The sale of a dental practice to an individual dentist or partnership is typically a one-and-done situation. The seller receives the agreed-upon sale price in cash at the closing table, as the buyer has borrowed funds from a bank for the acquisition price. Unless there are unusual circumstances in the sales agreement, the settlement table may be the last time the buyer and seller see each other.
Bruce Bryen.
Part of the agreement may include a short-term employment arrangement allowing the buyer hands-on introductions to patients. Advisers to the buyer and seller have time to determine the tax liability in advance based on the sales agreement and the fact that there are few, if any, contingencies.
Compare this type of sale to one where the seller normally receives an amount of money at the closing table from the dental service organization (DSO) buyer, and then about half of the sale price is based on incentives the seller must earn to acquire more money from the DSO.
A hypothetical example: On a sale of $1 million, the seller, after paying federal and state taxes of about $400,000, would retain $600,000, unless some high-level, expensive tax planning was sought. In that case, the seller may have a tax of $250,000 and retain $750,000 over a deferred period of time.
The ramificiations of selling to a DSO and taking less at closing but possibly more in later years
Looking at the same hypothetical sale of the dental practice for $1 million to a DSO, the potential exists for earning up to $1.5 million with the buying DSO and possibly much more if the buying DSO is acquired by another DSO, hedge fund, or venture capital firm.
The basic agreement with the initial DSO buyer is that the buyer will pay up to 50% at closing and then offer an additional amount over a period of years that can convert the remaining 50% into much more. Certain incentives will be built into the contract so that if goals are reached by the seller, instead of receiving another $500,000, the seller may receive twice that amount or more.
For example, if the seller has a projected growth rate of $150,000 per year but at year-end accounting, the portion the seller grossed was $200,000, he or she may get a bonus of up to 75% of the increase over $150,000. Of course, if the hypothetical projected revenue was $150,000 the year after the sale, the seller may be penalized financially.
There is usually an employment agreement for the seller, and if incentives are not reached, the penalty may be severe, such as a reduction in the following year's payment. If things are going well and the seller has reached his or her projections when another DSO, hedge fund, or venture capitalist acquires the original DSO, the upside to the original seller can be unlimited based on the original agreement.
What is the actual sale price to the seller if a dental practice valuation must be prepared, for example, for a divorce?
We know that a cash payment used primarily during typical dental practice transitions would not be the reason the seller opted to go with the DSO. It offers such a high range of options through its incentive programs that the payment at closing is a mere inducement to follow the DSO's reasoning for a higher sale price than with the traditional dental practice transition.
The potential for earning an additional 50% -- and possibly more -- with the current DSO and then an additional bonus if that DSO is acquired is a difficult decision to ignore. The downside to the incentive goals, if they are not reached, will usually cause the sale price to possibly decrease below $1 million if the reduction in gross revenue is severe.
It takes a special person with a big enough ego, confidence level, and sense of marketing and capability in his or her own clinical skills to rely on the DSO leaders to fulfill what the guidelines are in the original agreement on their side. Without the administrative chores, the seller to the DSO will usually feel that the aggravation of employee hiring, firing, and worrying about legal, accounting, and insurance details will free up so much time that production levels will have to increase.
There is a charge for everything at the DSO, and its charges are not insignificant. This is because they hope they are hiring the best for each position. Knowing the details of what is being received for the cost can help the dentist determine if that offset against the increase in production makes sense.
A hypothetical example involving a DSO sale price and adjusting it for incentives that may or may not be reached
Using the above hypothetical sale to a DSO, what does a court during divorce hearings think the actual sale price should be?
Starting at $1 million, there must be a reduction in each of the incentives, since they may or may not be reached. If during the second year of operations, for example, the seller to the DSO has a gross revenue of 15% more than anticipated and not 20% more, the incentive payment the following year may drop again.
The essence of the value of the sales agreement can be $1.5 million, $900,000, or even less, or much more. There must be a discount for the downside of the potential decrease in value for the lack of meeting the incentive goals. There also must be a discount based on the DSO's ability to make the payment to the seller based on potential decreases in its value, its ability to arrange financing, and other areas regarding it and the seller.
Bruce Bryen is a certified public accountant with more than 45 years of experience. He specializes in providing litigation support services to dentists, with valuation and expert witness testimony in matrimonial and partnership dispute cases. Bryen assists dentists with financial decisions about their practice, practice sales, evaluating whether to join a dental service organization, practice evaluation during divorce proceedings, and questions about the future or financial health of dental practices. He can be reached at [email protected].
The comments and observations expressed herein do not necessarily reflect the opinions of DrBicuspid.com, nor should they be construed as an endorsement or admonishment of any particular idea, vendor, or organization.
