January 10, 2023
Buying a Dental Practice: a Q&A with Dentist Attorney Pat Stanley
By Patrick Stanley
Buying a dental practice can be a better alternative to opening a practice from scratch. The permits, leases, equipment and patient base are already in place. You should be able to start practicing immediately after the sale. However, there are some considerations to keep in mind when negotiating and finalizing the purchase of a practice.
What Should I Know About Financing The Practice?
One of the first steps to take is to reach out to lenders to develop relationships and to get pre-qualified for a loan.
When you apply for the loan, the bank will look at two primary factors. First, the bank will review your personal credit history and determine whether there are any red flags. Then, the bank will review the financial data from the practice to evaluate the associated level of risk. If you have a poor credit history, you may have a difficult time securing a loan. Banks may also shy away from a practice with too many red flags. These can include things like declining revenue trends and high overhead.
You will also need to make sure the loan is right for you. In addition to the interest rate, you should consider factors like the length of the loan and any discounts the bank offers. Above all, you will want to be comfortable with the bank and your banker.
How Do I Find The Right Practice?
Location is essential when buying a dental practice. You may want to research demographic data, such as how many dentists are already practicing in the area, the ratio of dentists to the population in the area, as well as average age and average household income in the area. Much of the general demographic information can be found for free through searching U.S. Census data.
You can also research your potential competition by searching online review sites such as Yelp. For more detailed demographics, there are also companies that provide fee-based reports, which advertise being able to track factors like the number of dentists per person or household.
You also want to have the resources available to help you find the right practice. Practice brokers are a good resource in finding available practices. However, brokers typically represent the seller, and will not owe you any fiduciary duties. Additionally, most brokers are not lawyers and are not trained in drafting and interpreting contracts. You may want to consult with a CPA for financial due diligence, as well as attorneys to help you and the seller prepare the asset purchase agreement.
You can also find opportunities in classified ads and through networking. Getting involved in organizations like the Arizona Dental Association can be a great way to find doctors who may be looking to sell their practices. The Arizona Dental Association may offer other resources to assist you with practice management.
How Do I Value The Practice?
Evaluating the purchase price of a dental practice can be a difficult task. Potential lenders often conduct their own valuation of the practice as part of the underwriting process. But banks are risk-averse by nature and will often undervalue practices in their underwriting. In fact, in many cases, the bank will require that the seller carry back some of the purchase price. In these circumstances, the seller will essentially loan the buyer a portion of the purchase price, so that the buyer makes payments to both the lender and the seller over time.
There are several rules of thumb for looking at what a practice should sell for. The most common being to use a percent of collections over a period of two to three years. You should remember that this should not be the limit of your valuation. To get a more precise market value, you should consult with a business valuation specialist (such as a dental CPA or a dental practice broker). Remember that ultimately, the decisions of whether to sell and at what price remains with the seller.
What Is A Letter of Intent And Do I Need One?
The next step will likely be negotiating the terms of the purchase. Although the initial contact and preliminary negotiations can be through verbal discussions, it should be documented in a more formal letter of intent. Letters of intent are usually short synopses of the final terms of the sale that often include the following:
- Purchase Price, with any reductions for the earnest money deposit.
- Allocations, showing how much of the purchase price is allocated to goodwill, versus tangible assets.
- Due Diligence period, letting the buyer know when and how he can inspect the assets of the practice.
- Closing Date, which is the date on which the practice actually changes hand.
- Contingencies that have to occur before the sale can happen.
- Non-compete agreement, with the radius and duration.
In addition to the letter of intent, the seller may require that you sign a separate confidentiality agreement and a business associate agreement. The confidentiality agreement will generally require that you only share information you obtain about the practice with your advisors and that any information you receive will be returned in the event the transaction does not close. The business associate agreement may protect the practice from liability under HIPAA if you review protected health information about the practice’s patients during the due diligence period.
What Should I Be Focused On During The Due Diligence Period?
Looking at a practice’s annual production and collections can give you a rough estimate of a practice’s value. However, determining a practice’s true worth is more complex. Ideally, you will have already begun some of the due diligence when negotiating the purchase price and formulating the letter of intent. The due diligence period, though, allows you to review the initial data in greater depth to make sure there will not be any surprises.
Generally, there are five broad categories you will probably want to look at:
- Financial records to make sure the assumptions that went into the letter of intent are accurate and to identify potential areas for revenue growth or expense reduction.
- Patient care records to ensure that the clinical work performed in the office is satisfactory.
- Business records including office and equipment leases and contracts with any vendors.
- Employment records for the office staff.
- Public records, which can include board complaints, court records and any liens against the practice.
Here’s a non-exhaustive list of some of the records you’ll likely want to take a look at under each of these five categories.
- Tax returns (individual and corporate) for at least three years.
- Monthly profit and loss statements for at least three years.
- Accounts receivable aging reports for at least three years.
- Agreements with all active third-party payors (insurance companies, AHCCCS/Medicaid, Care, Credit, etc.), including reimbursement rates.
- Samples of patient charts.
- Samples of treatment plans.
- Clinical observation, if the seller will allow it (but most won’t).
- Any written follow-up and post-op recall protocols.
- Any lease agreements, for the office space or equipment.
- All advertising and marketing contracts.
- Any other vendor agreements.
- Declarations pages from the seller’s malpractice and general liability insurance policies.
- Associate or staff employment agreements.
- Employee handbooks.
- Written employment policies.
- Six months of payroll records for the staff.
- Look at court dockets to see if either the practice or the seller is involved in any ongoing or recent litigation.
- Research the county recorder and Arizona Secretary of State’s website to see if there are any existing liens or UCC-1 financing statements involving the practice.
- Search the Arizona Board of Dental Examiners’ website to see if there is a disciplinary history for the selling doctor.
- Research the doctor on consumer rating sites like Yelp. Negative reviews can hurt patient recruitment.
You want your review to be thorough to avoid uncovering any nasty surprises after the deal has closed. However, a 30 day due diligence period is usually sufficient. If there are delays in receiving the information, or if the review raises some red flags, though, you may consider extending the closing date until the review can be completed.
What Is The Purchase Price Allocation?
The purchase price allocation is the division of the total purchase price into several categories. These categories include the amount attributable to equipment, goodwill and the covenant not to compete. The allocation of purchase price can have significant tax consequences for both the buyer and the seller.
A buyer will likely want to allocate as much of the purchase price as possible to equipment. Lenders may require that a certain percentage of the purchase price be attributable to tangible physical assets like equipment. Additionally, purchased equipment can often be deducted under Section 179 of the Internal Revenue Code. This can result in an immediate tax savings, whereas goodwill must be depreciated over 15 years.
Sellers, on the other hand, may want to minimize the allocation of the proceeds to equipment and other tangible assets. Sellers have likely already depreciated these assets under Section 179 and these amounts will be taxed as ordinary income. However, goodwill is taxed at the capital gains rates, which are significantly lower.
How Do I Address Accounts Receivable?
The asset purchase agreement should address accounts receivable. The first consideration is who will own the accounts receivable following the sale. Are they going to transfer to the buyer or remain the property of the seller?
If the buyer gets the accounts receivable, the next step is to value the receivables. This requires evaluating the age and collectability of the receivables to determine a price. For example, a buyer could pay 100% of the face value of all current receivables. However, the buyer would pay less for older receivables, based on their age. This option allows the buyer to maintain control of all patient communications.
If the seller keeps the accounts receivable, the buyer will pay less at closing. The buyer also will not have to worry about collecting the receivables. However, the seller, in collecting the receivables, may use methods to collect the debt that anger your patient base. For example, a seller could refer a patient to a collection agency or sue a patient to collect the debt. This also leads to potential confusion, as the buyer may receive payments that are intended for the seller.
Alternatively, the parties could take a hybrid approach where the seller retains the accounts receivable, but the buyer collects them on the seller’s behalf. Under this approach, the buyer is in control of the collection efforts, but any payment is then sent to the seller. Since the buyer must use staff members to collect, the seller also pays an administrative fee to the buyer, typically a percentage of the collections.
How Does The Buyer Protect The Investment In The Practice?
Every asset purchase agreement should contain restrictive covenants to prevent a seller from competing. In fact, lenders typically require that an asset purchase agreement contain restrictive covenants. The two most common common restrictive covenants are non-compete agreements and non-solicitation agreements.
A non-compete agreement simply states that the seller will not practice dentistry within a certain radius of the existing practice for a certain period of time. A non-solicitation agreement prohibits marketing to former patients. Non-solicitation agreements also often prohibit the seller from attempting to recruit former staff.
However, you have to be careful in drafting restrictive covenants. Arizona courts disfavor them, especially in the healthcare setting, due to concerns over patient choice. Additionally, Arizona has specific requirements for restrictive covenants that, if not followed, can lead to a court invalidating them. You should consider retaining experienced legal counsel to ensure the agreement is enforceable.
The above are just a few of the many issues that can arise when buying a practice. If you are considering buying a dental practice and have questions about an asset purchase agreement, please feel free to contact one of our attorneys directly.
This post is for informative purposes only and should not be used as a substitute for consultation with a licensed attorney. It provides general information and a general understanding of the law, but does not provide specific legal advice. No attorney-client relationship is created by the posting of this information. If you have specific legal questions after reading this post, you should contact a licensed attorney.