When you are evaluating a practice, you may be told that there are a certain number of “active” patients in the practice. That term “active” is one of my least favorite terms when trying to evaluate or sell a practice. One person may define “active” as having been in the office once within the past 24 months. Another person may define it as the patient having been in the practice once in the last 12 months. And yet a third may say the patient is “active” because they came into the office at one point or another while the doctor was practicing. It doesn’t even matter to them how long ago it was, or if the patient is even alive. If I were in your shoes, I would throw out what anyone says and count the charts myself. If the practice is digital, I would look at the number of hygiene appointments seen in the past 12 months and divide by two to get the number of active patients seen that year. You can gross it up by 50% to account for walk-ins and other types of procedures, but that should give you a ballpark of the number of active patients. Another quick rule of thumb is to divide the annual collections by $1,000. A practice producing $500,000 per year, should have in the neighborhood of 500 patients ($500,000 divided by $1,000 per patient)
Patient demographics is another thing to be aware of. Buyers often blow off a practice that has an aged patient demographic. Little do they know that a lot of elderly patients pay cash for their treatment and they still want their treatment. They also have more required work than patients that are in their 20’s, 30’s and 40’s. These patients are very profitable patients.
Hopefully looking at these two areas of patient demographics will help you make the right decision when evaluating a practice.
The reason you would consider doing a merger is because you get all of the revenue and current patients from the new practice, but you don’t get all of the expenses. You don’t bring over the fixed expenses like rent, telephone, electricity, etc., You already have those in your practice and don’t need to incur them again when you bring over the practice you just acquired.
As an example, say you own a practice that collects $600,000 per year. Youhave overhead of $390,000 with 30% of the overhead in fixed expenses – rent, utilities, insurance, etc., Another practice comes on the market that collecting $500,000 with overhead of $325,000 with fixed expenses again at 30% or $150,000. You purchase the practice for $350,000 giving you a debt service payment of $3,500 per month. You work closely with the broker to ensure 100% of the patients transfer to your practice. Your practice now goes from $600,000 up to $1.1 million in revenue. You incur the variable expenses of the second practice, but you do not incur the 30% fixed expenses of $150,000 because you already have rent, utilities, insurance etc., at your current office. In essence, you just gave yourself a $150,000 raise, less $42,000 in debt service and dropped your overhead to the neighborhood of 55%. It would take you much longer to do this if you just did marketing and advertising. By consolidating practices, you get instant growth and income. If you have a practice for sale near you, you should consider merging it into your practice in order to achieve quick growth.
- Find a practice. Finding a practice isn’t hard. Finding a good one is. Get in touch with all of the brokers and get on their e-mail lists.
- Begin speaking with banks that specialize in dental practices.
- Review the documents the broker sent you. You should get a prospectus that gives a decent summary of the practice along with demographics. You should get at least 3 years tax returns, profit and loss statements, production by procedure report, production by provider report and an accounts receivable aging balance. And, that’s just the start.
- Review financials with your accountant. Or, if you minored in accounting or understand numbers, you can review them yourself.
- Make your offer and negotiate. Don’t low-ball the offer unless you know they may accept any offer. A good practice will go quick, so wasting anytime will result in missing out on the practice. Add your contingencies in the letter of intent. Review with an attorney.
- Do your due diligence – review charts, x-rays, staff pay and benefits, equipment, UCC filings, the reputation of the doctor and practice, state licensing review on the seller, etc., Get in as deep as you can.
- Review the lease. Make sure it’s not too high, no tear down clauses, lease expiring, etc.,
- Begin legal review of agreements. Get your attorney involved. Choose a good dental attorney.
- Complete the Omni 70 point checklist for closing the sale of a practice.
- Hold staff meeting to be introduced as the buyer
- Work through escrow in closing the sale.
- Begin your new life as a practice owner.
As you can see from this abbreviated list, there’s a lot to do. You can go it alone and swim with the sharks, or, you can have our Buyer’s Transition Consultant help you through the process.
Stock Sale. If you are incorporated, sale of the stock in your corporation to the dental practice buyer can potentially yield you the greatest tax savings, because the sale of stock is almost exclusively taxed at the lower fixed capital gains rate as compared to the higher, tiered ordinary income rates. However, and this is a BIG however, stock is a non-depreciable asset to the buyer. As such, the dental practice buyer is not able to write off the sales price and essentially ends up buying your practice with after-tax dollars. Consequently, a buyer is likely only to agree to buy your stock if you are willing to reduce your purchase price by 30 percent or more. For this reason (and many associated legal and liability complications), almost all dental practices are sold as “asset sales.” In other words, the seller retains his/her corporation and all of its stock and instead sells all of the tangible and intangible assets of the corporation (i.e., the dental practice). The buyer is then able to depreciate and amortize (write off) the entire purchase price.
Price Allocation. The IRS requires the total price of a dental practice for sale to be allocated to the various types of assets being sold and that the allocation be made according to the fair market value of the assets. As a general rule, the tangible assets are taxed as ordinary income above basis, and the intangible assets are taxed as capital gains. (Above basis means the difference between what you are selling the tangible assets for and your book value or depreciated value.) Any consideration for a covenant not to compete will also be taxed as ordinary income. Since fair market value is somewhat subjective, there is some room for negotiating the overall allocation of the purchase price. As a dental practice seller, you will save taxes if you can negotiate with a buyer for a lower allocation to tangible assets (equipment, furniture, fixtures, supplies, etc.) and a higher allocation to intangible assets (goodwill and patient records). (Unfortunately, it will benefit the dental practice buyer to have just the opposite allocation, so consideration must be given to making the allocation fair to both parties.)
Carry back a note. Sellers frequently ask us, “Won’t I save on taxes if I self-finance part or all of the sales price (i.e., carry back a promissory note from the buyer)?” The answer is, “No, but maybe . . .” As mentioned above, the portion of the price in an asset sale that will be taxed as ordinary income will be due in the year of the sale. That recapture will be taxed regardless of the receipt of any actual cash at closing, which means you owe the ordinary income tax associated with the recapture even if you do not receive a cent at closing. Consequently, if you do not want to have to pay to sell your practice, it would be prudent to ask for enough of a cash down payment to cover the tax liability you will incur from the recapture. Since most of the remainder of the sales price will be taxed as capital gains and since the capital gain tax rate is a fixed rate, the same tax will be applied and the same tax amount owed whether you receive that portion of the price now or paid to you over time; unless . . . there is a change in the capital gains tax rate before the note you are carrying is paid off. If the rates go up, you would be taxed at that higher rate on that income as it comes in. Otherwise, self-financing a portion of the price serves only to defer capital gains tax, but it will not lower the total tax. (Also note that the interest portion of any promissory note payments will be taxed as ordinary income to the holder, while the principal portion subject to capital gains will be taxed at the capital gains rate.)
Sale Timing. As discussed above, the tax associated with recapture over basis on the sale of tangible assets will be determined by your ordinary income tax bracket in the year of the sale. If you are planning to retire after the sale of your practice and, consequently, will have a drop in your ordinary income level, it may behoove you to strategically time the sale of your practice until after the start of the next tax year. Also, if you have owned your dental practice for less than one year, you should, if possible, wait at least one full year before selling it since the sale of goodwill within a year of ownership will result in the higher short-term capital gains rate being applied instead of the long-term capital gains rate.
“C” Corporation Consideration. If you are currently incorporated and being taxed as a regular “C” Corporation, the sale of goodwill by your corporation will likely be subject to double taxation, once as capital gains inside your corporation and then again as ordinary income when paid as a distribution to the shareholder(s). There is some case precedence that allows for the shareholder(s) of “C” Corporations in closely held and professional businesses to sell goodwill individually, outside of the corporation, thus avoiding that double taxation. If this applies to you, consult with your CPA and/or tax attorney regarding the details of such a tax strategy and its application to your particular situation.
1031 Exchanges. If you are selling a dental practice now and are planning to buy another practice within six months, a 1031 or “Like Kind” Exchange may be a tax deferral strategy to consider. It allows you to defer the taxes associated with recapture over basis you would otherwise incur with the sale of your tangible assets. A 1031 Exchange has very specific and rigid requirements. Consult with your CPA and/or tax attorney regarding the details of such a tax strategy.
Charitable Remainder Trusts. Charitable Remainder Trusts are not subject to capital gains tax. As such, a seller may potentially eliminate capital gains tax on the sale of his goodwill by donating it to a qualified charity. The downside, obviously, is that the seller must donate the goodwill proceeds to that charity. This is another strategy where you would want to receive guidance from your CPA and/or tax attorney.
First off, have you ever calculated the cost of acquiring a patient via old fashioned word of mouth? It requires a lot of work if you include everything from building your brand, training your staff, maintaining a spotless, high-tech practice, etc., the cost could easily be $1,000 per patient. The cost of acquiring a patient via marketing is even more. Acquiring a practice with existing patients can typically run from $800 per active patient to $1,000 per active patient. Slightly less to maybe equal of acquiring a patient through a normal channel. However, you get a high volume of patients very quickly.
Secondly, you acquire a stream of revenue at a near dollar to dollar relationship. If the selling practice is producing $500,000 per year, you should be able to repeat the $500,000 in revenue by merging the practices together, or worst case, slightly below the $500,000. The good news, is you don’t bring over all of the expenses of the selling practice. You typically can save in a number of ways including reducing staff of the selling practice, utilities are not double as the practices merge to one location, there is only one rent payment (more on that in a minute), only one set of books, so only one payroll service and one bookkeeper and accountant and several other services can be eliminated. So, while getting the majority of the revenue to increase your practice collections, you only get a portion of the expenses. This increases the income of the practice owner – you!
Regarding rent, you may initially have to bite the bullet and take on an additional rent. A perfect scenario is when the seller is month to month on their lease, or a short period left on the lease. But, if there is a longer period of time left on the lease, you can evaluate the location to determine if it can be sub-leased. Another scenario may call to take on the second location for a few years while the lease runs out. This dilutes the savings, but still allows you to increase your collections.