How to Structure Associate Buy In
“Does anybody out there have advice on how to let associates buy in?”
Today’s associates are from a different generation; their values and perspectives are different. They want a greater clarity on expectations and timelines. They have more options and more leverage, and they are looking for a place that “feels” right. Money is key, a foundation piece in any business plan, but so is lifestyle. The high cost of associate turnover is well known and not what you want. So, it’s important for you to know three things: 1) Design an associate agreement that defines the timeline for a potential buy-in. Associates who do not buy-in within a 2-year timeline are building their own goodwill and they can take that with them when they potentially move in down the street! 2) Have a restrictive covenant where they agree not to set up their shop next door and compete within a certain period of reasonable time or distance, reasonableness being the key. 3) Agree on the methodology for a future practice valuation early, so when the time comes to discuss a future buy-in, you have already agreed to the method of establishing your practice’s value.
Associates want to know how the practice sale transition will unfold, how they can afford to buy the practice and how their income will be determined. It is difficult for the dentist/associate looking at the purchase of a practice or portion of a practice to understand that the “purchase of a practice” is an investment and as an investment they are entitled to a certain return on that investment (ROI) over and above any salary. Further, they are typically ill-prepared to understand “the practice” as an investment and don’t know how to read normalized financial statements, let alone how to normalize them or what a cash flow projection is. So they, like you, probably haven’t a clue what the practice’s financial statements mean to the investment value of the practice. Why is this important?
Because as an owner of a practice you would want a certain return for your investment into the practice. You would also want some control. Now, here is the rub, you want both and to get both you have to manage the practice to a profitable business. That includes management of the staff and all the issues that come up around operating a business. If you were not getting a certain return on investment, why invest at all in a practice, why not just be “an associate” and invest in some other market, the stock market or the real estate market for a “passive” rate of return. You avoid all the management stuff, you just do clinical dentistry, you do it very well, and you take your savings and invest passively without all the bother of operating a practice. Sounds good, doesn’t it? Think about it; when it comes right down to it, you either want both a “greater return” and “control” from owning a practice, (that’s why you are buying a practice), or you are just working in the practice as an associate. Associates who remain an associate don’t need both, apparently, or at least at this stage of their career. A good question to ask an aspiring associate is: “What do you see yourself doing in five years, what are your possibilities?”
Assuming you are hiring an associate to eventually buy all or part of your practice, then you would hope that the associate can generate enough practice revenue to pay the agreed upon purchase price, (typically 5-7 years). But, when creating an associate agreement, how do you define the future method of valuation that you will use to establish the purchase price?
There are three primary approaches to the valuation of a dental practice; income approach, asset approach and market approach. The truth is that all three methods are valuable, but for different reasons. One excellent 4-hour CE course that explains valuation and helps you get your head around financial literacy, at least enough to ask good questions and to understand the answers, is ABMD’s course, “Run Your Practice Like A Business, Think Like A CEO”. You can Google it.
“How much money should I pay my associates?”
Make sure that your associates’ salaries and benefits, or percentages of collections are, at the very least, market competitive. If you pay your associates less than market value, then they will eventually figure this out and leave for a place where they feel properly valued. Besides the money, it is about control and this brings us to how much you are selling, 33%, 50% or what have you. It doesn’t matter if you are talking about selling part of the practice or the whole thing. The important thing is to sell what you can of your practice more than once because that is the only way you can capture your goodwill value of your practice more than once and not wait until typically you have slowed down and your practice is not worth as much.
Every 10 – 15 years you will have depreciated down your assets and built up a substantial amount of goodwill, goodwill that you can’t capture unless you sell. Don’t miss out on one of the most missed opportunities in dentistry, and that is selling your practice more than once in your career. Build up your goodwill, then sell it, over and over again.
“What is an example of where lifestyle is important and what are some other intangibles?”
Well, beyond recreation and proximity to friends and family as examples, it is important to communicate your practice’s “vision”, short and long term strategies and the part that the associates will play in these plans. This gives the associate a sense of direction, that the practice has a mission, goals and leadership. Inherent in leadership is the culture of your practice and what sets you apart from the others. This could include any expectations you may have for the associate to become active towards the greater community you serve, to focus on a particular demographic, or simply to be encouraged to “dream” the dream practice, share the dream and to work towards it. Tell the associates as directly as possible what would make them more valuable to your practice. This then would serve as a roadmap to make them feel more secure and see the practice’s “vision” and how they are a part of it. For example, consider a mentoring program where your new associates team up with more experienced ones who will also advocate for them. Or, consider providing CE for learning skills not taught in school, like how to read and interpret a set of financial statements (after all, after you graduate, your report card is replaced by your financial statements and your financial statements can be a wonderful motivator if used in the management of your practice because you will be able to see trends and identify where your operating efficiencies are and where they are not!) and how to ask great questions and how to listen for great case acceptance.
“How long should I have them work as associates before offering them ownership?”
Two years would be maximum; after that, if they are not interested, then they should move along as per the associate agreement that states their option for a buy-in or move-along clause within a strict timeline that you agree to. It they choose not to buy-in, and you retain them, then you run the risk of developing their goodwill at the expense of yours.
“I am also concerned about the tax implications of buy-ins and the best way to avoid Uncle Sam and his lust for our hard-earned money.”
Traditionally, taxes seemed fairly stable. You could count on the tax laws remaining relatively the same from year to year. However, as I note from the Naden/Lean Group at http://www.nlgroup.com/resources/taxtips.htm “the so-called "kiddie tax" was one provision that was unchanged for many years. Recently, Congress changed the kiddie tax rules for the second time in two years. It's very likely that you'll have to adjust your tax plans if you have children in your household.”
And again, from the N/LGroup’s web site, “just this past May, Congress extended the WOTC even further. Under the Small Business and Work Opportunity Tax Act, the WOTC is available through August 31, 2011. If you aren't taking advantage of this credit in your business, now may be a good time to start. The WOTC is designed to help individuals who are economically challenged or who live in areas that are economically disadvantaged. They do so by helping businesses to employ them. Generally, the maximum credit is $2,400 (40 percent of the first $6,000 of qualified first-year wages). The credit is lower if the individual is employed for 400 hours or less”, etc. (And it’s the “etc.” that answers why you need professional advice.)
Or, for example, you can visit the Costin Company 2007 tax changes, http://www.costincpa.com/tax/2007changes.shtml, to see what’s new with Traditional and Roth IRAs, 401(k), 403(b), Health Savings Accounts, Educational IRAs and miscellaneous changes, etc.
The bottom-line being that tax laws change regularly and you need current tax advice and advice specific to your set of circumstances, from a professional.
And remember, anything that helps your practice run more smoothly or efficiently is practice management. Anything that improves the value of your practice, as improving profitability or efficiency would, is business management. Therefore, practice management is business management and you really are an investor in your practice! So, keep in mind that as a business, your number one in expense is your taxes and the best way to save this money is not to spend it. This underscores, once again, why professional tax and management advice is critical.
Good Luck!
Today’s associates are from a different generation; their values and perspectives are different. They want a greater clarity on expectations and timelines. They have more options and more leverage, and they are looking for a place that “feels” right. Money is key, a foundation piece in any business plan, but so is lifestyle. The high cost of associate turnover is well known and not what you want. So, it’s important for you to know three things: 1) Design an associate agreement that defines the timeline for a potential buy-in. Associates who do not buy-in within a 2-year timeline are building their own goodwill and they can take that with them when they potentially move in down the street! 2) Have a restrictive covenant where they agree not to set up their shop next door and compete within a certain period of reasonable time or distance, reasonableness being the key. 3) Agree on the methodology for a future practice valuation early, so when the time comes to discuss a future buy-in, you have already agreed to the method of establishing your practice’s value.
Associates want to know how the practice sale transition will unfold, how they can afford to buy the practice and how their income will be determined. It is difficult for the dentist/associate looking at the purchase of a practice or portion of a practice to understand that the “purchase of a practice” is an investment and as an investment they are entitled to a certain return on that investment (ROI) over and above any salary. Further, they are typically ill-prepared to understand “the practice” as an investment and don’t know how to read normalized financial statements, let alone how to normalize them or what a cash flow projection is. So they, like you, probably haven’t a clue what the practice’s financial statements mean to the investment value of the practice. Why is this important?
Because as an owner of a practice you would want a certain return for your investment into the practice. You would also want some control. Now, here is the rub, you want both and to get both you have to manage the practice to a profitable business. That includes management of the staff and all the issues that come up around operating a business. If you were not getting a certain return on investment, why invest at all in a practice, why not just be “an associate” and invest in some other market, the stock market or the real estate market for a “passive” rate of return. You avoid all the management stuff, you just do clinical dentistry, you do it very well, and you take your savings and invest passively without all the bother of operating a practice. Sounds good, doesn’t it? Think about it; when it comes right down to it, you either want both a “greater return” and “control” from owning a practice, (that’s why you are buying a practice), or you are just working in the practice as an associate. Associates who remain an associate don’t need both, apparently, or at least at this stage of their career. A good question to ask an aspiring associate is: “What do you see yourself doing in five years, what are your possibilities?”
Assuming you are hiring an associate to eventually buy all or part of your practice, then you would hope that the associate can generate enough practice revenue to pay the agreed upon purchase price, (typically 5-7 years). But, when creating an associate agreement, how do you define the future method of valuation that you will use to establish the purchase price?
There are three primary approaches to the valuation of a dental practice; income approach, asset approach and market approach. The truth is that all three methods are valuable, but for different reasons. One excellent 4-hour CE course that explains valuation and helps you get your head around financial literacy, at least enough to ask good questions and to understand the answers, is ABMD’s course, “Run Your Practice Like A Business, Think Like A CEO”. You can Google it.
“How much money should I pay my associates?”
Make sure that your associates’ salaries and benefits, or percentages of collections are, at the very least, market competitive. If you pay your associates less than market value, then they will eventually figure this out and leave for a place where they feel properly valued. Besides the money, it is about control and this brings us to how much you are selling, 33%, 50% or what have you. It doesn’t matter if you are talking about selling part of the practice or the whole thing. The important thing is to sell what you can of your practice more than once because that is the only way you can capture your goodwill value of your practice more than once and not wait until typically you have slowed down and your practice is not worth as much.
Every 10 – 15 years you will have depreciated down your assets and built up a substantial amount of goodwill, goodwill that you can’t capture unless you sell. Don’t miss out on one of the most missed opportunities in dentistry, and that is selling your practice more than once in your career. Build up your goodwill, then sell it, over and over again.
“What is an example of where lifestyle is important and what are some other intangibles?”
Well, beyond recreation and proximity to friends and family as examples, it is important to communicate your practice’s “vision”, short and long term strategies and the part that the associates will play in these plans. This gives the associate a sense of direction, that the practice has a mission, goals and leadership. Inherent in leadership is the culture of your practice and what sets you apart from the others. This could include any expectations you may have for the associate to become active towards the greater community you serve, to focus on a particular demographic, or simply to be encouraged to “dream” the dream practice, share the dream and to work towards it. Tell the associates as directly as possible what would make them more valuable to your practice. This then would serve as a roadmap to make them feel more secure and see the practice’s “vision” and how they are a part of it. For example, consider a mentoring program where your new associates team up with more experienced ones who will also advocate for them. Or, consider providing CE for learning skills not taught in school, like how to read and interpret a set of financial statements (after all, after you graduate, your report card is replaced by your financial statements and your financial statements can be a wonderful motivator if used in the management of your practice because you will be able to see trends and identify where your operating efficiencies are and where they are not!) and how to ask great questions and how to listen for great case acceptance.
“How long should I have them work as associates before offering them ownership?”
Two years would be maximum; after that, if they are not interested, then they should move along as per the associate agreement that states their option for a buy-in or move-along clause within a strict timeline that you agree to. It they choose not to buy-in, and you retain them, then you run the risk of developing their goodwill at the expense of yours.
“I am also concerned about the tax implications of buy-ins and the best way to avoid Uncle Sam and his lust for our hard-earned money.”
Traditionally, taxes seemed fairly stable. You could count on the tax laws remaining relatively the same from year to year. However, as I note from the Naden/Lean Group at http://www.nlgroup.com/resources/taxtips.htm “the so-called "kiddie tax" was one provision that was unchanged for many years. Recently, Congress changed the kiddie tax rules for the second time in two years. It's very likely that you'll have to adjust your tax plans if you have children in your household.”
And again, from the N/LGroup’s web site, “just this past May, Congress extended the WOTC even further. Under the Small Business and Work Opportunity Tax Act, the WOTC is available through August 31, 2011. If you aren't taking advantage of this credit in your business, now may be a good time to start. The WOTC is designed to help individuals who are economically challenged or who live in areas that are economically disadvantaged. They do so by helping businesses to employ them. Generally, the maximum credit is $2,400 (40 percent of the first $6,000 of qualified first-year wages). The credit is lower if the individual is employed for 400 hours or less”, etc. (And it’s the “etc.” that answers why you need professional advice.)
Or, for example, you can visit the Costin Company 2007 tax changes, http://www.costincpa.com/tax/2007changes.shtml, to see what’s new with Traditional and Roth IRAs, 401(k), 403(b), Health Savings Accounts, Educational IRAs and miscellaneous changes, etc.
The bottom-line being that tax laws change regularly and you need current tax advice and advice specific to your set of circumstances, from a professional.
And remember, anything that helps your practice run more smoothly or efficiently is practice management. Anything that improves the value of your practice, as improving profitability or efficiency would, is business management. Therefore, practice management is business management and you really are an investor in your practice! So, keep in mind that as a business, your number one in expense is your taxes and the best way to save this money is not to spend it. This underscores, once again, why professional tax and management advice is critical.
Good Luck!
