Understanding the significance of dental practice valuations during covid-19

by Bruce Bryen, CPA, CVA

While always important, during the pandemic, the “buyer beware,” phrase takes on more meaning. 

Who would acquire a dental practice without some due diligence?  During the period of the virus’s economic effect on all businesses, it is especially important for the review of the dental practice valuation and the significance it plays on the soon to be made purchase.  The potential buyer will certainly have his or her dental CPA and financial advisor carefully study the valuation and have these experts offer comments about the loss of business during the virus’s turmoil and the upside that the practice has achieved in the past for comparison.  The growth record of the practice under consideration and its prior trends of revenue and operating profit will be an important aspect during the analysis and reporting of the valuation and its methodologies. The detail presented will assist the buyer in determining that the dental practice can achieve enough earnings to pay the practice acquisition debt and support enough profit for the willing buyer to see the upside to the potential purchase or an offer will not be made.  Even though the losses may have been significant during the time of the pandemic, the valuation should offer what the purchaser needs to see to be able to make his or her decision with a degree of financial certainty and confidence.   The reduced amount of patients and the speed at which the current owner has been able to lessen costs will have contributed to the most recent profit and loss statement.  The practice worth as a whole should be presented in the valuation so that past earnings and recent activity won’t distort the value of the practice for the owner or a possible acquirer.  

Some of the items that need understanding:

One of the most critical issues for a buyer to understand is the actual or normalized earnings of the dental practice.  An experienced buyer or one who is not but who has a dental CPA or financial advisor with expertise in the field of dentistry will look at the schedule of normalized profits to see what the dental practice has really earned during the last few years.  When the owner’s perks are added back to the profit, the actual earnings available for debt service and for the buyer’s income will be revealed.  Sometimes the owner will have his or her dental practice pay for personal items like telephone charges and travel to seminars that are not needed to run the practice.  If these charges are written off for tax purposes, they reduce the amount of earnings that are shown in the practice profit bottom line.  Sometimes rent is increased to reduce the social tax effect for the owner and as another way to withdraw profits from the practice. Any excess above fair market value of the rental in the area should be added back to the bottom line to increase the profit. If practice salaries to the owners’ family and himself or herself are included on a higher than normal basis to also reduce the taxable income of the practice, these excess salary items should also be added back to the profit.   Along with these excess salary amounts, the additional payroll taxes and retirement plan benefits should also be included in the normalized profit.  These and other similar items when added back to the profit of the dental practice allow a potential buyer to understand what is available from the practice for use in paying off the debt used to acquire the practice and for supporting his or her own family after the acquisition has occurred.  Any item that is not needed to successfully operate a dental practice should be included in the normalization of profit schedule for each year used to evaluate the worth of the dental practice and will almost always increase the profit and its value.

How has the dental practice evaluator presented the covid-19 results? How has the dental practice value been effected by the evaluator’s formula?  

The evaluator’s experience and understanding of debt implications are necessary attributes in the determination of which expert to retain for the completion of the dental practice valuation.  A normalization of debt and the interest charges for the potential buyer should be included where the covid-19 effect is comprehended. How much weight the report assigns to the results during covid-19 compared to the prior years operating amounts is critical to understanding what the buyer is actually buying.  As an example, if the prior years’ gross revenues were on a downward trend, an assumption will be made that the pandemic is not the only cause for the decrease in gross revenues and profits.  Since the normal operations were producing less prior to the virus appearing, a good guess would be that the lower operating results were merely continuing.  Even though a reduced value using the pandemic as a result may be a lesser overall practice value, there would have been a lower valuation result anyway based on the trends produced in the practice in spite of the virus’s effect.  Conversely, if the dental practice had consistently produced higher gross earnings and net profit as the practice was on an upward operating trend, the results of covid-19 should not have produced a substantially less attractive dental practice valuation.  These items are necessary for the evaluator who is to be retained to discuss with the owner prior to the valuation being undertaken.  The independent evaluator will answer the questions of the owner honestly but any coercion into preparing a valuation that is not independent of the owner or anyone else’s opinion is forbidden.  Even though it may be tempting for the owner to attempt to influence the evaluator’s opinion, if the result of the valuation was biased, consequences would result. If the buyer or seller ever decided to begin litigation over the results of the written report, reputations and economic losses would occur if testimony was given that the results of the valuation were not independent.   

Dental Practice valuations during covid-19

by Bruce Bryen, CPA, CVA

What a financial and emotional beating dental practices and their owners have taken during this pandemic.  Patient revenue has dropped substantially. Layoffs have taken place with employees.  Overhead expenses remain as well as monthly obligations for equipment loans, rent and other fixed overhead items while the toll was being taken on the practices and owners’ lives. Many of those dentists who were readying their practices for transitions just before the virus struck were in a quandary about what their practices were worth.  The practice evaluator that was retained and his or her preparation of the valuation report typically was effective as of December 31, 2019.  As the months progressed, more practices were losing large amounts of gross revenue.  The dentists themselves were also experiencing drops in profits to the point of negative earnings at many of the practices. This caused personal financial difficulty as well since the amount of the dentist’s pay was decreasing in many cases in ratios similar to the practice’s losses. Offers to transition the dental practice were still being made by many of the brokerage firms who represented dentists interested in acquiring practices but not under traditional terms of all cash at closing or varying creative approaches to the purchase of the practice but almost always involving a substantial cash payment. 

To panic or not to panic, that is the question. 

Some of the dentists, including many of the older dentists, felt a panic set in where they thought that this was the death knoll for their practices and that they had to take the best offer that was available.  Those with sound practice advisors such as dental CPAs, dental practice consultants and other advisory service professionals offered a slower pace to field and accept or reject offers.  Taking what ever time was needed to secure the best transition approach possible was their quest for their client or advisee.  Listening to the type of offer and knowing that some creativity was needed in order to close their transition during the pandemic helped more practices go to settlement and the dentist to achieve the dream of the practice sale.  An update in the valuation was necessary in order to achieve this.  Almost all indicators in the transition value being offered by acquiring dentists were on the lower side of what the seller originally anticipated receiving.  The fact that many of the offers did not include an all cash transfer was another indicator of the practice sale prices being offered during the pandemic.  These offers were based on the buyers feeling that the sellers were panicking and that they could negotiate at fire sale prices.

The reputation of the dental practice evaluator became extremely important to all of the parties involved with the transaction.  Being independent and presenting an accurate valuation that may have been unlike any previously seen with the full explanation of why, was important to the seller and the buyer. Relying on data and an unsupported explanation about why the practice value should be higher or lower during covid-19 would betray the credibility of the evaluator and the valuation.  Offering valid explanations and support for those explanations whether for the buyer or seller would support the valuation in front of a court.  The final test of value is the court if negotiations continue past the mediation stage.  Being encouraged to use alternative facts won’t win in the long term for the valuation’s credibility.

The valuation presentation and the terms of the acquisition during covid-19:

As the dental practice valuations during the pandemic present lower or similar amounts of value compared to the last valuation report, it is very important to realize that the terms in the valuation are typically based on a 100% cash payment.  The new valuations being prepared during the covid-19 pandemic may offer “earn outs,” sellers holding part of the sale price in a promissory note from the buyer in a secondary position or other creative approaches to attaining the price being accepted by the seller from the buyer.  The valuation may reveal a discounting method to provide what the report projects in terms of the present value of the dental practice if the payment is not by cash at or prior to closing but some type of hybrid is the method to be used.  If it is critical to the seller of the practice that the transition occur during the virus period, then that dentist must understand that the valuation being different than the past is the only way for the settlement to occur.  If it is to be accomplished, then a different outlook on the valuation determination must be accepted. If the value stays high, it is because of the past performance of the dentist and the potential for its repeat. It will also be because the seller is under no compulsion to sell as quickly as possible because he or she thinks that the market will return.  Being at the practice when that occurs will bring a significant increase in the value of the practice.  Of course if a buyer is willing to negotiate based on the probability of a semi return to normalcy, then the price that is settled upon will be higher.  The asset allocation at the transition table and the ability to assign as much as possible to the goodwill of the selling dentist is another area where the pricing and valuation will remain on the high side based on the evaluator’s allocation to the goodwill in the current dental practice valuation. 

The solo or limited number of professional dentists at the selling practice:

As the number of owners is limited, the higher the value of personal goodwill will almost always become.  This is because the patients have few or only one dentist to see at the practice and all of the referrals will go to him or her.  This concept creates a much easier personal goodwill allocation.  The point of this is that a smaller practice with fewer dentists will probably suffer less and have a faster recovery once the pandemic subsides. This of course assumes that the dental practice manages to remain open while losing substantial amounts of money. 

Having a current valuation to compare to the last valuation is important as it represents where the practice was and where it may return once things are normalized.  Having sound dental practice advisors should help as well to reduce the panic and to make a more thoughtful decision about when to sell. 

Divorce, Bankruptcy and Mediation as some Results of the Coronavirus and Approaches to Solving its Problems

by Bruce Bryen, CPA, CVA

Whoever thought that the dental profession would be faced with a pandemic of this article’s title’s proportion that ultimately could produce any of the three points mentioned?  When the world of dentistry was looking at consistent continued growth, income and reputation building, all of a sudden there was the coronavirus and the implications of what came with it.  There were tensions building, staff layoffs and locking down at home while the country and the world isolated itself to overcome some of the results of the virus.  Sickness and death were everywhere and dental offices were shutting down at a rapid rate.  Who knew how temporary or long term the shut downs of the practices would be. Congress passed certain laws to allow cash flow to dental practices and some dentists and dental advisors had their own creative ways to produce a cash flow during this mess.  There were consequences to all of this trouble, however, with the tensions that were building while trying to survive personally, financially and professionally.  One pressure point was living at home twenty four hours a day and seven days a week and the emotional impact that was incurred with that.  Proceeding with divorce became an outlet for some dentists mainly from the financial and emotional heartbreak from the virus, closing the office for an undetermined time and living twenty four hours a day in an isolated home environment.   Steps should be taken to attempt to change the situation prior to going to court if there is any hope for resolving the issues.  Mediation could be an approach to settling a lot of the problems, at least when it came to the financial basis and for some of the emotional setbacks. Before going through a divorce trial or even proceedings leading up to a divorce, it is certainly worth the risk of attempting some type of resolution.  One can always go to court if all else fails to ameliorate the problems.

Too many bills and not enough income:

For some dentists who just have “had it,” with some dental supply houses, equipment sales companies and other bills in general, the thought and actual filing of bankruptcy occurred.  This concept is a must for consultation with experts on the results, reputational consequences and overall financial effect that it has or will have on the dental practice and personal outcome for the dentist.  If the current cash flow and the expected future results of operations are so low that there seems to be no hope, expert attorneys and other dental advisors are those to look to for guidance in discussing this approach.  Sometimes it leads to a new start and expected turn around in the dental practice’s fortunes as well as those of the dentist/owner. This concept should only be taken when there is no other choice to explore to resolve the problem of having less income than overhead.

It is definitely the time to speak to the supply house first for assistance with the financing prior to speaking with the attorneys and dental practice advisors about the outcome of a bankruptcy petition for protection from the creditors.

Some dentists had recently purchased one or more dental practices and added desperately needed new equipment and dental instruments which of course forced a high expenditure. While the dental supply houses were happy to provide these items, neither they nor the dentists ever expected the dental practice to suffer such financial hardships as they have during this crisis.  Even those dentists who maintained their own practices without additional acquisitions to it may have purchased one or two expensive pieces of equipment with easily obtained financing.  Now they payments are not affordable since there is little to no patient income flow and the prospects for opening at almost full capacity are bleak.

What does the dentist do after discussions with the dental supply houshane lead to no resolution? 

The threat of a bankruptcy petition to protect the dentist from his or her creditors may enlist the ear of the dental supply house or equipment and instrument seller. A reasonable approach for the supply house and the dentist is certainly worth considering. Of course the terms must be appropriate and acceptable to each party or there can be no compromise.  Sometimes merely stretching out the payment terms allows a lower monthly payment that can be achieved event during the financial conditions coming from the virus A financial restructuring will allow the amounts paid to attorneys if a law suit ensued to be used in a settlement for the payment to the supply house without the litigation.  Worse for the supply house would be the bankruptcy petition where the dentist would be mostly protected from the payment to his or her creditors at least at the current level.  The virus has caused all kinds of problems financially, emotionally and also for many of those employed by the dentist. The reason for layoffs of personnel was because there was no cash flow to pay the employees.  The same circumstances affect the dentist himself or herself as well since there is little to no patient income.  If there are parties who are willing to work together with proper advice, many of these issues can be over come or at least postponed until the virus situation has settled somewhat.  A return to the more normal approach to the dentist’s affairs regarding financial security and the relationship with suppliers and other creditors will be returned once there is some clarity to the downturn in the situation caused by the virus.    When the various governors open their states for the dental profession to continue, there should be a surge in patient requests for appointments and the flow of patient income will commence. 

Speaking with advisors:

Its always good advice for dentists to speak with their trusted advisors regarding any type of financial situation. While the virus is still in existence, it is even more important to talk to advisors.  Seeking their opinions about the approaches they see as significant for the future can only assist the dentist in returning to the financial wellness of his or her practice prior to the inception of the Coronavirus.

Comparing some Advantages and Disadvantages of the S Corporation to the LLC

by Bruce Bryen, CPA, CVA

This is a topic that is extremely important to those dentists who may be receiving advice from their dental CPAs or other financial advisors.  Incorrect advice may cost thousands of dollars in tax both on a federal, state and local level. The primary and most significant short and long term effects of the differences of each will be part of this article.  There are many aspects of each that are similar.  Those similarities will not be addressed at length as in the opinion of this author, it is not necessary to do so. The first material item be looked at will be the concept of earned income and the tax based on that amount.  With the s corporation, salary to the shareholder is considered to be earned income.  The corporation withholds payroll and income tax on a state, federal and sometimes local level. These withholdings come from the wage and the employee retains the net amount. The employer then matches the payroll tax to the employee to a degree based on the federal, state or local requirements for that withholding.  These earnings are available for the computation of retirement plan contributions.  They are considered earned income so the defined contribution or defined benefit computations are based on these gross amounts.  The profit after all expenses is normally taxed to the shareholder as unearned income and is not used to determine deferred compensation amounts.

How does this compare to the LLC?

As an owner/member of an LLC, salary or wages to these personnel are not permitted.  The entire amount of the gross revenue minus the expenses equals the amount that is subject to all social security and medicare taxes as well as a potential state payroll tax and any local tax payment. Since there is no owner payroll, the matching tax paid in the above paragraph by the s corporation, is now paid by the individual reporting this income on his or her personal income tax return.  Procedurally, this is done so as part of the quarterly estimated payments that include the federal income tax liability for the filer.  This is for the federal tax only. From a retirement contribution stand point, since all of the earnings of the LLC are considered earned income, the entire amount is used to determine how much the retirement plan contribution shall be in that year.  For the short term, therefore, the s corporation requires a lower tax due based on the earnings of the entity not paid as a wage to the shareholder.  The resultant retirement plan contribution is usually lower than that of the LLC owner based on the earned income being lower in the s corporation.  Of course if the salary in the s corporation is as high as is allowable for the maximum retirement plan contribution determination, then the shareholder/owner is paying the maximum social security and medicare as well. 

Flexibility and cash flow:

When payroll is paid to the shareholder/owner of the s corporation, the payroll taxes and income tax withholding are due at that point.  With the profit accounting for the amount of income tax and payroll tax due from the member/owner of the LLC, there is planning time allowed since the taxes from the owner are due quarterly.  The opportunity to buy equipment, pay into the retirement account and make other tax effected decisions allow the LLC owner to defer those tax payments almost until the last quarter of the year. This is based on the concepts that are accepted by the owner and put into place by the end of the year.  Those funds could be used to pay down debt or to acquire assets needed to enhance the economic value of the dental practice. There is also the flexibility of being able to draw any amount at any time as the owner of the LLC and to determine the ultimate tax for the year based upon planning decisions. When the shareholder of the s corporation wants additional funds, the taxes on those funds must be calculated as if the draw was a salary at some point.  The net draw must be “grossed up,” to include and pay the taxes as the draw is taken.    Along with these types of decisions, the s corporation has to be concerned with the deductibility of losses according to the basis plus debt due to the shareholder of the company.  Any debt of the corporation directly to the lender does not offer the opportunity to use that loan to count towards the basis of the owner’s capital account. If the owner guarantees the s corporation’s debt, that is not good enough. The only issue that the LLC has regarding business debt is that the owner guarantees that liability to its lender.  This of course is almost always insisted upon by the lender anyway unless substantial assets are pledged for that loan which has a value well in excess of the loan amount.    Examples follow in the next paragraph about outcomes based on equipment loans to the s corporation and to the LLC. 

Examples of deductibility of losses to the s corporation and to the LLC: A dentist is purchasing a cerec machine for $150,000 in his or her s corporation and is using the depreciation to throw off a large loss.  The loan is to the dental practice and is guaranteed by the dentist.  The owner/shareholder has a basis and loans to her from the corporation of $50,000.  There is a loss to the s corporation of $100,000.  The owner/shareholder can not take the loss in the current year even though she guaranteed the loan from the corporation to the lender because the loss exceeded her basis in the corporation.  The result was a loss of $100,000 minus the basis of $50,000, equaling $50,000 that is suspended until the s corporation has another $50,000 worth of basis.  Her additional tax in 2020 based on the suspended loss between the federal, state and local levels is about 45% or $22,500.  The LLC with the same set of circumstances can deduct the entire loss of $100,000 in the current year so she saves the 45% or $22,500, immediately.  There are other comparisons that note worthy as well.  It is of critical importance to discuss the differences between the s corporation and the LLC with the dental CPA so that when planning for taxes are discussed, there are no surprises.

The corona virus and the financial struggles caused by it

by Bruce Bryen, CPA, CVA

Almost all the dental practices in the United States have been advised to close their offices by either their local dental organizations or by the ADA. Additional advice has been to lay people off and to cut expenses to the maximum. Those still maintaining an office presence are doing so with a minimal staff.  The essence of the organizations and financial advisors advice has been to do what it takes to retain as much cash as possible. The money should be conserved to maintain the dental practice presence in the minds of the patients as well as potentially new clientele. Cutting costs during this crisis is sound, as is doing so when there is no crisis.  Whatever expense item that can be eliminated is good to follow up upon so long as the practice can maintain its reputation and communicative skills.  There has been one suggestion that has not been made in any article or by any financial advisor or dental CPA that this author has had the opportunity to relate.  The concept that no one seems to be paying any attention to is one of trying to increase the reportable income of the dentists who have had their practice’s finances decimated by the corona virus. 

Keep cutting expenses but be smart with income as well.

For those with good dental CPAs as well as other creative types of financial advisors, there is a way to manufacture income so that the reduced reportable income from the dental practice won’t go to waste.  Having a much lower tax bracket because of the corona virus can be utilized in a sound business like approach.  When markets return to a good performance level and when the dental practice gross revenue bounces back, the ability to utilize this creative plan won’t exist anymore.  Conceptually what would occur is that those who have reached age 59.5 or older should consider withdrawing more from their retirement plans now so that they can report more income in 2020 while the retirement plan distributions will be taxed at a much lower income tax rate.  In order to do this before age 70.5, the retirement plan document should have an “in service withdrawal,” provision.  Age 70.5 is the normal required minimum distribution age for most retirement plan participants.  If the dentist is age 70.5 or older, a required minimum distribution is required.  This does not prevent the dentist from distributing more than the minimum, especially if he or she is still practicing.  This is because the corona virus reduced the taxable income of the dental practice so significantly that the additional taxable withdrawals from the retirement plan will not have a detrimental effect as it would have had with continued high income being reported from the practice as well as the required minimum taxable distribution. Some may say that by taking the additional withdrawals that the 401k/ profit sharing plans will have their total assets substantially reduced and that the future will be detrimentally affected if this plan is followed.

What can be done to overcome any asset dissipation in the 401k/ profit sharing plan? 

Each dentist’s own dental CPA or other financial advisor should review the concept to see if it makes sense for him or her based on the direct knowledge that the dentist’s own advisors have the direct knowledge of his or her financial structure so that a plan is approved by that advisor and not by merely reading this article. 

The opportunity for a total review of the retirement plan and the advice surrounding its implementation is available to overcome any asset loss.  If the advice is taken to reduce the asset value of the 401k/ profit sharing plan by taking additional taxable withdrawals, the following should be discussed. This opportunity may never be available again but the dentist’s own advisors must be tax oriented, understand retirement plans and be able to communicate the upside and downside to the potential that will be explained.  To understand the possibility of saving huge amounts in taxes now, it is important to understand the difference between the two types of retirement plans.  A short explanation of the defined benefit plan and the defined contribution plan follows so that the advantages and disadvantages can be understood and why this concept can be so attractive in 2020. 

The upside and downside of the defined benefit plan and the defined contribution plan:

With additional “in service withdrawals,” from the 401k/ profit sharing plan, the account balance and value will lessen.  This becomes the time to discuss a new retirement plan concept rather than the defined contribution plan currently in use. The adoption of a defined benefit plan will cause future deductible contributions to increase dramatically and therefore add back the asset value very quickly. As an example, in 2020, for those fifty years of age and older, the deferral allowed to be contributed to the 401k is $26,000. That amount combined with the profit sharing allowable maximum of $37,500 equals a total of $63,500 allowed under certain conditions based on age and income from the practice.  A defined benefit plan can double or triple the deductible contribution so that in a short period of time the account balance will substantially improve.  With the stock market at a low point and maybe even getting lower, it would be a good time to buy with these additional funds or to invest them as one saw fit to do so. The defined benefit plan is one that is managed differently from the 401k in that you don’t need mutual funds to be the investment choice. There are many options available for investment. The dental CPA who understands retirement plans and the speed at which the defined benefit plan can overcome asset losses will be a good resource.  If the dental CPA does not understand the value of setting off this year’s potential low practice income by utilizing the retirement plan income potential, he or she possibly should be asked to get a second opinion for the dentist who wants to take some type of action to keep taxes down and not waste the lower tax bracket taking place with the 2020 income.  This is a very sophisticated plan and should be addressed with those who understand the ramifications of the many issues being addressed with it.  The dentist should make sure that he or she is getting advice from the person who can expertly offer advice during this economic and health pandemic. 

The Pros and Cons of married or partnered dentists who work together:

by Bruce Bryen, CPA, CVA

This topic is a matter of grave concern for the dentists, the dental practice and   families of those dentists who fit in with the above title.  For the dentists who have been involved with a start up or an acquisition, working together provides considerable positives and negatives for all of those involved with this possibility.  One of the most difficult personnel choices for the dental practice is the hiring of licensed dentists who are reliable in their work habits, hard working, competent and also trustworthy.  Having married or partnered dentists practicing together in an office will give each a sense of relief in that they both feel that they are attempting to achieve the same goals. This is typical and understandable at the beginning of this experience. Not worrying about the professional showing up for work on time, working hard and contributing to the income and growth of the practice is a given since these two people share so many things.  The management of the practice, hiring and firing of personnel and training employees normally just flows through one of the dentist’s verbal job descriptions without any discussion, argument or advice from advisors. Once the organization chart is imaginatively formed by doing those things necessary for the operation of the practice, there is usually no thought of memorializing those items as they just occur.  They just happen naturally and both parties are typically so busy that they just continue doing what it takes to continue the practice.

The independence of two unrelated dentists working together as partners compared to the married or partnered dentists:

Some comparisons are as follows:

The married or partnered dentists have a relationship where events unfold.  Job classifications and responsibilities are assumed by merely occurring on the go with little or no points memorialized in writing as neither party feels the need to do so.  The independence of other dentists who create a partnership almost always make sure that operating agreements are prepared that are fully executed, or should be. These written agreements take time to prepare and are usually completed with the input of advisors and attorneys as well as the professional dentists themselves.   When changes occur, the married or partnered dentists typically accept the result and continue moving forward without the thought of retaining an advisor such as a dental CPA to assist them in doing so.  After all, they are together emotionally and physically almost twenty four hours a day and seven days a week while these events are taking place.   The independent dentists would normally meet, review the situation and amend their written agreements to comply with what is occurring or with what they desire to be taking place.  Some dentists have no written agreements whether in a personal relationship or not.  This concept is definitely not a good idea.  It causes many dental partnerships to incur unnecessary legal and expert fees, lost time and revenue and many bad feelings.  What may happen eventually in either case where there is a verbal understanding without a written agreement most often becomes an attorney’s dream and the dentist’s nightmare.  If litigation occurs without good documentation, the dentists should be aware of the amount of time and money they will each need to resolve the issues that were not in writing.  It is certainly much cheaper to have the agreement that is executed in advance of the partnership becoming an operating one. The married or partnered dentists normally do not think along these lines unless they also have a prenuptial agreement. That contract typically changes the thought process for the dental partnership.  The dental practice agreement then usually is in writing. 

What type of approach can be used for the married or partnered dentists who decide to work together?

For the younger professionals, some may request a prenuptial agreement for their marriage or relationship partnership.  For most of the young dentists, it is not a common thing to ask for such a thing.  The more mature dentists or those who may have been divorced are more likely to want an agreement prior to when their personal contract is in place.  It is much easier to have a formal agreement for the dental partnership arrangement when the prenuptial agreement is already one of the points agreed upon before the living arrangement.  For those with no premarital agreement, just the idea of a written dental contractual basis does or should provide for the inclusion of others in the practice.  This is an important point for the relationship of those married or partnered for the future growth of the practice.  It is not that difficult to have an agreement in place specifying a formula for valuation of the practice.   In the event that a third party wishes to join the practice, rather than waiting weeks for the preparation of the agreement, the value is stated.  The methodology for the acquisition is in place. The responsibilities are listed in the agreement.  A dentist who wants to become a partner will be ready to read the contract, ask questions and be ready for a decision quickly.  If a contract has to be prepared at that point in time, the potential partner may go elsewhere because of the wait involved.  He or she may think that the practice is so unorganized without a contract in place that the thought of joining it becomes less appealing to him or her.

What about the negatives in working together as married or partnered in a relationship dentists?

The most important reason for not working together in one of the titled positions is the event of a separation or a divorce. If that occurs, it’s not just the personal relationship, but also the dental practice that may likely dissolve or at least face a multitude of issues. This dual calamity is not common to the independent dentists in a partnership with an operating agreement.  The thread here is that the living arrangement will end with a written agreement notably the divorce papers, that will probably be expensive to each party and also very time consuming.  Financially, the dental practice revenue will most likely suffer as the patients and staff understand what is occurring, and feel the tension in the office very quickly. 

Accounting for goodwill in a transition, divorce or potential partnership transaction

by Bruce Bryen, CPA, CVA

For a dentist who is involved in a transition, divorce or potential ownership position, the accounting for goodwill is of the utmost importance.  It has a tremendous bearing on the reputation of the dental practice. It is also a valuable asset when it comes to determining the tax ramifications of a transition to a potential buyer and to the seller, whether that may be a partnership situation or an outright sale.  During divorce proceedings, the segregation of personal goodwill from the dental practice goodwill or enterprise goodwill value could mean hundreds of thousands of dollars. In equitable distribution states where personal goodwill is not part of the marital estate, the allocation of personal goodwill rather than enterprise goodwill separates what is to be distributed from the practice compared to what is not to be distributed.  We will look at each of these points and describe with examples how each is treated in the following paragraphs. 

The sale of the dental practice to a third party:

In the event that the owner or owners of the dental practice have decided to sell it and have found a buyer, the advisors to the dentist(s) will offer advice about how to allocate the proceeds of the sale.  This is an extremely important point in the discussions because the goodwill of the dental practice is treated in such a way that the sellers receive a capital gains tax treatment.  If the dental practice is an c corporation, then it is even more important that the allocation of the goodwill between the dental practice (enterprise) and the personal goodwill of the dentist have excellent support for the basis of the allocation.  The capital gains tax treatment will be the lowest tax paid upon a transfer for a complete transition of the ownership where the funds go directly to the seller or sellers.  There will probably still be a state tax but that would occur anyway without a sale of the practice.  If the organizational format of the dental practice is not a c corporation it is still important to allocate the personal goodwill and the dental practice goodwill especially if there are two or more owners. Each of the selling dentists may have a different perspective as to how much goodwill should be allocated to each and how much should be apportioned to the dental practice.  With a partnership arrangement as an example, there may be a profit sharing arrangement that is different than the ownership arrangement.  Many factors such as production capacity of each partner may be taken into account when determining who receives what allocation upon the transition.  It is also important to know that with the allocation of the transition proceeds to goodwill for the seller, the buyer receives the lesser ability to write off the amount allocated to the goodwill.  This is a common occurrence in a transition in that whatever economic and tax benefit that goes to one party in the transaction, the other party has a reduced benefit in comparison.  A potential acquisition of a partnership interest is treated the same way as the sale to a third party except for the potential discount for past services or for some formula based on production. 

Goodwill represented in a divorce involving a dentist:

The goodwill allocation in a divorce that is segregated between the personal asset and the goodwill of the dental practice is probably the most important proration of goodwill other than the income tax result of the value placed on goodwill.  An example in a state where there is equitable distribution allows the personal goodwill of the dentist to be separated from the marital asset value so that only the goodwill of the dental practice is available for distribution to the spouse of the dentist.  It is critical for the evaluation of the dental practice to be clear with plenty of support for the presentation to a mediator or to a court so that the personal goodwill can be substantiated.  This amount attributed to the personal goodwill is the dentist’s and can not be transferred.  It is not available for the spouse as the dental practice goodwill is.  Examples of the dental practice goodwill would be the dental equipment, furniture, and any item of personal property.  Some dentists do have leasing companies whereby those assets are in their own name and rented to the dental practice so that they would not count as marital assets since the lease would provide a debt to the dental practice and reduce those asset values.  If it is proven that patients are coming to the practice not because of the dentist but that that practice is easily accessible and the patient would see any dentist, then that is not considered to be personal goodwill.  This is but an example of how difficult it is to prove what may be personal goodwill versus dental practice goodwill.  Only an experienced dental practice evaluator can present a valuation of the dental practice that is supported by other articles, books and previous experience. 

In conclusion:

Whether a transition to a third unknown party, an acquisition of a partnership interest or divorce proceedings, the allocation of goodwill is a huge financial point.  If the goodwill allocation is primarily towards personal rather than dental practice goodwill, the seller of the practice receives a huge tax advantage.  In a divorce, the personal goodwill allocation to the dentist allows him or her to retain probably the most valuable asset in the dental practice.  Start with a dental practice valuation by a CVA for an independent opinion that will be supported and will be looked upon favorably by a mediator or a court. 

Advice on the Acquisition of a Dental Practice

by Bruce Bryen, CPA, CVA

Advice on acquiring practices that are low gross revenue/ start ups or high grossing:   

Which of the above makes the most sense and why?

Let’s analyze which of the above scenarios gives the dental practice buyer the best chance for success over the short and long term.   Some will look at a low grossing revenue practice and think that it would be easy to increase the revenue.  Methods to do so may be by increasing the marketing budget, offering more service and higher end dentistry or by increasing the hours of the practice.  It’s really important to understand why the practice has had a low gross revenue output over the years.  In determining whether this is the best opportunity for probably the lowest initial cost, it is extremely important to get a dental practice valuation.  Analyzing the revenue trends, employment status of the staff regarding compensation and turn over and the local competition will give the potential buyer an opportunity to learn about the practice.  The geographic area in which the practice is located will allow the acquiring dentist to decide if the area is a good one for increasing the gross and net of the dental practice.  If marketing dollars and advertising charges have been relatively low over the years, they may be good indicators that spending money on items such as these may revitalize the practice.  If there has been poor service and high personnel turn over, that is bad sign but one that may be over come with proper training. A good relationship builder can do wonders for the practice if this is one of the reasons for a lack of consistency with the employees.  With happier employees comes more profitable hours without complaint by them which also means more revenue to the practice on a regular basis. Acquiring a low gross revenue practice takes time to energize and money to assist with overcoming the reputation and morale problems associated with the former employees who have been retained in the short term.  The acquiring dentist who is trying to increase the patient flow must be patient himself or herself in order to give it enough time for the results to happen and for success to come.  Staff members will be weeded out as to who fits with the new employer and who wants the progress and morale boosting that should come with a new owner.

The start up practice:

Those dentists who feel that transitioning into a practice is not what they want to do may opt for the start up practice with the opportunity to design the facility as they wish.  These dentists may like the excitement of a start up where there are no patients when the doors are first opened and building the practice is the paramount goal for the entrepreneurial type.  He or she may want to be totally involved with the input of the operating procedures, personnel manual and the administrative side of the practice.  Of course the hiring of employees, clinical decisions and flow of the office are all resting on the shoulders of this dentist.  The upside is that there are no employees retained from an acquired practice with accumulated bad habits from the selling dentist.  There are no guidelines with patients about fee schedules, timeliness of payments or appointments and follow up reminders about them and the appearance of the patients.  The ability to borrow to fit out the office should not be a problem as long as the credit worthiness of the dentist is good.  The energy of the dentist who opts for a start up practice is typically excellent so the hours the office is open is not going to be a problem since initially at least, the patients will be accommodated whenever they are ready to come to the office.  Some nights and Saturdays will probably be part of the start up appeal to patients. This may not be appreciated by the employees but those who want to grow with the start up will see a tremendous opportunity for advancement as the start up grows and succeeds.  Most dentists appreciate the loyalty and investment of time and energy to the practice, especially the start up that these initial employees will give to it.  The ability to have a good line of communication with the owner should exist because the dentist will want as much input as possible as the time will appear to have that interaction between employee and owner.  This opportunity in a start up does not typically exist in an acquired practice since most guidelines to procedures are already in place. These are difficult to change.    

Acquiring a dental practice with relatively high gross revenue:

This type of dental practice may be the most expensive of those being reported upon in this article at its point of acquisition.  Since the higher gross revenue practice is hopefully also a profitable one, the old adage of “buying a winner and paying for it out of its winnings,” may be the answer to the seasoned dentist who may already be an owner of one or more practices. Even if this is a new geographic area and the dentist has just sold a practice, the profitable practice may need little adjustment from the purchaser other than specific tweaking to his or her liking about non essential items.  The staff is probably stable with some longevity and familiarity with the patients and their habits.  Their experience will assist the buyer with a potential turn key situation where little improvisation has to be made to the staff job descriptions, normal operating procedures or any interaction with the patients. The patient base is most likely a good one with close to a saturation level of bookings and the potential for using this type of practice as a base for additional acquisitions is there.  An additional operatory or the hiring of an associate may come once the dentist is settled into a routine where he or she understands the norm of the dental practice’s stream of occurrences.  The new wave of dentistry model such as the DSO is a target for this type of practice since the seller can stay and work for a while and receive reasonable compensation with little or no administrative chores to interfere with the clinical duties.  This is a winning situation for those in this type of practice since the usual headaches come from the areas of least appreciation, namely administrative chores.  Also, the potential buyer who enjoys a profitable practice with most of the aggravation ironed out by the previous owner will have a good situation with a mature staff available to assist with any future issues that may occur.    

The DSO: Comparing start ups to those operating and successful

by Bruce Bryen, CPA, CVA

The start up DSO from the perspective of owners, the management team and professional employees, has a risk in maintaining an adequate capitalization base in the short term but especially in the long term. A positive line of communication between management and the professional team is a must for the DSO. From a professional dentist’s point of view when the DSO is not funded properly, the ability to have enough supplies on hand, money for payroll and other needs frequently is lacking and the thought of the employee is, “why?”   These types of occurrences create morale issues, reliability problems and damage the reputation of the start up.  Besides requiring adequate capital, another area of concern for the start up DSO is the need for an experienced, business oriented and sound management team.  Compared to an existing well funded and expertly managed DSO, the start up may struggle to maintain its personnel, relationships with suppliers and importantly with its lenders and investors.  How many start up DSOs, similarly to start up dental practices, don’t have the proper advisors necessary to compete competitively for lack of sufficient funding?  Do the start ups have the ability to have a positive response when the need for further investment or working capital arises? What are some of the specifics missing in the start up that the thriving DSO has over come?  The following paragraphs list some of the hard ship examples and concepts for curing the problems necessary for the start up DSO to become a successful DSO.  

Some points that hinder the success of the start up DSO:

The start up DSO has incredible expenses to get its doors open in a positive manner.  Those not intimately involved with business expenses of the type needed for long term growth and private offerings to raise capital will be terribly surprised when the interviews with the professionals occur and their fee quotes are heard. Attracting investors as part of the business plan that has acquisitions as an integral ingredient for success must be accompanied by important advisory names with recognition factors as well as the experience necessary to succeed.  Experienced attorneys who know how to prepare private placement offerings do not charge inconsequential fees. Raising money has a charge as do the CPA firms and other advisors who have the experience in taking start ups and smaller businesses to the next level.  The fully operational DSO has already paid these charges and has the name recognition that goes with the attorney’s name on the papers needed for execution. The CPA firm with the experience in this type of work has a name recognition factor that assists when a potential investor looks at the financial statements.  The lenders and investors of significance want these types of expensive, experienced business people on board to assist in the approach to the start up so that the process is a smooth one.  Egos must be put aside if the DSO is going to be successful.  Lenders also have a comfort level when they recognize the names of the professional advisors of substance and experience.  If the start up DSO is composed of successful dentists who capitalized the start up and are managing it, they are used to funds being available from profits or their bankers.  When dentists are the source of funding and additional “calls,” for capital are placed, the reality is that the non sophisticated investor/dentist will probably hedge and stall prior to understanding that the “call,” is not a request but a need and demand.  This is so different from a successful DSO following a budget and sending the need for funds to its owners.  These are probably hedge fund managers, venture capital firms and individual wealthy business people who understand and want budgets and desire to see them followed in an orderly fashion. 

Lines of Communication:

Communication is typically a missing item when problem areas arise.  Successful DSOs have solid lines of communication between management and those working

at the DSO.  A reason why there may be a situation of fault in talking points may be the lack of funds available for management and the unwillingness to have honest discussions with the staff, especially the professional dental employee about the problems.  There may be an embarrassment with the directive of the owners to be vague about why there are not enough supplies on hand or why paychecks are running late or are not correct.  An adequate capitalized DSO does not have this problem.  The start up DSO may have been founded by a group of financially successful dentists who are excellent clinicians and think they are good managers.  They are learning the hard way by experience that the DSO is not like the practice they ran.  The need for funds on the scale of the DSO far outweighs that of the solo or smaller dental practice.  Telling the truth to the employees is a stressful point when it is money that is the problem.  A cure is that a line of credit can be opened if the originators of the start up DSO don’t’ want to make another capital investment or can’t.  Lenders typically require personal guarantees of owners of small businesses which may create another situation for the original investors.  Another source is to add additional investors.  This of course reduces the originators percentage of equity positions and they are usually not happy about the circumstance. This may cause them to delay in this approach. Either of these decisions is difficult but communicating the facts is critical to the success of the DSO.  If money is the issue, delaying or not acting to cure the problem immediately will cause long term losses of personnel who lose credibility in their management team.  There may be other issues than funding but without the honest communication with the management team and the employees, they will not know. 

Analysis of the management team:

The question which came first “the chicken or the egg,” has a comparison to what is more important,” the funding or the experienced management team?” Just like

the first query, the answer is almost the same in that it doesn’t matter.  Both questions and answers are extremely important.  Success is a result of both being addressed almost simultaneously.  Without the professional management team, a DSO is likely not to survive.  Regardless of how successful the dentist may have been in managing his or her own practice, the DSO is much larger with more egos to soothe than the dental practice that the investor/dentist was probably managing.  Decision making involving substantial monetary points of view, are also more intricate than in the individual practice.  The standard dental practice with even a few owners almost always had those owners egos bathed from their employees. Now the owner must reckon with the dentists who work for the DSO and their personalities.  Retaining the professional management team means that proper capitalization must be available.  The managers may be former dentists but more likely, are successful business people used to what is needed for a profitable organization to continue with its plans for growth.  It is smarter to have the investment available and the management team in place while attempting the hiring process to begin the start up DSO.  Attempting various rounds of funding while the growth is occurring without a strong performance record makes the job harder.  Properly capitalized DSOs look to venture capital firms, hedge funds, or individual investors who have business experience, not necessarily in the field of dentistry for their financial base.  These types of people will insist on good communication, a strong capital base and managers with business experience.   Organizational articles as well as shareholders and employment agreements will be prepared so that future hires will be more easily attained and expansion available with a reasonable economic base and the proper management team. The plans for expansion can not be achieved with out the management team and the necessary funding.

Disregarding the start up and selling to an existing DSO with a strong capital base and solid management team:    

DSOs look for dentists who want to sell their practices for any number of reasons. 

One may be that the selling dentist is fed up with the management time and requirements needed to have his or her practice continue to grow and remain profitable.  They may or may not be older dentists who want to retire and did not properly plan for an exit strategy.  Now that the DSO has become so popular, this can be a perfect transition situation for the dentist who wants to sell but needs a few more years of working and earning in order to retire in the manner that he or she would like to live for the rest of their lives.  The DSO gives the transitioning dentist the opportunity to sell the practice to them. The seller can work in the clinical areas of the practice and earn a reasonable amount of money for that type of effort and production including fringe benefits and bonuses.  The DSO provides all of the management services that the dentist typically detests being involved with anyway.  At an agreed upon time frame, the dentist who has sold to the DSO leaves the practice and the DSO takes over the clinical side of the practice management as well.  This creates a winning situation for the DSO as well as the transitioning dentist.  Sometimes shares in the DSO are available for the dentist who has transitioned to it.  The DSO has its management team in place and is responsible for all administrative, legal, accounting, hiring, providing personnel, purchasing and all other non clinical details.  Comparing this situation of the sale to an established DSO versus a start up, other than the glory and ego involved if the start up is successful, there is almost no question of which is the better opportunity.  The concept of growth and expansion is already at hand with the established DSO as well, compared to the start up.  With the proper capitalization, experienced management team and outside advisors who have experience working with DSOs, additions to the established DSO number of dental offices will most likely be secured, profitable and well run.  The entire process will occur according to the budget provided and will be supervised by the management team with investors happy and expecting the positive outcome.  

Turn the retirement plan into a transition vehicle

by Bruce Bryen, CPA, CVA

The opportune time to adopt sophisticated retirement plans for tax savings and as an option for the transition of the dental practice:

Based on consistently reporting high earnings at the dental practice, it is always the opportune time to adopt a sophisticated employer sponsored qualified retirement plan.  At the end of the dental practice’s fiscal year, the format of the IRS approved deferred compensation plan couldn’t be more appropriate for the current year’s timing of the tax deduction.  Since the more involved types of retirement plans such as the defined benefit plan defer huge amounts of income and taxes, a last minute adoption allows the entire current year’s allocation to be deferred almost indefinitely.  Based upon the owners and key employees ages, past income amounts and estimates for the future, sums of $150,000 or more can be deferred annually.  If the goals of the participants want that much to be placed in the accounts for them, it can be done.    

What are some of the details?

Of course with anything good, come the details of implementation.  The dental CPA with a background working with dental practices as well as with high income dentists is one of the most important advisors that the dentist can retain for this purpose.   Understanding the usual retirement plans is not enough.  The difference between the 401k, any defined contribution plan and a defined benefit plan could be hundreds of thousands of dollars in only a short time.  Learning on the job is very expensive for the dentist who wants to engage his or her regular CPA who may not be a dental CPA.  Someone with experience in these matters is needed. Even though that person’s price may seem high, especially the first year or two, there is a leveling off period and the fees become pretty reasonable for what you get.  When you count the current tax benefit and the amount of earnings and taxes that are tax deferred, a million dollars in about 6 years is a reasonable goal of achievement for the dentist. 

How do I get there?   

Let’s find out if an employer sponsored qualified defined benefit plan is the correct one for you.  Are you approaching fifty or older?  Do you have fairly consistent earnings that are typically on the high side?  Do you have a staff that is on average on the younger side or are you employing a large number of one specialty, such as hygienists? If you can answer yes to any of these questions, the defined benefit plan may be right for you.  Of course it is important to confer with your dental CPA before proceeding with anything of this nature.  The consistent earnings of a higher nature are important because unlike a defined contribution plan where there is a statutory maximum allowed as a deductible contribution, the defined benefit plan is based on a formula.

Here’s how it works:

The employer sponsored qualified defined benefit plan allows a reasonable design to be submitted for approval of its format.  Working with the dental CPA and a qualified actuary with an understanding of what the dental CPA has discussed regarding the goals of the owner, a plan can be arranged whereby the owner reports his or her compensation and then receives a deductible contribution based on the current and past compensation.  If the formula calls for the highly compensated employees, such as the owner, to receive 100% of compensation in retirement, that can be adopted as the approved formula.  Of course there can be no discrimination in the plan.  That means that all employees must receive “similar,” benefits based on their compensation, length of service at the dental practice, age and other criteria.  That information will be addressed by the dental CPA and actuary when designing the formula for retirement plan benefits. 

Looking at a specific hypothetical example:

An example can be the dentist who was reporting $300,000 in wages and paying federal and state taxes on those wages.  This scenario may now equate to reporting $150,000 in wages and the requirement of contributing $150,000 to the defined benefit plan as a deductible contribution on his or her behalf.  This saves the federal, state and medicare taxes for the current year and each succeeding year on the $150,000 previously reported as wages that was included as part of the $300,000.   At an assumed 50% tax rate including the double medicare tax as the owner, federal and state taxes and the extra medicare tax on the amount of earnings in excess of $250,000 for a married filing joint return, there is at least $75,000 per year not being paid in tax.  That means that about ½ of the expected $150,000 retirement plan contribution is being paid with the tax savings.  One can interpolate based on whatever salary or earned income, such as LLP, LLC or sole proprietorship “flow through,” earnings are reported.  “S” corporation income that is classified as a dividend or is reported as profit and not as salary does not count as earned income. The funding balance can be attained though various methodologies, especially if there is any type of personal savings accumulated.  This is another area to be discussed with the dental CPA.  Just like almost all qualified employer sponsored retirement plans, the defined benefit plan is immune from creditors and the earnings grow without tax until the funds are disbursed. 

Is there any downside to the implementation of the defined benefit plan?

There is a downside if it is thought of in that regard.  The defined benefit plan is dependent upon the sponsor’s (the dental practice) on time contribution.  Its earnings percentage in excess of the guarantee that is part of the original plan design reduces the succeeding contributions.  Its losses are added to the future contributions so that the plan guarantee of its earnings percentage is always met. In the event of a loss, the addition to the next year’s guarantee almost negates the cost as long as the earnings of the dental practice are consistent. Effectively, the government is assisting in paying for the losses that must be overcome by the plan sponsor.  Suppose there is a loss of $50,000 based on the stock market.  It that amount was added to future contributions and if the dentist is still in an approximate 50% tax bracket, doesn’t the government take on $25,000, or half of the additional contribution based on the dentist’s tax savings in paying for the previous loss. The losses are not contributed in the following year but that is another matter to discuss with the dental CPA so that it is understood how the payment of the losses is affordable. 

Start planning for the current and future year’s tax savings and an affordable exit strategy. 

Any time is the right time to adopt the employer sponsored qualified defined benefit plan for current tax savings.  Using the same format in the adoption of the plan, think how a hypothetical buyer and the dental practice owner can defer the taxes on the transition of the practice.  Discuss with the dental CPA how the net effective tax cost to the potential buyer is drastically minimized and the seller’s tax is deferred for almost as many years as is desired.  Does the idea of a $500,000 sale today subject to taxes being deferred into a $500,000 sale with minimal to no taxes today sound like a good concept?  Also, when the funds are ready for distribution after the transition and after an accumulation in the retirement plan, how much will be there?  Will it be $750,000 or more?  Won’t the taxes to be paid upon the distributions come from money that would not have been there except for the adoption of the retirement plan?