One of the many changes that is occurring within the dental profession today is the increase in the phased-in transition scenarios. Why does this appear to be on the rise with professionals known for being primarily independent, solo entrepreneurs, who build successful practices and retire by selling 100 percent of their practices? Many dentists have developed large practices with more growth potential, but are at the maximum capacity relative to how hard they want to continue to work. Many of these individuals are not ready to fully retire, but, at the same time, they do not want to shoulder the full load of practice management and do not want to see their practices stop growing. As a result they are looking for a qualified associate to share their success and, jointly, move the practice to the next level. So, let’s say you have identified the right associate, and are going through the initial buy-in stages. There are two key issues that need to be discussed and resolved before the process is implemented and contracts signed:
- How will income be divided between the two parties?
- How will the value of the practice be split, at death, disability, retirement or voluntary withdrawal?
There is no right or wrong solution to these two key issues; but, they must be addressed and both parties must agree to how the income and value will be split in the future. For this article, I will assume the buy-in is for 50 percent of the practice and the two parties own equal shares. In an ideal world, both parties will produce about the same income and the issue of splitting the income will become a non-issue. However, since this scenario may be unrealistic, this issue needs to be resolved prior to finalizing the contracts.
Although there are always multiple options, normally the parties will agree to split a fixed percentage of the income 50-50, with the balance of the income split based on each individual’s collections as a percentage of the total collections. For example: If net income is $400,000, the first 50 percent of the income after practice expenses ($200,000) is split 50-50, with each doctor receiving $100,000. The balance is split based on individual collections. Let’s say Dr. A. produced 60 percent and Dr. B. produced 40 percent. In this scenario, Dr. A may produce/collect more in the beginning, but he will produce/collect less as he scales back his work schedule. Dr. B will take home more income as his production/collections increase due to more days worked and Dr. A’s decreasing work commitment.
The second issue can be more complicated, since it is an event that is going to occur sometime in the future, usually when the original owner-doctor (Dr. A) is working less and the associate (Dr. B) is working more. The natural tendency is to expect that because Dr. B may be producing 60 to 70 percent of the total production in the practice, he should get 60 to 70 percent of the value placed on the practice.
This can be resolved in a number of different ways. Dr. B purchased 50 percent of the practice originally and the practice is now owned 50-50. So, to me, the value placed on the practice in the future should be split per the ownership percentage. If the parties discuss and agree to this at the beginning of the process, it normally does not become a problem. This is fair, in most situations, because Dr. A has voluntarily cut back his time in the office to the benefit of Dr. B, who can pick up Dr. A’s production and will receive a higher portion of the net income as a result. Dr. A could also bring in a second associate and allow him to work part of his half of the practice, clearly not as advantageous for Dr. B, since Dr. B will not get the production and related income.
The important concept is that the parties to this type of transaction must think ahead and attempt to anticipate the future. For those of you who are involved or are contemplating this scenario, establishing a workable plan with proper guidance is essential.
John M. Cahill, MBA, of John M. Cahill Associates has more than 30 years of experience in the dental industry, including all aspects of appraisals, sales, purchases, and buy-ins in connection with dental transitions. Cahill is a member of American Dental Sales, Inc., and can be reached at (510) 844-0330 or by email at firstname.lastname@example.org. See the classified ads for names and addresses of ADS members in your area.