard case was lost based on the covenant-not-to-compete that Dr. Howard had with his corporation. Any covenant-not-to-compete you have with your corporation must be distinguished from the covenant-not-to-compete that you would enter into with a purchaser of your practice. If Dr. Howard would not have had a covenant-not-to-compete with his corporation, the question probably would have been, “What is the value of the personal goodwill versus any corporate goodwill and why?” Without this specific type of appraisal — which is a separate appraisal from the appraisal of your practice — you lose.

4. Expect increased audits on the sale of personal goodwill. The IRS is well aware that dentists are avoiding the double tax by structuring the sale of the practice primarily as the sale of personal and not corporate goodwill. Because Forms 8594 must be filed with the IRS by all parties to the sale (you, your corporation, and the purchaser), the IRS can determine whether you sold your personal goodwill. Authorize your advisors to plan in advance to defend why your goodwill is personal and not corporate.

Hypothetically, a very significant factor is: If you sell your practice without a covenant-not-to-compete and establish another practice near your former location, what percentage of your patients would follow you? Usually, all of them.

Factors indicating personal goodwill include your efforts to transfer your personal goodwill to the purchaser, continued limited employment with the purchaser, an introductory letter to patients (and referral sources if a specialty practice), personal introductions to patients (and any referral sources) and a distinction between fee-for-service versus reduced-fee plan payment methods as an indicator of patient loyalty and personal goodwill.

5. Personal goodwill in co-ownership buy-outs. For shareholder buy-outs in multi-doctor/co-ownership practices, it is common to structure the transaction as the corporation’s purchase of your stock at a low value excluding goodwill, coupled with the corporation’s purchase of your personal goodwill. Under the Howard and the two 1998 favorable cases, you cannot have personal goodwill if you have a covenant-not-to-compete with your corporation. However, would not the other shareholder(s) of your corporation’s dental practice require a covenant-not-to-compete from you? This point almost effectively eliminates the buy-out of personal goodwill in multi-doctor/co-ownership practices.In co-ownership cases, this problem is also applicable to S corporations if the buy-out is deemed corporate goodwill and could either cause the termination of the S election due to a disproportionate distribution or be considered as the S corporation’s redemption/purchase of your stock. This would result in a double tax or purchase of your practice interesting after-tax or nondeductible dollars to the purchaser.Another important deterrent to this method is if your practice was formed prior to August 10, 1993, the anti-churning rules apply under Internal Revenue Code Section 197(f)(9) and the goodwill is not amortizable because you and the other shareholder owned the practice together.

Final advice

While the Howard case should come as no surprise, it teaches us some important lessons.

First:
Terminate any employment agreement and covenant-not-to-compete that you have with your C corporation and take steps to ensure that your goodwill is personal.

Second:
Consider converting to an S corporation if you plan to practice several more years.

Third:
If you plan to sell your practice and personal goodwill as a C corporation, obtain an appraisal of the personal goodwill.

Fourth:
Expect increased audits of sales of personal goodwill.

Fifth:
Be very cautious of the purchase and sale of personal goodwill in multi-doctor/co-ownership practices.

One transaction structure is to sell the corporate stock, LLC membership units, or partnership units to the buyer. This is great for sellers as they will usually accomplish long-term capital gain treatment. This is not so wonderful for buyers as they don’t get any tax benefit until they sell the practice at some point in the future. In addition, a buyer is also purchasing any contingent liabilities that may come with the practice.

The more common approach to dental practice sales is to structure the transaction as an asset and personal goodwill sale. With this structure, the seller typically achieves long-term capital gain treatment (currently 15%) on the goodwill sale, but typically pays ordinary income rates (up to 35%) on the asset sale.

The buyer in turn gets some tax benefit through the ability to immediately expense items such as supplies and certain assets up to a limit, and can depreciate/amortize the remaining asset purchase over varying periods from five to 15 years.

What becomes critical in these transactions is the allocation of the purchase price between tangible assets and goodwill. In this scenario, the dollars allocated to goodwill benefit the seller, but alter the tax deduction timing to the buyer because it takes 15 years to amortize the goodwill purchase.

Conversely, the more dollars allocated to assets speeds the tax deductions to the buyers. They can depreciate them over shorter periods (five to seven years), and this is detrimental to the sellers as they typically have to pay a higher tax rate.

What becomes clear is that the objective of buyer and seller regarding taxes can work in contrast to each other. Therefore, when negotiating a dental practice purchase or sale, the purchase price allocation should be discussed along with the price and should be included in the “Intent to Purchase” document that outlines the offer and acceptance.

The allocation of purchase price must be reasonable, and in most cases the IRS will not heavily scrutinize it as long as the buyer and seller report the same amounts on their tax returns. In most dental practice sales, a majority of the purchase price is allocated to goodwill. Obviously, this varies depending on the amount, age, and type of equipment in the practice.

One other item that can affect the tax consequences is how the purchase price is paid. In most practice sales today, the buyer borrows the money from a lender and pays the seller in cash at closing; however, there are still some transactions that are handled with a “deferred sale,” whereby the seller is paid out over time. This obviously has tax ramifications for both buyer and seller.

In many cases, the seller will continue to work for the practice as an associate following the sale. There have been cases where the seller’s compensation has been modified to essentially include part of the purchase price.

This arrangement can be detrimental to sellers as they are paying ordinary income tax rates on the funds received; however, the greatest risk with these arrangements is they are subject to IRS scrutiny because they do not represent the essence of the transaction.

The result is that taxes can have a dramatic effect on both the net purchase price paid by the buyer and net purchase price received by the seller. Therefore, taxes should definitely be a consideration when negotiating a transaction. Both buyer and seller should consult with their accountants and/or attorneys before agreeing to the terms of the sale.