27 most commonly asked questions on Dental Practice Transitions & Valuations
Our learning videos answer the 27 most commonly asked questions regarding Dental Practice Transitions and were prepared for the AAO Annual Session in Seattle. To learn more about a specific topic, please choose from one of the video links below.
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Would it be better to have a local appraiser?
A local appraiser might be more convenient in some cases. However, the most important thing would be to have an appraiser who is familiar with the practice of orthodontics and also familiar with the legal documents needed to affect the transition. We’ve done hundreds of orthodontic appraisals in all 50 states. Orthodontic appraisals and the documents are based on the UCC, which is the Uniform Commercial Code, and the IRS code (Internal Revenue Code) and they are applicable to all 50 states. The most important thing is to be thorough and specific.
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Do you do on-site visits for the appraisal?
On-site visits are usually not required. The information that we request is easily supplied by the Seller, the Seller’s staff or the Seller’s accountant. There are several reasons why there might be an on-site appraisal. One, the appraiser is not familiar with orthodontic practices and he’d want to go to the site to become familiar with it. There might be another reason, that would be to meet the selling orthodontist first-hand, sort of a meet and greet, which is nice. But one of the reasons is that you can charge more fees. If a normal appraisal costs $5,000 and you want someone to come physically to your office, it’s probably going to cost double. We feel that’s a totally unnecessary expense.
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What kind of information do you request for an Appraisal?
We supply an Engagement Letter to all of our clients, which gives a laundry list of things that are needed. One would be inventories, specifically of Dental Equipment, Office Furniture and Equipment, Office Supplies, Dental Supplies. We also need Photographs of the office from the very front door to the back door. Every surface of every room; just as though we were there. We need a Staff Census. You have to list all of your staff members, how long they’ve been there, their job description, how much they make, what their benefits are. In addition, your accountant should supply Tax Returns and Profit & Loss Statements for the last 2 years. Most importantly, we need to see an Aging Report. The alphabetical listing of all active patients, how much
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Shouldn’t a local attorney draft the documents?
Not all attorneys are familiar with Orthodontic Practice Transitions. And remember, even though I am an attorney, I’ll tell you that attorneys are trained to be advocates. They’re confrontational. They’re trying to get an advantage for their client over the other party. We believe in Dual Representation of a Buyer and a Seller, which is permissible provided all parties agree to it. Remember, I’m an orthodontist first. I practiced 30 years as an orthodontist. I also just happen to be an attorney. We don’t have to reinvent the wheel. We can be more thorough, more specific and more cost effective than most attorneys.
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Do you prefer to work with both the Buyer and the Seller?
Yes. As a general rule, I’d much prefer to work with both the Buyer and Seller. I figure that 3 orthodontists can sit down in a room and decide what is fair for everyone. The desire is to make sure that nobody gains an unfair advantage. I’ve taught Practice Transition law to the orthodontic residents every year since 1997 at the 8 Regional locations throughout the country put on by 3M Unitek. These are Practice Transition Programs. I’ve also given Practice Transition Programs at the AAO. Education is what I believe in. I want to educate my clients and have them understand the deal.
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Tax-wise, what is the best a Seller could hope to do in a Sale?
The best tax advantage that a Seller can hope for is Capital Gains treatment, which is 15% tax on the proceeds of the sale compared to ordinary income tax of 35%. So, that’s a difference of 20%.
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What is the best a Buyer could hope for?
The best the Buyer can hope for, tax-wise, would be to be able to deduct all of the payments as they are made. In other words, pay pre-tax for everything they pay for the practice acquisition.
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That sounds simple enough. What’s the catch?
Tax allocations are required by IRS. It means, if the price of the practice was $1,000,000, they want to say $1,000,000 for what? You know, it has to be allocated to certain things like Stock, Assets, Goodwill, Consulting Agreements, etc. They want to know what that is. The problem is that there’s no one single category that will both give the Seller Capital Gains treatment and allow the Buyer to deduct it as paid (the preferred tax treatment for each).
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How do you then advise both a Buyer and a Seller when they have competing interests?
We go right to where the rub might be. For example, we’ll go to a table and show each of the categories and how that tax allocation might affect the Buyer or the Seller, so that each person knows when they’re having the advantage or the disadvantage. Then, it’s up to us to select different categories that, on balance, even-up the advantages and disadvantages.
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What are the main advantages of Dual Representation?
Clearly, Dual Representation gives you better communication. There’s less hassle, less stress, less time involved and less cost. And when you have Dual Representation, the Buyer and Seller can split the fees. Therefore, it’s a cost savings as well.
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How long does the process usually take?
It usually takes us 100 days from the time that we receive the data from the Seller to do the Appraisal to the time we have Final Documents to be signed. That’s final Associate Employment Agreements and final Purchase and Sale Agreements. 100 days.
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Would you represent only a Buyer or a Seller if the other side has their own attorney? Yes. Frequently we’ll represent one side only when the other side is represented by someone. That’s usually a case in which one of the residents comes out of school, finds a job opportunity and that Seller already has his attorney or has had the practice appraised by someone else and the resident wants us to represent him/her. But it does occur.
I do think I should share with you my story of how I got into this business though. In the late 90s, I was at the NESO meeting in Boston and I was giving a talk on Practice Transitions. A resident from NYU came up after the meeting and said, “would you consider hiring me? Let me work for you as an Associate and maybe buy your orthodontic practice at sometime?” And I said, “well, you know really I’m getting pretty busy doing this Orthodontics and Law at the same time. I’ll tell you what I’ll do. I’ll go home and do the appraisal. I’ll draft up a 6-month Employment Agreement for you, then I’ll do a 6-month Post-Closing Employment Agreement for me. You can buy me out after that first 6 months and we’ll be done.” So, I did that. I sent it to him and he said, “oh, you know you’re in this business. I feel a little uncomfortable with that. Do you mind if I hire my own appraisal firm?” and I said, “no, you know go ahead. As long as you pay for it.” So, he did. But it took 6 months from this competing firm to get their Appraisal done. And they’d appraised it at $17,000 higher than I did! And then he had to pay them $10,000 for the Appraisal Fee as well. So now he’s out $17,000. And then we sent the documents to his attorney because this practice transition firm didn’t have lawyers, so he hired his own local attorney who happened to be his dad’s friend and I supplied that attorney with all the copies of the documents. That meant I had to hire my own attorney. So I had to send copies of the documents to my corporate attorney and they fiddled around, back and forth, months and months.
Not one word had been changed. I drafted all these things and yet we’re spending $75,000 for this process.
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Was that unexpected?
In those days, our fee for the entire deal was $15,000 and that split 50/50 between the Buyer and Seller. $7,500 a piece, not $75,000!
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What did your attorney say?
My attorney tried to explain it by saying that the fees generated had nothing to do with the documents. He said the fees were generated because the attorneys had to go back and forth and argue points of understanding. He said, besides, the total fees were less than what I would have had to pay if I had hired a broker and paid him 10%. Plus, I’d have had to pay attorney fees on top of it. That didn’t make me feel any better, but it did Propel me into Dual Representation. That’s why I ended up being an orthodontist that’s an attorney that does Orthodontic Practice Transitions today.
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When and how do we start the process?
Once a Senior doctor decides that he/she wants to hire an Associate, maybe either to become a Partner or to sell his/her practice, he/she should start looking early. Sometimes it takes a year or two before we can find a suitable candidate.
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If I don’t have a Junior Doctor in mind, can you help me find one?
I speak to all of the orthodontic residents in the United States each year. They submit their email addresses to us for the purpose of contacting them in case any opportunities come up anywhere in the country. As far as the Senior doctor is concerned. All you need to do is contact us, we’ll contact the reps through email, the 3M reps, or we’ll contact the residents directly. We do both.
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Once the Seller has a Resident in mind, where does he/she go from there?
The first step, once a Buyer and Seller have kind of found each other and they come to us, we ask them to fill out wish lists. The wish list is going to tell us what each of them is expecting in the transition. It helps us tremendously in shaping the deal because it’ll ferret out whatever differences there might be. The next step would be to do the Appraisal itself, so that we can determine how the transition should be designed. We established the price before the Junior Doctor comes. We do the first drafts of the Associate Employment Agreement and Purchase and Sale documents, because this will really key everyone in on what the possible areas of potential conflict might be.
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Do Sellers ever just want to put off the Appraisal and Purchase and Sales Documents until later and just do an Associate Employment Agreement now?
It’s not uncommon for Senior Doctors to want to do as little as possible up front with a kind of wait-and-see attitude. This is barely above a handshake deal. It usually says something like this: “Would you come join me for a while? You’ll be my associate. If it works out, then possibly, maybe I’ll offer you something in the future, where you could come in with me. We’ll work those details out later.” That’s a recipe for disaster. That’s not going to work. In fact, I think it would be almost impossible in today’s climate to find a Buyer/Resident who’d go along with that. They want to know specifically what the terms would be. I would come here and work for you for six months, a year, 18 months. Here’s what my pay would be. Here’s what my benefits would be. Here’s what you could fire me for. Here’s what your expectations of me are. Then, if everything goes well (and here would be the reasons why it wouldn’t go well) specifically, to have to meet these criteria, then the buy-in would begin and so forth. All of the specific terms, all of the conditions and all of the remedies need to be spelled out before that Junior Doctor comes to the office.
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How many Partnerships fail once the papers are signed?
Well, actually very very few. In the 12 years that I’ve been doing this, I’ve only had two out of hundreds and there’s one huge reason for that. It’s the process. If you go through the process (the first drafts of Associate Employment Agreements, first drafts of Purchase and Sale Agreements) before anyone ever starts, the failure is going to occur if it occurs at all and they do fail during the “negotiation process,” not once they start. Because all the possible areas of potential conflict known to man from every known transition you’ve ever gone through come up front. We ask the questions, but it sure is cheaper to negotiate up front, air the differences out, resolve them, specify the remedies, if something doesn’t work out in the future, you’re going to be far better off.
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Are there different remedies depending on when the deal fails?
Absolutely. A potential deal could fail during the drafting phase and that’s where we prefer it would fail if it’s going to fail at all, because we have less time, less energy, less money involved in the thing. But, it could later fail during the Associateship period. It could fail later than that, during the buy-in years. And, it could fail even after that, 5 years later, after the full partnership begins. So, you can see there has to be different consequences for when the failure could occur. For example, who’s going to pay the legal fees? What does the Buyer get back during the buy-in years? If he leaves or if he’s fired? How about after they’re partners? How is it split-up? Who stays and who leaves? How is it going to be determined what the price is? How’s it going to be paid? We want no surprises at all, when this is all Ironclad, up-front so everybody understands.
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if a practice is incorporated and 100% is sold at one time, does the Seller keep his Corporation?
Yes. The Seller would keep his Corporation in a 100% Sale. That’s called an Asset Sale, because the Corporation is just selling its Assets. The rest of the transaction involves the Seller, individually. The Corporate Assets are both Tangible and Intangible. Tangible Assets would include the Dental Equipment, Office Equipment & Furniture, Dental Supplies & Instruments, Office Supplies, Accounts Receivable. The Intangible Assets would be Charts & Records. The Corporate Assets are going to amount to about 10% of the total sales price. The 90% is going to be split equally between Personal Goodwill and a Consulting agreement. This is done to equalize the tax advantages and disadvantages to the Buyer and Seller. Goodwill, you’ll remember, is taxed to the seller at 15%, whereas the Buyer has to amortize that over 15 years. The Consulting is taxed to the Seller as ordinary income, but the Buyer can deduct it as paid. So you have a conflict. The Assets, on the other hand, are taxed to the corporation as ordinary income to the extent they exceed the Depreciated Book Value. The Consulting Agreement, here’s the good thing, the Consulting Agreement can be made with the Seller’s Corporation. Therefore, all the payments go to the Seller’s Corporation, the Seller can still deduct business expenses through that Corporation, therefore reducing the income before any W-2 income is reported, so they get a real good tax advantage doing that. So the Seller may elect to finance part of the sale through his Corporation through a Consulting agreement. So we’ll keep that in mind
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How does it work when a Seller hires an Associate that he later sells an interest to and they become Partners?
A Fractional Sale is involved when the Seller decides to sell part of his ownership interest to the Buyer over time. Since this is a corporation that we’re talking about, the transfer unit in a corporation is called Stock and Stock is a good thing for the Seller because the Seller only pays Capital Gains Tax. Stock is a bad thing for the Buyer because the Buyer can’t deduct the payments at all. So, we try to keep the value assigned to Stock as low as possible (usually about 10% of the total sales price) and the way the deal is structured – the Associate Employment Agreement might be a duration of maybe 1-1.5 years, then the Fractional Sale would begin (10% per year for 5 years) – so, if we assume that 50% of the value of the practice being sold is $500,000, 10% would be $50,000 which would be for Stock. That Stock payment would be paid (a portion each year) for 5 years or $10,000 each year for 5 years. The other portion of the sales price ($450,000) would be paid at $90,000 per year for 5 years.
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How does compensation work during the 5 year buy-in period?
Compensation is done this way. First, the Gross Income is collected and all refunds are subtracted. Then, from that number is deducted all of the True Office Overhead Expenses for staff, rent, utilities, etc. (Net Income). The Net Income is then divided into two piles. One pile is split between the Buyer and Seller based on their days worked. So, in other words, if both the Buyer and Seller work the same number of days, they would split that half of the Net Income evenly. If, on the other hand, the Seller decides he wants to take more time off, then he would make less out of that half of the pile. The other pile is split based on Percentage of Ownership. So, in this case you might have a Net Income of $800,000. The two piles would be $400,000 each. If the one pile is split evenly, that would be $200,000 for each owner, whereas the other pile would be split (that other $400,000 pile) would be split the first year 90/10, because in the first year the Buyer is only a 10% owner.
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Where does the payment come in?
At this point, once you’ve divided up the piles as I described, the payment must come in. $10,000 per year is going to be paid for stock and there’s a $90,000 payment for an income differential or a management fee on the part of the Seller. So, we can subtract this $100,000 at this point from the $240,000 that would have been going to the Buyer, leaving the Buyer with a W-2 income of $140,000 for the first year of the buy-in.
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What if the relationship doesn’t work out during the buy-in years?
During the buy-in years, those 5 years after the Associate Employment Agreement is over, if Junior decides he wants out, then he is going to be entitled to get back half of what he paid in. If, on the other hand, the Senior decides he wants Junior to leave, he will pay Junior back everything that he’s paid in.
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How does it work if there’s a split after the buy-in is complete?
After the buy-in years are over and now the Junior and Senior doctors are 50/50 partners and there’s a split, it’s the Senior’s choice. Senior can choose to buy-out the Junior or sell to the Junior his portion, his choice, at the current re-appraised value.
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How does the buy-out work?
The buy-out occurs after the Associate Employment Agreement, After the buy-in (5 years), after the time the Buyer and Seller have been equal partners for a period of time. The buy-out is triggered by either the death, disability or retirement of the senior doctor. At that point, the practice is re-appraised because, hopefully, it’s worth a lot more now. The half that’s being sold by the senior doctor to the junior doctor will be allocated to two things: roughly 10% for stock, the other 90% for the seller’s goodwill. All of that is designed to advantage the Seller at this point. The buy-in, after all, was designed to benefit the Buyer because he didn’t have any money when he was coming out of school. The buy-out is designed to benefit the Seller to even-up the tax advantages/disadvantages of the transaction overall. At the time of sale of the buy-out, it’s an all cash sale. Third-party financing is involved and the senior doc rides off into the sunset, very happy.
- Who should appraise the value of the Practice?
- Is an on-site visit necessary to do an Appraisal?
- What information does the Seller need to provide to have the Appraisal done?
- Who should draft the transition documents?
- Why do you prefer to work with both the Buyer and the Seller?
- Tax wise, what is the best a Seller can hope to achieve in a sale?
- Tax wise, what is the best a Buyer can hope to achieve in a sale?
- Is there a single tax allocation that simultaneously favors both the Buyer and the Seller?
- How do you advise both a Buyer and a Seller when they have competing interests?
- What are the main advantages of Dual Representation?
- How long does your entire process usually take?
- Would you represent only a Buyer or a Seller if the other side has their own attorney?
- Are high fees to be expected when the Buyer and Seller are independently represented?
- How do some attorneys justify their high fees for single representation?
- When and how do we start the process?
- If I don’t have a Junior doctor in mind, can you help me find one?
- Once the Seller has a Buyer in mind, where does he go from there?
- Should the Appraisal & Purchase docs be drafted initially with the Associate Employment Agreement?
- How many partnerships fail once the documents are signed?
- Are there different remedies for terminating the Agreement depending upon when it happens?
- If a practice is incorporated and 100% is sold at one time, does the Seller keep his corporation?
- How does it work when a Seller hires an Associate that he later sells a partnership interest to?
- How does compensation work during the five year buy-in period?
- How are the practice acquisition payments made?
- What if the relationship doesn’t work out during the buy-in years?
- How does it work if there is a split after the buy-in is completed?
- How does the buy-out work?