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Feature Article: Sinning is oh so costly
7/1/2009


Consider these simple facts:

1. Most doctors have no income-producing asset that makes more money than their dental practice.
2. Any practice transition activity will, by definition, have some type ofeffect for the rest of your life, both at the professional and personal levels.
3. Any misstep in this area can be costly — often beyond measure.

Here is a list of some of the more deadly sins committed during transition activities. This is by no means an exhaustive list of the errors that will cost you money, time, and lost opportunities. These are seven of the most common sins. But the good news is that each of these sins can be corrected with minimal effort, and correcting them will reap untold benefits.


1. Beginning too late
It’s easy to wait too long to begin transition planning. Doctors may hesitate because of the anticipated complexity, or because of the emotional landscape. No matter the reason, waiting too late is costly.

With the exception of a few metropolitan areas, there are generally more sellers than purchasers. When this is the case, it will take a doctor longer to find the right person(s) in order to consummate a transition plan. Exacerbating this situation is the fact that most young doctors are reluctant to go to small communities, thus making the planning time frame longer before the right person is found. Not every dental school graduate plans to purchase part, or all, of a practice immediately. All of these factors can be overcome, but it takes time. Finally, if there is a decline in the practice or a life-threatening illness, this will make transition activities more difficult.

Thus, while beginning too late is common, the way to avoid it is simple: begin earlier. One can seldom begin too early.


2. Fees
Not keeping your fees updated will produce the following negative implications for your practice transition:

(a) If everything else holds constant, the more profitable the practice, the higher the value. Without current fees, your profitability (and therefore your value) will suffer.

(b) You lose money in the interim between now and the transition date. If there will be several years before the actual transaction takes place, this amount is usually measured in the tens of thousands, and many times in six figures. This does not mean there will be additional dentistry to be done. It simply means there is unrealized revenue.

(c) Purchasers do not want to raise fees immediately after taking over a practice. As a corollary, if you bring in an associate/partner, you do not want your patients to associate
a fee increase with the arrival of the new doctor. Thus, from any perspective, your practice’s marketability and attractiveness to a young doctor will be jeopardized if you do not keep fees up-to-date.

(d) Additional revenue from keeping your fees updated can help you maximize funding of your qualified pension plan. This is true even in practices with a defined benefit plan where the doctor’s contribution is in excess of the maximum on other types of plans.

(e) Keeping your fees current will reduce your stress since you realize the benefits of increased value and marketability, with no additional dentistry required of you.

One of the most effective and successful programs we have seen for adjusting and keeping fees current is the Revenue Enhancement program available through Dr. Charles Blair & Associates (www.drcharlesblair.com). Dr. Blair has information on reimbursement from insurance companies for the zip codes in which you practice, for each ADA code.


3. Allocation of the purchase price
When you sell a practice, a portion of the purchase price must be assigned to a specific asset class (fixed assets, consumable supplies, goodwill, covenant, and patient records). Some items are more beneficial to the seller, and others to the purchaser. It is possible to resolve this in a mutually beneficial manner if the purchase price is allocated correctly. Allocating the purchase price incorrectly can result in the loss of tens of thousands of dollars. In short, while the purchase price is important, the amount of after-tax gain is even more important. This is governed by the allocation of the purchase price.

If your practice is currently unincorporated, you are in the best possible position to minimize taxes on the sale of your practice. If your practice is incorporated, these issues can still be satisfactorily resolved with adequate planning.

A word of caution: if you are incorporated, it does not make good financial sense to dissolve your corporation in order to be unincorporated, since your corporation’s dissolution will trigger a significant tax liability. There are other methods available to address the situation.


4. Associate compensation
If your transition plans involve including an associate prior to the sale of your practice, or a fractional interest therein, you will need to figure out a compensation basis that is fair for you and the associate. This arrangement must provide two additional motivations for the associate: (a) the incentive to increase productivity, and (b) the incentive to become an owner.

In most cases (with the exception of certain specialty practices), the most likely arrangement will be a commission based on collections attributable to your associate. However, your associate, like everyone else, will have certain fixed and basic income needs. Thus a draw against a commission is an attractive bridging mechanism in that it gives the younger doctor a financial safety net, yet does not limit the amount of income an associate can earn.

Basically, any amounts over the earned commission that help to reach the draw (the financial safety net) in the early months, will be recovered by the owner doctor as the associate’s collections increase over the amount necessary to cover the draw.

Beyond this, remember that the commission is the product of careful analysis that takes into account the overhead rate of your specific practice, a return on the investment you have made in the fixed assets, and a reasonable profit (usually 5% to 10%) for you as the owner. This protocol is explained in my new book, “Transitions: Navigating Sales, Associateships and Partnerships in Your Dental Practice,” available through the American Dental Association at www.adacatalog.org.

The commission arrangement should also provide for threshold increases as the total practice income rises due to the associate’s productivity. This increase would not be available where income is simply shifted from senior doctor to younger doctor. On the other hand, it’s appropriate where the associate is adding to the total practice income. These increases are available and affordable because the overhead (expressed as a percentage) will decline as total practice income increases due to the fact that most overhead costs in a dental practice are fixed.

Finally, there should be a deliberate difference between what an associate can earn as a non-owner, and what is available to an owner. Without this difference, there is no incentive to become an owner of your practice.


5. Financial Structure
If you plan to sell a fractional interest in your practice, the financial structure of the buy-in is an area whose importance cannot be overemphasized.

Essentially, financial structure addresses this question: how can the buy-in be made affordable for the new doctor while keeping it fair, equitable, and tax-efficient for the senior doctor? There is a built-in push-pull in the tax code with respect to the senior doctor and the new doctor, and resolving this issue can mean the difference between success and failure. If planning for the sale of a fractional interest has an aspect that is rife with potential for catastrophic errors, this is it.

This short article will not permit a full discussion of the solutions, but the best results are achieved by examining comparative results for each doctor over a 10-year period. To say the least, this requires an extraordinary software program, as well as a professional with experience to look at the tax and cash flow implications for both doctors.

No other area of planning for the sale of a fractional interest is more critical than the financial structure. By definition, one of the solutions will be more efficient for the doctors than the others, and an examination of those comparative results is critical to the success of a plan.


6. Income distribution formulae
Any time there are two or more owners in a practice, an income distribution formula is necessary to direct how the practice income and expenses — and therefore, the profits — will be allocated among the owner doctors. To undertake a new partnership without establishing a plan in advance invites disaster.

It is theoretically possible to allocate profits solely by ownership percentages while ignoring each doctor’s level of production. But this is only a prescription for heartache, and it eliminates a doctor’s incentive to produce. Little more needs to be said about that.

On the other end of the same spectrum, doctors could allocate profits based on their individual percentage of the total production. Known as a productivity (or pro-rata) distribution formula, this generally produces acceptable results.

Many doctors employ a multitiered distribution formula where the majority of profit is allocated by each doctor’s percentage of production, but a modest portion is allocated by ownership. By allocating this portion on the basis of ownership, a number of desirable benefits are realized:

• It smooths out month-to-month variations in the doctors’ individual collections.
• It helps focus the doctors on the practice more than on themselves. This is always a healthy perspective.
• It provides for a modest profit allocation even when the doctor is away from the practice for vacation or other reasons.
• It tends to blunt unbridled competition among the doctors.
  

In summary, we have found the best results are achieved by providing multiple sets of cash flow projections in which the only difference is a variation in the way profits are allocated. These comparative results can then be contrasted on a single page, allowing the doctors to visualize the financial outcomes over a 10-year forecast under different income distribution formulae assumptions. In this way, the doctors can make a decision with perspective and not suffer the consequences of a distribution formula that might otherwise be unacceptable. In short, the ability to see the comparative results dramatically increases the chances for a successful transition.


7. Planning failure
Of all the reasons that a transition plan might fail or be only minimally successful, the hands-down winner is: without the necessary analysis, planning, and review, the doctors will not know what to expect in the following important areas — 1) the financial outcome, 2) the legal arrangements and obligations, and 3) the process or protocol that will guide them through the transition. For each transition activity — whether the outright sale of the practice, the inclusion of an associate leading to partnership, or the delayed sale of your practice — establishing a realistic level of expectation in these three areas almost always means the difference between success and failure.

Many times doctors will say, “I don’t know if I did it right, but I did get it done.” Tragically, they will never know how much better it could have been had they simply invested the time and money to do it right.


8. One more for good measure … trying to do it all — The obvious question to this is: Why would you? For an event in your life that involves your largest income-producing asset, and that will affect you personally and professionally for the rest of your life, trying to do it yourself makes little sense. Transition planning requires expertise in many critical areas, including law, valuation, tax implications, associateship arrangements, and more. Mistakes in transition planning are always costly in terms of money, stress, relationships, and lost opportunities.

Moreover, by doing it yourself, you will invariably be placed (often uncomfortably) at “the hub of the wheel” to bring together information in the many disparate areas listed above, and trying to explain it to the other doctor(s) involved in your transition plan. Instead, it makes infinitely more sense to invest the fees to have the planning done on your behalf, such that you are in the position of “chairman of the board” in reviewing and approving those plans. In short, the fees invested for transition planning will not cost money — those fees will make money for you.

Roger Hill, ASA