The three-phase plan
by Barry F. Levin, Esq., and Philip M. Bogart, Esq.
Unfortunately, dentists are not immune from the tough economy and down stock market. As a result, many dentists have postponed their retirement plans or suspended indefinitely any efforts to implement exit strategies. Planning ahead is key; it is never too early. But, it can be too late if you don’t start the process early enough.Of course, there is no “one-size-fits-all” succession plan. This article will present a general discussion of one potential succession plan that a solo dentist may consider as he/she contemplates retirement and the eventual sale of his/her dental practice. Phasing out in three steps
One widespread exit-strategy consists of these three phases:
- The senior dentist hires an associate (a junior dentist) for a one- or two-year term to determine whether the junior dentist is a fit.
- If the parties are still interested at the end of the junior dentist’s initial term of employment, the junior dentist buys a portion of the practice.
- Finally, upon retirement of the senior dentist (or upon certain other events), the junior dentist buys the remaining ownership of the practice from the senior dentist.
While this arrangement is common, there are numerous issues to consider and pitfalls to avoid while carrying it out. For example:Write it down; handshakes do not work.
Some dentists try to avoid lawyers like cavities. Handshakes may technically constitute a legally binding contract, but they rarely work. Even the most trustworthy and intelligent people are well served by formalizing the terms of a dental practice succession plan in a written agreement. In the absence of a contract, chaos can reign. People change, memories fade (often selectively), and unexpected circumstances arise. A trusted advisor with experience in dental transitions is essential to prepare any appropriate paperwork. Remember, contracts help everybody by creating a road map for the transition. Keep in mind there is no template that a dentist can download from the Internet to fill in the blanks. The documents must be tailor-made on a case-by-case basis to be useful.The associateship.
The associateship phase provides the senior and junior dentists with the chance to test-drive the relationship. Will the parties work well together? Is the junior dentist the right fit? How will patients, staff, and referrers react to the new kid on the block? Will the associate understand the importance of marketing the practice?Commitment to buy-in.
Prior to the associateship phase, the parties may agree to some ground rules concerning the associate’s potential buy-in. There are many approaches to this aspect of the transaction. The parties may simply agree to negotiate the terms of the buy-in at a later date (e.g., 60 days before the end of the employment term). Of course, such an agreement to negotiate will not guarantee the senior dentist’s ability to exit the practice. Given this, it is often advisable to at least agree on some general terms that will be operative if the parties agree to become partners. For example, at the outset the parties may agree on the structure of the buy-in and the method for determining the price for the purchase. As the cliché goes, however, the devil is in the details. Thus, at the outset and in the spirit of avoiding unnecessary squabbles, the parties may want to agree in advance to a term sheet or a letter of intent or, in some circumstances, the actual form of agreement. Therefore, if the parties are compatible, the transition to joint ownership will be smooth and not delayed or obstructed by the other professionals negotiating the deal terms.Price for buy-in.
Not surprisingly, determining the price for the practice is typically the major issue of contention. Senior dentists often think their practice is worth more than it is, and junior dentists often think the senior dentist’s practice is worth less than it is. It is prudent for the dentists to establish some basic stipulations relating to the calculation of the purchase price at the beginning of the relationship. Sometimes dentists agree on the purchase price at the outset, even if the initial buy-in will not be effective for a few years.The senior dentist, assuming that the value of the practice will continue to increase, may insist for the price to be established at the time of the actual purchase based upon the practice’s performance, not at the beginning of the associateship relationship. The associate, on the other hand, may argue that the price should be locked-in at the beginning of the associateship phase, as he/she is a key catalyst for any increase in value. The junior dentist believes he/she should not have to pay the senior dentist for the increased value attributed to the junior dentist. While the junior dentist’s argument may be persuasive, the junior dentist is not an owner and the increase in value belongs to the senior dentist. On the flipside, it is imperative to launch the joint ownership right way; it is not healthy for the junior dentist to feel resentful at the beginning of the relationship. No payday?
Dentists interested in selling their practices are normally shocked at the low offers they receive from prospective buyers. (See earlier article entitled, “How much is my dental practice worth? Does it really matter?”) It is helpful to keep in mind that, while the sale of the dental practice can be one part of a retirement plan, the real money comes from regular income derived from practicing dentistry.Payment method.
How will the junior dentist pay the senior dentist? This question applies both at the beginning of the relationship, when the junior dentist purchases his/her initial portion of the practice, and at the end of the relationship, when the junior dentist completes the buy-out upon the departure of the senior dentist. The purchase price may be paid several different ways, depending on whether the senior dentist is willing to be “the bank” or whether the junior dentist will be able to obtain a loan from a commercial lender and pay the senior dentist in cash. If the senior dentist is willing to be paid over time, there may be “tax-friendly” ways to structure the buy-in. It is crucial for both parties to work with their tax advisors to establish a mutually beneficial buy-in structure.Managing the partnership relationship.
The parties will need agreements governing their relationship to work effectively following the junior dentist’s initial purchase. These definitive agreements typically address several matters, including:
Guaranteed exit strategy.
- Salaries and distribution of profits
- Responsibility for expenses
- Terms of employment
- Decision making
- Restrictive covenants (non-competition agreements)
- The timing of the senior dentist’s final exit
Upon selling a portion of the practice to the junior dentist, the senior dentist relies upon the junior dentist to ensure the senior dentist’s retirement. While there are no guaranties, the senior dentist may wish to include certain provisions and protections to increase the likelihood of the junior partner’s compliance with the senior dentist’s exit plan. For example:
The final exit.
- Where permitted, a strong non-competition and non-solicitation agreement to prevent the junior dentist from leaving the practice and setting up a new practice in the same community should be included.
- In the event the junior dentist breaches his/her obligation and departs from the practice, that departing dentist should not have the ability to demand the fair market value of his/her interests in the practice. Rather, as a deterrent, the departing dentist may only receive a fraction of the fair market value.
- Where the buy-out obligation is a company obligation, the junior dentist may be required to personally guarantee that requirement. In some situations, it may be helpful to require the spouse of the junior dentist to guarantee the payment obligation, as well.
- Life insurance or disability buy-out insurance may be purchased on the lives of both dentists.
The final buy-in by the junior dentist and the departure of the senior dentist may occur upon certain events, for example:
- Death or disability of the senior dentist
- A mandatory retirement, where the senior dentist must retire by a certain date
- A voluntary retirement, where the senior dentist may retire after a certain date
In conclusion, when all the factors are aligned and the senior and junior dentists are committed to the transition of the practice, the three-phase plan has proven to be an effective one. However, for many dentists flying solo for several years, it is a huge leap to welcome another owner into the practice. That’s why it is important to work with legal counsel who understand the unique challenges of transitioning dental practices, and who have successfully helped numerous other dentists meet these challenges.
Barry F. Levin is a partner and vice chair of Saul Ewing LLP’s Business Department.
Philip M. Bogart is a special counsel in the business department in Saul Ewing’s Baltimore office. They represent dentists, and the business entities in which clinicians practice in all aspects of the dental practice structure through and including the structuring, negotiation, documentation, and implementation of associateships or employee arrangements, partnership arrangements, acquisitions, sales, and mergers of mature practices.