Wednesday, May 17, 2017
There are many commonalities in deals that fall through, and business owners and potential buyers often fall victim to them time and time again. There are, however, 10 key steps in buying or selling a practice that either party can do to increase their likelihood of having a successful transition.
1. Due Diligence
The parties proceed with due diligence either by: (1) preparing a letter of intent with confidentiality requirements and a right to conduct due diligence prior to drafting the contract, or (2) entering into a written contract that provides for due diligence as part of the terms, with a closing to follow upon satisfaction after due diligence.
The buyer should satisfy himself by conducting a detailed accounting of the practice assets and an inspection of the premises, assets, books and records, tax returns, financial statements, patient charts, accounts receivable, work in progress, personnel files, employment agreements, leases and contracts, list of creditors, insurance policies and benefit plans, and any municipal and other local, city or state approvals required to operate the practice. The buyer should determine the viability of the real estate lease where applicable, ratify the fairness of the purchase price, verify financial data, be satisfied as to personnel contracts and other key contracts, verify clear title to the assets, inspect charts and cross-reference them with billings and procedures, and determine insurance plan participation needs.
2. Lease
A tremendous amount of goodwill attaches to the location of a dental practice. The buyer should not assume a lease is good simply because the seller has been in the location for a long time. He should request a copy of the lease immediately upon taking an interest in a practice and begin an early dialogue with the landlord.
The seller should anticipate a sale and speak upfront with the landlord. It is usually advantageous for the buyer to negotiate a new lease directly with the landlord. The two parties will, in most cases, need the landlord’s consent to the new tenancy. The buyer’s lender will generally require a lease term and/or extension rights to cover the entire length of the loan. If a seller has a short term remaining on the lease, he should organize extension rights and clean up the lease relationship before listing the practice.
3. Financing
Specialty lenders will finance 100% of the purchase price, plus, in some cases, additional money for working capital. This makes for a robust market for financing practice transitions. Financing requires a lien on the practice assets, so if the practice’s cash flow can service the debt, cover the practice’s expenses and provide enough income for the buyer to pay his personal bills, the lender will generally fund the entire deal.
Typically, the rates are at market and comparable to other commercial loans, but the terms may vary based on the ability to service the debt, the debtor’s credit score and the size of the loan. Loan terms are commonly five, seven or 10 years, with equal monthly installments of principal and interest. Larger or multi-practice deals may have longer terms. Because borrowers in the acquisition market expect to receive 100% financing, lenders often have a say in setting the price for a practice during due diligence. Sellers who seek premium pricing are often asked to take back a note and finance amounts in excess of what a specialty lender will lend.
4. Zoning
Consider whether there is a valid certificate of occupancy, and whether local building and zoning ordinances permit its continued use as a dental practice. All municipalities have their own zoning rules and regulations, and copies of their zoning code and zoning map are available. Identify the particular “zone” where the practice is located and review the applicable requirements and prohibitions.
5. Accounts Receivable
The most common ways to manage accounts receivable are:
- The seller keeps the receivables and the buyer collects them as a courtesy or for a fee
- The seller keeps the receivables and collects it himself
- The buyer pays additional consideration and collects the receivables post-closing
Determine early in the negotiation how much accounts receivable the seller has and its aging. The seller generally wants the buyer to collect the receivables and pay them over as collected, but the question is who gets paid first.
The buyer should either purchase the accounts receivable for a fair price based on dollar amount and historic collections performance, or collect it for the seller as it comes in, as a courtesy or for a small administrative fee. The seller may collect the receivables himself, though the buyer risks damage to the practice’s goodwill if the seller adopts aggressive methods to chase patients for payment of old bills.
6. Restrictive Covenants
It is reasonable to require the seller to enter into a post-closing restrictive covenant with a time and geography limitation. The seller receives significant consideration—the purchase price—and the buyer acquires all of the goodwill and, in most cases, takes on significant debt to buy the practice. The seller should be prepared to remove himself from the marketplace. A restrictive covenant of five years is common. Geographic limitations vary depending on location.
7. Transition Period
It will benefit all concerned to have a reasonable transition period; the arrangement should be agreed upon early and included in the contract. Six months is optimal, as the outside buyer will have the opportunity to work with the seller’s patient base for an entire treatment cycle.
At a minimum, the seller should be willing to answer questions and make introductions to patients, staff and referral sources for little or no consideration. If the seller is going to continue to treat patients, however, he will be an employee and should be paid a percentage of collections, less laboratory fees—typically 35%. The buyer should reserve the right to terminate the seller if the post-closing chemistry is not working.
8. Purchase Price Allocation
The purchase price can have significant tax implications for both parties. Typically, in an asset purchase, sellers want to allocate as much of the purchase price as possible toward goodwill. Such allocations receive capital gains treatment, which is a significantly lower tax rate than ordinary taxable income.
Conversely, if allocation is applied toward furniture, fixtures and equipment (FF&E), to the extent the seller has already depreciated such FF&E, he will have to recapture the prior depreciation, which is subject to ordinary income tax treatment at a higher tax rate. Buyers prefer FF&E treatment because they will depreciate the FF&E on an expedited basis and get a faster tax benefit, whereas goodwill is depreciated over 15 years.
9. Corrective Treatment
Make decisions about how corrective treatment will be handled for cases completed prior to closing. Generally, the seller will “warranty” his or her work post-closing for six to 12 months, including the work required and associated lab fees. If the seller stays with the practice, the logistics of corrective treatment are easy. When the seller retires or moves away, however, the parties should agree that the buyer handles the treatment and charges back the cost to the seller at a reasonable rate.
10. Work in Process
There will be a number of monetary adjustments between the parties prior to closing, including cases in process and those not yet finished at the time of closing.
Typically, the parties will establish values for the various open cases in the contract. The percentage attributed to each stage of the case is usually proportionate to the number of steps involved in the case. After determining the value of each stage, review what portion of the overall fee has been paid by the patient at the time of closing.