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!

Q & A for the ADA's New Dentist

• First, some general advice you often give to new dentists.

I would suggest that dentists should choose to practice where they want to live when they retire. The reason for this thinking is that only about 6% of dentists can afford to retire in a manner to which they have grown accustomed, so they may have to keep working. And the reason they may have to keep working is that a similar percentage of dentists do not recognize the importance of practice management both from a macro and micro level, the ultimate result being a practice not realizing its full financial potential. Micro management is the day-to-day running of the office efficiently with a satisfied staff, and macro management is the dentist taking an ongoing and active role in understanding the financial aspects of the practice as a business, having a plan.

• What are classic pitfalls of inefficiency in the dental office?

One common mistake in monitoring efficiency in the dental office is not relating your expenses to a percentage of your production. For example, there is a world of difference between staff wages and benefits at 20% of production vs. 36% of production. This is a measure of productivity; productivity is the “end game” of efficiency. Know your numbers!

• What common mistakes should new dentists avoid, and how?

A couple of answers:

Make sure your staff is happy. There is nothing like staff who are working for you because they love what they do and because they feel valued. Have staff meetings regularly. Define your ‘vision’ of your practice to your staff and have your staff define ‘their’ vision for you. Work collaboratively to realize your collective visions by establishing goals. Consider hiring a dental coach to facilitate this process.

New dentists should recognize that their practice is an investment, like any other investment and should realize a return (ROI) at least equal to and preferably greater than a passive investment into real estate or the stock market, for example. Before you purchase a new practice analyze it from an investment perspective, i.e. understand the numbers. If the numbers indicate a likelihood of a lower return than you can be guaranteed elsewhere, then why not just be an associate, invest your money passively and not worry about the management of a dental office? Why, because you want security and something to sell in the future. So, once the practice has been purchased, manage it actively, know your returns and recognize that your practice is a business and that practice management is also BUSINESS management.

• Is there a commonsense aspect of increasing productivity that dentist might already know — but not actually do? What would you recommend?

Most dentists already know and recognize that procedures per hour is an important dynamic to productivity, but few recognize that it is the most important clinical dynamic that is within their control. Further, there is no evidence that speed of procedures actually compromises quality of care. There are, “How to Do a 35 Minute Crown Prep” videos and literature out there, however, most dentists don’t take ownership of the fact that they may be part of the problem.

• Any other words of wisdom that you’d like to offer.

My parting comment is rather radical but worth considering and that is regarding one of the most missed opportunities in dentistry - the transition from one practice/one career to many practices/one career. By years 10 –15 you have already depreciated most of the value of your assets and you have built up a significant portion of your goodwill. You can only capture the goodwill value of your practice when you sell. Selling your practice more than once can be an excellent way to leverage your return on your investment into your practice.
Note: This does not necessarily mean you would have to move your family from your community as you could sell ½ of your practice or commute to a new area outside any restrictive covenant. Further, this strategy allows you to capture the value of your practice while it is “peaking” and not sell when you are retiring and typically have slowed down.

That’s it!

Retirement Savings of Dentists in Private Practice

ABSTRACT

Background Retirement planning is an issue that concerns all working people. In this article, the authors present their analysis of the results of a 1995 American Dental Association survey that asked dentists questions about their plans to finance their retirement.
Methods. The ADA's Survey Center conducts a periodic "Survey of Current Issues in Dentistry," which gauges dentists' opinions about a variety of topics of interest to dentistry. The authors analyzed the results of the 1995 survey in which retirement savings was one of the topics.

Results The majority of responding owner/dentists whose primary occupation was private practice (40.7 percent) indicated that they were relying only "a little" on the sales of their practices to finance their retirements. Overall, dentists whose primary occupation was private practice reported saving an average of 10.5 percent of their income specifically for retirement. The average total amount of money dentists invested in various retirement plans increased with age and was highest for the 55 to 59 and the 60 to 64 years of age cohorts. The only exception was the 401(k) plan, in which the peak occurred in the 65 years of age and older cohort.

Conclusions Fifteen years ago most dentists retired between the ages of 60 and 69 years. Recent trends show that dentists are retiring at younger ages. This means that while in practice, dentists must save enough to support themselves for 20 or more years of retirement.

Practice Implications The transition from private practice to retirement can be difficult. Therefore, planning for the future is important. Dentists can benefit from making appropriate decisions based on age, investment goals, risk tolerance, monetary constraints and time until retirement.


Brown LJ, Lazar V. Retirement Savings of Dentists in Private Practice. JADA 1999; 30(8):1210-18. Copyright © 1999 American Dental Association. All rights reserved. Reproduced by permission. For free access to the full text of the article, please click here; http://jada.ada.org/cgi/reprint/130/8/1210.

What Is the Lifecycle of a Dental Career?

By analyzing the life cycle of a dental career we know that the first 10 years make up a period known as the rapid growth phase. At the end of this phase most of the practice’s assets will have been depreciated down significently. The next 15 years will be the peak earning years. Around the 25th year in practice a dentist will experience a slow but steady decline due to his or her desire to work less. According to the past president of the CDA, only 6% of dentists will be able to retire at the age of 65 in a manner and standard to which they are accustomed.

Don't miss out on the most missed opportunity in dentistry, that of capturing the goodwill value of your practice more than once in your career. This is accomplished by selling your practice more than once. For example, by years 10 -15 you have substantially built-up most of your practice's goodwill value and you have depreciated down most of the value of your assets. Think about it, this is the time when your practice is at its optimum value to sell, not thirty years later when you have reduced your schedule and are generally slowing the practice down.

This does not mean that you would have to move from your community, as you could consider selling 1/2 of your practice or all of your practice and commuting to a different area outside of any restrictive geographic covenant.

What Are Some Of The Factors That Practice Value Depends On?

Market Value
Goodwill
Interest rates
Effects of supply and demand in your area
Cash Flow
Expectation of future earnings growth, which can further be classified by:

Prospects for growth from the efficiency of operations

Expense to Gross Revenue (overhead)

Potential to increase production

Increased debt financing to invest (either inside or outside of the practice providing the investment yields a greater return than the cost of borrowed money)

The growth rate of a practice typically ranges between 0 and 20% and can be measured by a modified Return on Investment, (ROI)), as a proxy for the growth rate. Anticipation of the growth in profits makes one practice more attractive than another. An improving trend would signify increased value. It is important to know the reasons for the trend.

What Are Some Of The Problems Associated With A Practice Sale?

There are all kinds of problems or issues that go hand in hand with the sale of a Practice; usually all of them can be solved.

Consider the following:

Taking "positions" in the negotiation of a practice sale could be detrimental to the outcome. Try focusing on mutual interests. The buyer and seller have a mutual interest in that they are both investors, when all is said and done.

Make sure you agree on some fair standards of negotiation, ahead of time. Try to separate the "people" from the "problem", i.e. try not to let personalities get in the way. Focus on the common interests of buyer and seller and use objective criteria during the negotiation process.

Of course, this is the ideal scenario and not easy when it comes to the selling of a practice that you’ve put your heart and soul into and it is equally difficult for the buyer who is about to invest a substantial amount of money into a practice. For this reason, the use of a practice broker is key towards a successful sales agreement. The practice broker frequently demonstrates a "hand-holding" approach. However, it is important to note that the practice broker’s job is to get the very best price for the party he of she represents and to negotiate a successful sales agreement.

Staff Issues

Some of the problems to consider in regards to staff that may arise after the sale of a practice are: What if a staff person is let go following a practice sale? Who is legally responsible for compensation? What if key staff leave? What if the key staff are members of the seller’s family?

Group Practice Issues

Group Practices can potentially pose some specific problems. For example, what can you do to prevent the slippage of patients you purchased as part of the goodwill of the practice, to the other partners? The answer is to have a separate telephone number for each "partner" in the group in order to maintain separate identities. This should preserve the goodwill value of everyone involved in the group. Another thing the buyer has to be aware of is any rights of 1st refusal in a business agreement between the "partners". The potential buyer is an a vulnerable position after having possibly invested money into investigative and due diligence fees, and then finding out that the purchase opportunity could be sold out from underneath him or her to a partner in the practice.

What happens when the seller stays on as an associate?

Other issues to consider revolve around "authority", i.e. who’s in control of the practice if the seller stays on as an associate? Where will the old staff’s loyalties be? What about the transfer of patients to the buyer when the seller stays on in the practice? Part of the answer to these issues could be best addressed if the seller takes a 3-6 month holiday, switches office hours and agrees to reduce services.

Restrictive Covenants

Another concern can be if Dr. A, the seller, has a restrictive covenant with Dr. B, the associate, that says that Dr. B. cannot leave the practice and compete with Dr. A. during a specified time period and within a certain distance to the practice. If Dr. A. sells the practice to an outside purchaser, will the restrictive covenant with Dr. B be transferable to the new purchaser? This should be food for thought.

Seller’s Aged Receivables

How is the collection of the seller’s accounts receivables handled? The seller can deal with this problem alone OR the buyer could purchase the A/R’s for a discount considering the buyer’s time and trouble to collect the seller’s A/R’s and the fact that as the A/R’s age, they are less likely to be collected.

Re-Treatment of Seller’s Work

Sometimes, after the sale of a practice, the buyer has to re-treat "work" that the seller has done. When this happens, the seller should be responsible for all of the expenses needed to repair failed workmanship. To protect the buyer, an agreement should be signed to this effect between the seller and the buyer.

How Does A Buyer Select A Practice From An Investment Perspective?

The typical procedure for selecting a practice begins with an analysis of the entire business as a business. What kind of return on your investment would you be looking for?

Typically, the sources of information for this analysis include company reports, computer databases, and financial statements. This information is used to focus on the fundamental characteristics of the practice. Items including, but not limited to, earnings, book value, cash flow, and capital structure (i.e. how much is owned vs. how much is owed), are all analyzed to develop an estimate of the practice’s intrinsic value.

Once a practice is given an estimated value, this value is then compared to the market or asking price of the practice. If the current market price is substantially lower than the estimated value of the practice (from an investment perspective), then one could say that this practice could offer an above-average chance for profits and is likely a "good deal". If the asking price is considerably higher than the estimated value of the practice, then the buyer would have to seriously consider whether this is a wise investment.

Why Would A Seller Use An Investment Perspective To Value His Or Her Practice For An Eventual Sale?

In reality, both the seller and the buyer are investors. The seller is hoping to realize a good return on his or her investment into the practice and will likely invest the proceeds of the sale into some other investment vehicle. The purchaser is counting on the practice allowing for a good salary and a healthy return on the investment, as well.

Therefore, analyzing a practice from an investment perspective should align the interests of both parties, the seller and the buyer, towards a common value.The process to establish this value involves a combination of different valuation techniques to establish a range of values. From this range of values the seller selects a market price that can be justified to the buyer.

The key point to reinforce is that what both the seller and the buyer have in common is that they are investors. The "numbers" have to make sense to both of them and once that has been achieved, a sale price can be established that is satisfactory to both parties.

How do you know if you will have enough cash flow to service your needs when you buy a practice?

With respect to Cash Flow, it is wise to know what the Cash Flow is from Operations (CFO), how many days does it take for the Accounts Receivable to be collected and what percentage of the accounts are aged 0-30 days, 30-60 days and 60-90 days.

It may also be valuable for you to have your accountant do a Projected Income Statement (Profit and Loss Statement) and a Projected Cash Flow Statement, (Pro Forma), of the practiceyou're considering buying, before you commit to the purchase. Remember, though, that anything that is "projected" is subject to the accuracy of the information going into the analysis. Often it is somewhat biased therefore it is used to "guess" at best-case and worst-case scenarios.

In order to know whether you will have enough cash to run the practice and make a profit, you should "run" the numbers, taking into account that they may be biased to some degree.

What do you need to know about the Practice Sale Agreement?

If the practice were a proprietorship or partnership, then the purchaser would be buying the assets and goodwill of the practice. In Canada, it is important to know that if the buyer were purchasing an incorporated practice, then the sale should be structured so that he or she would be buying the seller's shares of the practice (which is an advantage to the seller as the tax implications are less).The purchaser and the seller have to be aware of the pros and cons of how the practice sale agreement is structured. It is always advantageous to seek professional help in these matters.

In fact, there are three methods to the valuation of a dental practice:

• The Market Approach
• The Asset Approach
• The Income Approach

The truth is that all three of these approaches contribute useful perspectives to value. Most of you are already familiar with the Market and Asset Approaches, with their Rules of Thumb, and commonly used by practice brokers and written about in the dental literature.

If not, then, we can discuss this further when you post your questions.

What exactly are you "buying" when you buy a Practice?

When you buy a Practice, you are buying the Net Income and Cash Flow of the Practice, autonomy and job security, as well as any subjective attributes that have attracted you to the Practice in the first place. Of course Goodwill always plays a key role and the hope for the buyer is that the Practice is a going-concern with lots of ongoing patient treatment plan momentum.

Ultimately both buyer and seller are investors and to arrive at investment value one needs to use the Capitalization of Earning Method within the Income Approach to valuation. Comparing this value to the market price value of recently sold comparable practices in your geographic area is the only way for you to know if the return your were hoping to get from your investment into your practice was realistic and for the buyer, whether or not the asking price represents a good deal when seen from an investment perspective.

The income approach to valuation is the best way to understand you practice from an investment perspective.

What Are The Benefits of Owning A Practice?

Owning a Practice has many advantages: job security, a sense of autonomy, salary (or your draw) and corporate income (if incorporated) or your profit after you’ve paid yourself. Of course another benefit of ownership is that you can "sell" at which time you will receive the difference between your purchase price and the selling price i.e. the after tax sale proceeds. Hopefully you will realize a substantial profit. Buying a practice is a major decision, hopefully you will base that decision on more than hope and a prayer. Do you know how to read financial statements? Do you know what a cash flow projection is? Do you know the difference between servicing the loan, paying the overhead and providing yourself with a resonable salary? Stay tuned...