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Issue #34 - 12.4.07
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The Deferred Buy-In / Buy-Out
A Wave of the Future
A deferred buy-in/buy-out is fast becoming a common practice transition strategy. With more practitioners realizing that there will be increased competition for qualified purchasers developing a pre-determined transition plan for a buy-in or buy-out is a prudent strategy.
When designing a deferred transition plan, it is wise to establish a baseline practice value within the first year of the relationship. This is particularly true if your candidate will be practicing on a full time basis. Associates do not like paying for something that they help grow. If you have untapped potential in your patient base your associate will be able to thrive and revenues can increase 15 to 25% per year in the first few years. So, if you establish a baseline value and let your associate work as hard as possible you will not be penalized for what you may think you’ll lose if you wait and have the practice valued a few years later at the time of the transition event. If you have done your associate economics correctly you should generate a 30 to 35% profit margin. For example, if your associate generates $300,000 annually, that is a $90,000 to $105,000 increase in your net income per year! So using a baseline value is not such a bad idea.
Some of the key ingredients to a properly designed deferred buy/in – buy/out are:
“Locking in” the Practice Value: The practice’s intangible asset value, (goodwill, location, covenant, reputation, etc.) which typically comprises 75% of a dental practice’s value, remains the same except for a cost of living adjustment made at the time of the buy in or sale. We use the Bureau of Labor Statistics CPI adjustor to determine the present value of the Intangible Asset Value. Tangible assets (equipment, supplies, leaseholds, etc.) will be re-appraised at the time of partnership or sale to account for “ wear and tear” of existing equipment as well as the purchase of any new equipment or technology since the baseline valuation.
Contract Agreement Preparation: All agreements should be prepared within 6 months of the associate/employment phase. The associate’s employment agreement should, however, be prepared prior to employment. Additional documents needed would be either Stock Purchase or Partnership Interest Acquisition Agreements. These documents should be prepared in their entirety, but will not become effective until the actual transition occurs. All issues relating to your professional relationship need to be addressed now by both parties. Some of the major issues include: income splitting, tax allocation issues, rules of business conduct, retirement age, and early partnership or shareholder withdrawal, Shareholder Agreements and Shareholder Employment Agreements are required in situations where a Professional Corporation is formed. For those practices functioning as a Limited Liability Corporation you will need an Operating Agreement.
Future Valuation Issues: This is the trickiest part of the deferred buy-in/buy out transition. We have found that many “junior “ partners lose interest in purchasing the remaining interest of their “senior “ partner either because they do not want to incur additional debt, or feel they may be “ overpaying “ for the departing partner's interest. To avoid this situation, we recommend that formulae be included in your agreements that will state exactly how a future value will be calculated. Not only is the future price of the retiring partner addressed but also what appropriate discounts should be applied in the unlikely event of disability or death of either partner. We recommend that if the senior partner is not contributing at the same level of production than in the past, an adjustment to final buy-out value is appropriate.
Consideration Payment: If you adopt a “deferred transition” strategy, the host doctor has effectively taken the practice off the market so it is not unreasonable to request a down payment as consideration for this action. Realistically, this request is not always made for many partnership opportunities, although, based on the host’s age, it may become necessary. If the associate changes direction and wants to back out, there can be an economic loss that may be hard to recover if the host’s retirement plans are fast approaching and no one is available to succeed him/her. In the case of a deferred sale, this payment is a must! By structuring win-win agreements a long-term deferred practice buy in/ buy out can be quite successful for both parties.
The Snyder Group provides a vast array of practice transition services. Please visit their website for details.
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