Pennwell web 500 325

Does Your Buy-Sell Agreement Have a Diastema?

Nov. 16, 2011
Attorneys Levin and Bogart discuss some of the issues that should be addressed in buy-sell agreements.

by Barry F. Levin, Esq. and Philip M. Bogart, Esq.

One of the biggest mistakes made by dentists in a partnership or group practice is not having a written, thoughtful, buy-sell agreement. A handshake is never enough. Even among the best of friends, disputes arise. Often, solid agreements avoid disputes that otherwise might cause ill will, the dissolution of the practice and, in some cases, litigation (where there are no winners). The time to negotiate and execute the buy-sell agreement is at the outset of the relationship, when the dentists’ interests are most aligned. As time goes on and dentists start to think about retirement, it may prove to be difficult to agree upon all of the details. Then again, while earlier is better; late is still better than never.While many jointly-owned practices purport to have written buy-sell agreements, many agreements fail to address a broad enough range of circumstances and conditions. Frequently, generic “form” agreements fail to capture the true intent of the parties. Though, even the best of buy-sell agreements often contain gaps and fail to address many circumstances. The following is a list of some of the matters/issues which should be considered and addressed:1. Transfers of stock:Can a dentist sell his or her stock to another dentist? Should the remaining dentists have a right of first refusal? If the remaining dentists exercise the right to purchase the stock instead of the third party, how do they structure the price and payment terms?2. Bankruptcy of a stockholder:The buy-sell agreement should give the company the right to purchase a stockholder’s interest if the stockholder becomes bankrupt or insolvent. (Yes, it does happen.)3. Deadlock: What happens if the dentists cannot agree? How will deadlocks be resolved? There are various mechanisms that can be included in the buy-sell agreement.4. Death/disability: There are several considerations here:
  • What happens if a dentist dies or becomes disabled? Is the practice (or the remaining owners) required to purchase that dentist’s ownership interest or, is there merely an option to purchase?
  • How is a “disability” defined?
  • How will the purchase price be funded? Life/disability buy-out insurance? Remember, “disability insurance” is not the same as “disability buy-out insurance.”
  • Ensure that the term of “disability” is defined and, as applicable, consistent with the applicable insurance policy.
5. Termination for cause: If one dentist “misbehaves,” loses his or her license, or otherwise fails to live up to his or her obligations, the practice should have the option — but not the requirement —to buy his or her stock. Consider whether a stockholder may be expelled if he or she fails to meet a specific productivity or profitability threshold.6. Retirement/withdrawal:If a dentist retires, should the practice (or the remaining owners) be requried to purchase the retiring doctor's stock? How much advance notice should be required? What happens if more than one stockholder desires to retire at the same time or a few months apart? Does the senior dentist have the right to retire first? Can the practice owners ever force the senior dentist to retire? These are very real considerations, especially now, as the volatility of the stock market forces many dentists to postpone their retirement. Often, the parties need to grapple with emotional and psychological dynamics, as the senior dentist usually has a very strong bond with the practice; — the practice may be his or her “baby.” At times, the “next generation” may not fully appreciate this fundamental issue. Then again, the senior dentist may have unrealistic expectations about what he or she is “owed” by the next generation.7. Establishing the purchase price:Unfortunately, there is no standardized, universally-accepted formula that the buy-sell agreement can include to establish the value of a dental practice. Many objective factors should be considered to determine the practice value. There are also just as many nonquantifiable subjective factors unique to the dental industry (and to each specialty within the dental industry) that are just as important as the objective factors. So, the parties can agree upon a formula for determining the price. For example, a multiple of the annual collections of the practice. Alternatively, the agreement can simply state that the practice will hire a valuation company to establish the price. Ultimately, although it may be an over-used cliché, performing a valuation of a dental practice is more of an art than a science. Thus, the buy-sell agreement should include a mechanism for choosing a valuation company. Furthermore, the circumstances of a stockholder’s departure should also have a bearing upon the price. The estate of a deceased stockholder would want the full value of the stock. However, if a stockholder is terminated as a result of bad behavior — or if a retiring stockholder does not give the practice enough advance warning — consider reducing the price of the stock to offset the damages the practice might suffer.8. Payment terms:Depending upon the circumstances, there are many ways in which a departing dentist (or the estate) could be paid for the stock. If the practice receives insurance proceeds following a triggering event, the departing dentist (or the estate) will want to be paid in one lump payment. Otherwise, should the practice be required to finance a buy-out through a bank, or could the practice simply pay installments over time? It also depends upon the “fault” of the departing dentist. If the dentist was terminated for cause, perhaps the practice could have the flexibility to pay over a longer period of time. In addition, it is very common for the remaining stockholders to guaranty the payment obligation, and the corporation to grant the selling dentist a lien on the assets of the practice and the stock that was redeemed.9. Restrictive covenants:As a condition to any purchase, there should be a requirement for the outgoing dentist to agree to not compete with the practice and to not solicit the patients and referrers of the practice. Certainly, a significant part of the amount paid to the stockholder relates to the goodwill of the practice; that goodwill “purchased” by the corporation should be protected. In addition, all stockholders should be subject to a restrictive covenant to prevent a stockholder from leaving the practice and opening a new practice down the street. Otherwise, a stockholder could disregard the financial responsibilities set forth in the buy-sell agreement. 10. Personal guaranties: In order for the mechanisms in the buy-sell agreement to work, each stockholder should be required to guaranty the purchase obligations of the practice, as well as the payment of the purchase price. As a result, if the corporation fails to purchase the stock of an outgoing stockholder, the other remaining stockholder(s) would be required to do so.11. Cross-references to employment agreement:A buy-sell agreement should always be linked to, and be consistent with, the employment agreement of each owner. Each agreement should dovetail the other, as there are many inter-connecting pieces including, by way of example, (1) termination for cause provisions; (2) retirement provisions; (3) non-competition provisions, and (4) the definition of disability.12. Practice debt.: The agreement could also address circumstances in which the outgoing stockholder has previously guaranteed the debt of the practice. If the bank is unwilling to release the guaranty of the departing stockholder, the buy-sell agreement may require the corporation and the remaining stockholder(s) to indemnify and reimburse the retiring stockholder in the event the guaranty is ever triggered. 13. Management: The buy-sell agreement may include a management section which provides criteria on how decisions are to be made. Frequently, one dentist may have the day-to-day authority, while “significant decisions” may require a majority or unanimous vote. If that is the case, the buy-sell agreement should include an exhaustive list of “significant decisions.”14. Dissolution: Under what circumstances may the company be dissolved? This issue is particularly important if the applicable law provides rules permitting one stockholder to unilaterally cause a dissolution in certain situations.To summarize, the goal of the buy-sell agreement is to provide the dentists and the practice with clarity, certainty, and a “road map” to how to address a stockholder’s exit and other matters which must be dealt with from time to time. From each dentist’s standpoint, the buy-sell agreement is an integral part of any personal estate plan. After all, the stock is another asset which will be passed on to his or her estate at death. From the perspective of the practice, the buy-sell agreement can facilitate a smooth transition when a stockholder departs. Working with a trusted legal advisor who understands the business and challenges of a dental practice can ensure that the buy-sell agreement is as comprehensive as possible. Agreeing upon these issues at the outset is key to launching a strong dental practice which has understood and accepted ground rules.Barry F. Levin is a partner and chair of Saul Ewing LLP’s business and finance department. Philip M. Bogart is a special counsel in the business and finance department in Saul Ewing LLP’s Baltimore office. Messrs. Levin and Bogart are co-chairs of the firm’s Dental Practice Transitions group and regularly represent dentists — and the business entities in which clinicians practice — in all aspects of the dental practice structure. This includes the structuring,
documentation, and implementation of associateships or employee arrangements, partnership arrangements, acquisitions, and sales and mergers of mature practices. To learn more about Saul Ewing’s Dental Practice Transitions group, go to our website at