Thomas L. Snyder, DMD, MBA Managing Partner The Snyder Group, LLC Printer Friendly Version

The Top 5 Things to Include in Your Partnership Agreement

Many dentists today are deferring their transition plans.  Most doctors have lost a considerable amount of their retirement funds and are forced to continue practicing longer than planned.  In cases where there is an adequate patient base, an increasing number of practitioners are forming partnerships, allowing them to continue to practice for several more years, and then finally retiring at a later date. For those considering a partnership, here are some key points that must be included in your Partnership Agreement.

Income Splitting
Income splitting problems have led to partnership breakups.  It’s important that partners be compensated on the combination of personal clinical production and their respective ownership interest. As the senior partner begins to decrease his/her production in the later years, this approach will prevent the junior partner from feeling taken advantage of.  This often occurs in cases where partnership income is shared equally. As we stated in prior columns, we recommend an income sharing formula whereby each partner is paid a percentage of personal clinical production, minus lab, with the balance of available partner income being shared based on their ownership percentage.

Spending Authority Limits
We’ve seen some partners attend trade shows and incur large amounts of debt, particularly buying something on impulse.  This can be prevented by including clauses in your partnership agreement that restricts the amount of money either partner or partners can spend without another person’s approval.  We typically recommend this amount to be between $5,000 and $7,500.  Also include in your partnership agreement that no partner can obligate the partnership or corporation to any leases or other substantial debt without the unanimous approval of all parties.

Inefficient Tax Designed Partnership Buy In
Often we see junior partners purchasing a partnership interest with the senior partner being adversely affected on the income tax side. This typically occurs with internally financed transactions, whereby the selling partner receives a management fee that has to be reported at ordinary income rates. The junior partner, however, gets the benefit of a pre-tax buy-in. In this manner, the seller loses, considerably, had he/she sold his/her interest as a capital gain versus an ordinary income tax classification. To offset this imbalance, we recommend calculating the differential between the capital gains rate and the ordinary income tax rate of the senior partner, and that differential will be added to the monthly payment of the senior partner to offset this imbalance. The junior partner still gets the benefit of a pre-tax payment, which is usually more advantageous than overpaying for the partnership interest in after tax dollars.

Mandatory Buy Out
Too often, we’ve been called in to negotiate situations where the senior partner has difficulty in selling his remaining interest to the junior partner. We believe that this is a two part transition process: a buy-in and a buy-out.  Clearly defined expectations of the junior partner’s intent to purchase the senior partner’s remaining interest at a specified date are necessary. Of course, a buy-out formula should be part of the Partnership Agreement. In the event that the junior partner does not agree to a buy-out, we suggest that the junior partner be assessed a severe penalty in the form of liquidated damages if he/she fails to buy-out the remaining senior partner’s interest.

Partnership Valuation
Often senior partners expect too much for their practice at the end of their career, particularly if they have not been contributing significantly to the practice in their later years. We therefore recommend that a formula be included in the partnership agreement that will penalize the senior partner if his/her production decreases over the last several years of the partnership. Doing so will at least allow the junior partner to pay a fair price for the efforts of the senior partner.  This discount is applied only to the intangible asset portion of the senior partner’s practice value. The tangible assets should not be discounted, as they are an asset of either the corporation or the partnership, and have no bearing on the performance of the senior partner. Of course, the accounts receivable that are credited to the senior partner are also part of the remaining value and would be collected on the retiring partner’s behalf after retirement. 

Properly designed Partnership/Shareholder Agreements must be crafted in order to avoid unnecessary problems and legal costs to avoid failed partnerships.  An “ounce of prevention” is worth a “pound of cure,” and spending the time and money at the beginning of your relationship to have properly designed agreements will go a long way in solving any future problems. 

Dr. Thomas L. Snyder is Managing Partner of The Snyder Group, LLC, a nationwide practice transition and financial management consulting firm. With more than 75 years of experience in the field, The Snyder Group can provide you a full range of services relating to practice transition matters and retirement planning. They can be reached directly at 1.800.988.5674.

If you would like additional help, email Dr. Snyder at drsnyder@thedentistsnetwork.net.

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