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Jonathan R. Martin, CPA
Selling the cow & keeping the milk!
SITUATION: Immediate Buy-Out w/ Post-Sale Employment
o Annual income of approx. $1M
o Overhead rate < 45% (well below avg)
o Purchase price well above avg
o Seller wanted guaranteed post-sale employment for 10 yrs.
o Seller wanted $1,500 per diem with minimum 100 days per
year ($150,000 per year minimum)
PROBLEM:
o Practice isn’t large enough for two full-time docs
o Buyer paying higher price for additional profitability that
he/she isn’t getting
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Expecting someone to buy the cow when they
can get the milk for free!
SITUATION: Buy-in Following an Associateship
o 1 Year associateship leading to buy-in
o Seller made an offer that the buyer couldn’t refuse:
o Drastically reduced purchase price
o Above market associate compensation
PROBLEM:
o Associate makes more as an employee than they stood to
make as a partner
o Why would a buyer take on the risk of ownership while signing
up for a pay-cut?
Expecting someone to buy the cow when they
can get the milk for free! (Scenario 2)
SITUATION: Delayed Buy-Out by Existing Associate
o 1 Year associateship leading to sale
o Both parties agreed to terms and conditions in advance
o Associate never signed an employment agreement or
covenant not to compete
o Seller was in their mid 70s
o The practice was located in an underserved area
PROBLEM:
o Associate realized they could open up a location next door
at a substantially lower cost
3
Putting a square peg into a round hole!
SITUATION: Intra-Family Buy-in Following an Associateship
o Father promised son a place to work and an eventual
partnership
o Annual income of < $600k
o Little to no growth potential
PROBLEM:
o Practice was too small for multiple doctors
o Unrealistic expectations
Shotgun weddings!
SITUATION: Immediate Buy-in w/ NO Associateship Period
o Rapidly growing practice in rural area
o Owner had difficulty finding candidates and became
desperate
o Buyer had substantial experience as an employee and
wanted ownership
PROBLEM:
o The doctors didn’t have adequate time to evaluate the
potential for conflict
o No time for the practice to grow
4
Stepping over dollars to pick up pennies!
SITUATION: Buy-in Following an Associateship
o 2 year associateship leading to buy-in
o To avoid the cost of professional services, the seller
offered a “hand-shake deal”
o After 2 years, the seller proposed terms to the associate
PROBLEM:
o Neither seller or buyer knew what to expect
o The associate was shocked by the price and terms and
backed out of the deal
o Seller back at square one
◦ Fair Market Value (FMV)
◦ Taxes
Purchase Price Allocation
Sale Structures
◦ Other Considerations
◦ How to Fix the Aforementioned Scenarios
5
I. FAIR MARKET VALUE
FAQ:
Someone told me that a practice
is worth 70% of a year’s gross
collections. Is that true?
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Percentage of Income as Value
Practice A
•$1 million revenue
•3 operatories
•“vintage”
equipment
Practice B
•$1 million revenue
•6 operatories
•current
technology
Are They Both Valued at $700,000?
Percentage of Income as Value
Practice A
•$1 million revenue
•55.0% overhead
Practice B
•$1 million revenue
•65.0% overhead
Are They Both Valued at $700,000?
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General Valuation Theory
• Cost
• Comparable Sales (Market)
• Earnings
Earnings Based Approaches
◦ Basic Value Equation
$ Financial Reward = $Fair Market Risk % Value
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Risk Rate / Required Rate of Return
1. Average Market Return
2. Premium for Size (Illiquidity)
3. Risk Specific
General
Specialty
4. Discount Rate = (1 + 2 + 3)
5. (Long Term Growth Rate)
6. Capitalization Rate
4.94% Risk-free Rate (Long-Term Treasury Bond Yield)
6.50% Equity Risk Premium (Stocks over Bonds)
11.44% Average Market Return at Valuation Date
6.50% Risk Premium for Size (Small Stocks Risk Premium)
1.46% Subject Practice - Additional Risk Factors
19.40% Discount Rate
-2.50% Long-Term Growth Rate
16.90% Capitalization Rate
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Projected Professional Income $1,000,000
Costs of Professional Services (225,000)
Operating Expenses 58.0% (580,000)
Profit Before FIT $195,000
Estimated Taxes ($68,250)
$126,750
Capitalize @ 16.9%
Fair Market Value $750,000
II. TAXES A. Buy-Out
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Financial Structure ◦ Simultaneous Objectives
Affordable for Associate/Purchaser
Fair/Equitable for Owner/Seller ◦ Push / Pull in Tax Code
Solving Financial Structure: Two Alternatives 1. Stock Sale
2. Asset Sale
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Stock Sale ◦ Best Scenario for Seller Capital Gain (15% to 20%)
◦ Worst Scenario for Buyer Can’t deduct interest on loan
Can’t write-off stock
Exposure to existing liabilities (e.g. taxes, personal injury, creditor and other claims)
Asset Sale ◦ Majority of sale proceeds to seller taxed
as capital gain (15% to 20%) ◦ Buyer Can: Deduct interest paid
Depreciate/amortize assets
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o Allocation of Purchase Price
•Order of Allocation:
Receivables
Consumable Supplies
Fixed Assets
Patient Records
Covenant Not to Compete
Personal Goodwill
Corporation
Sells
Doctor
Sells
Three (3) Types of Receivables
1.Contracts Receivable
2.Accounts Receivable
3.Prepaid Accounts
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o Allocation of Purchase Price
•Order of Allocation:
Receivables
Consumable Supplies
Fixed Assets
Patient Records
Covenant Not to Compete
Personal Goodwill
Corporation
Sells
Doctor
Sells
*Although these items are capital assets, if retained in a C Corporation, they will be taxed at the corporation’s ordinary rate, and again when distributed to the shareholder(s).
Tax Effects to Tax Effects to
Asset Category Seller Buyer
Supplies Ordinary Expensed Immediately
Furniture & Equipment Ordinary Section 179; Balance over 5 to 7 Years
Accounts Receivable Ordinary Collected Tax-Free up to Amount Allocated
Orthodontic Contracts Capital Gain* Amortizable Over 15 Years
Patient Files & Records Capital Gain* Amortizable Over 15 Years
Leasehold Imrovements Ordinary Amortizable Over 39 Years
Corporate Goodwill Capital Gain* Amortizable Over 15 Years
Personal Goodwill Capital Gain Amortizable Over 15 Years
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Reduce Ordinary Income Taxes on
Proceeds
Pay Sale Expenses Through Corp
Legal Fees
Commissions
Accrued Expenses Payable
Maximize Retirement Contributions
Buy-Out: Tax Reduction
Strategies
◦Weigh Several Issues
Marginal Tax Rate in Year of Sale
There is No “Flat” Tax
Increasing Tax Rates (2013)
When Should I Sell?
15
II. TAXES A. Buy-Out
B. Buy-In
Solving Financial Structure: Two
Alternatives 1. Stock Sale with Earnings Shift
(Sweat Equity)
2. Asset Sale
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Stock Sale: Affordable and Tax Efficient
◦ Assign Portion of Value to Stock (Tangible)
◦ Remainder Paid with Pre-Tax Earnings Shift
(Intangible)
◦ Typically Paid Over 5-7 Years
Capital Gains Ordinary
Tax Income Tax
Tangible
Net
Worth
Management
Fee
(Pre-Tax
Income Shift) Intangibles Stock
Purchase
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ASSET SALE STRUCTURE (After Buy-In)
$ Income
(Overhead)
$ Allocable Profit
50.0% of Fixed Assets/Supplies/
Receivables 50.0% of Fixed
Assets / Supplies /
Receivables
50.0% of
Intangibles
Seller (Individually)
Purchaser’s Entity 50.0% of
Intangibles
Seller’s Entity
Partnership or LLC
III. OTHER CONSIDERATIONS
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(A) Trigger Point ◦ Sufficient Collections ◦ No Decrease in Earnings
(B) Income Distribution Formulae:
Basic Types
(1)Equity (Ownership)
(2)Days Worked
(3)Multi-Tiered
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100.0%
Days Worked
50.0%
Productivity Diff.
50.0%
50.0% 50.0%
S
E
L
L
E
R
P
U
R
C
H
A
S
E
R
60.0%
90.0%
80.0%
70.0% 30.0%
40.0%
10%
20.0%
(5 Years Illustrated – Can Be Varied)
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(C) Associate Compensation
o Term
o Compensation
Salary
Per Diem
IV. Converting Lose-Lose to Win-Win
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Stepping over dollars to pick up pennies!
(MOST COMMON PROBLEM)
Moral:
o Address financial expectations prior to hiring an associate
o Associate’s decision to join practice based not only on
compensation, but also:
o Purchase price
o Sale structure
o Income distribution
o timing
o NO SURPISES!
FAQ:
I am hiring a new associate and
plan to sell a partnership interest
after several years. When should
the practice value be
established?
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Timing of Partnership Valuations
1. Fundamental Concerns
A. Senior Doctor Wants Growth Included
B. New Doctor Wants to Exclude Created
Growth
2. Problem:
A. There is NO WAY to determine each party’s
contribution
Timing of Partnership Valuations
3. Solution
A. Establish value prior to associate’s arrival
B. Update value at end of associateship
C. Split the difference in intangible value
D. Tangible value is what it is
4. Benefits of This Protocol
A. Gives both parties credit for growth
B. New tangible items included
C. NO DIVISIVE ISSUES
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Putting a square peg into a round hole!
Moral:
o Don’t let your mouth write checks your tail can’t cash!
o Have your practice evaluated prior to making promises
in order to determine:
• Buyer and seller cash flow and the financial impact of
hiring an associate
• Your Trigger Point (Is this achievable?)
o Evaluate related party transaction tax ramifications
Shotgun weddings!
Moral:
o Always date before you get married!
o The practice typically needs this time to grow income,
referring sources, etc.
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Selling the cow & keeping the milk!
Moral:
o Decision to Sell is made on 2 levels:
1. Financial
2. Emotional
• Eliminate the financial aspect and make sure your personal
finances are in order and that you can afford to sell
o Make sure you have something to “retire to”
Expecting someone to buy the cow when they can get the milk for free!
Moral:
o Don’t eliminate the incentive to own by overpaying
o Have your associate sign an employment agreement
with a covenant not to compete
