Selling a Dental Practice
By Jon Almeida, Partner, Tax & Business Services
Selling a business is a huge step in the life of any business owner. If you are considering selling your dental practice, there are many considerations you’ll want to address to ensure the transaction goes smoothly and with the intended results. Your initial thoughts will range from “what am I going to do when I retire?” and “how long do I want to continue working?” to “what is my practice worth?” “how am I going to get the deal done?” and, of course, “how much tax am I going to pay?”
Although dental practices have been significantly impacted by the COVID-19 crisis in the short term, the demand for dental services was expected to increase prior to the crisis (the Bureau of Labor Statistics expected industry jobs to rise 19% from 2016-2026), and it stands to reason that this demand will continue and resume growing once the impact of the virus has been more fully addressed and absorbed by healthcare systems in the United States.
There are approximately 136,000 dental practices in the United States, and the great majority (90%) operate as general dentistry practices. The average practice generates $1 million in revenue annually and employs 7-8 workers. More than 80% of practices in the U.S are structured as partnerships, sole proprietorships and small business corporations (“S-Corporations”). Dental practices are considered highly marketable, in that they generate many transactions annually, and the goodwill of a dental practice generally is transferable to a buyer. There has been a trend over the past several years of dental service organizations increasing their share of the dental practice market through acquisitions.
General dentistry practices derive value from their existing patient base as compared to specialist practices, which derive value primarily from referrals. Practices with strong hygiene businesses derive significant additional value due to the recurring nature of the service and the low involvement required from the owner/practitioner to maintain this revenue stream. For a specialty practice, it may be more difficult for a potential buyer to maintain the goodwill or continuing cash flows, with the existing dental practitioner no longer in place.
When valuing a dental practice for a potential sale, it is important to consider not just the profits and revenue of the dental practice but the owner’s compensation and benefits, in deriving the cash flows available to the owner. A prospective buyer will want to adjust the practice’s cash flows to fair market value for compensation to the owner that is either too low, which would require a higher replacement cost to the buyer, or too high, which would result in greater cash flows to the business. Some discretionary expenses not vital to generating cash flow to the practice may be added back to cash flow in a valuation, effectively increasing the practice value.
Since the value of a business is often assessed based on the cash flows available to the owner(s), a dental practice owner may want to take a hard look at any inefficiencies, starting with how the business’s overhead cost rates compare to the industry in general. Efforts to shore up operational inefficiencies, such as overpaying for certain expenses, prior to marketing the practice for sale may result in more money in the seller’s pocket at closing. Not addressing inefficiencies in advance may result in a discounted selling price, to the buyer’s advantage, with the inefficiencies surely being addressed by the buyer post-sale.
A dental practice owner may also want to consider engaging a business valuation professional to make an assessment prior to marketing it for sale or in negotiating a successor buy-in.
Transaction and Tax Considerations
Most dental practice sales are structured as asset sales, meaning the acquirer is buying specific assets of the company rather than its stock. This is done for several reasons, primarily the acquirer’s ability to expense the payments for the assets purchased more quickly, versus company stock, as well as avoiding potential legal liabilities of the acquired company. Depending on the type of assets being sold, tax rates on gains can be very different if ordinary income rates apply, up to as much as 37%, versus capital gains rates, which range from 15% to 20%.
Due to tax considerations, of importance is agreement between the parties on the asset allocation statement, which should be included in an asset purchase agreement. When the parties to the sale report the transaction in their respective tax returns, the reporting on Form 8594, Asset Acquisition Statement, must be consistent on each return as to the sales price of assets and the fair market value of the respective asset classes. In a dental practice sale, the separate classes will most likely include accounts receivable, inventory, fixed assets (furniture and fixtures, equipment, vehicles), and goodwill.
Other than the obvious importance of identifying which assets are to be included or not included in the sale, the asset purchase agreement should identify the relative fair market value of the assets to be included as part of total sales price. For the seller, an increase in the allocation of the sales price to goodwill is generally beneficial, as lower capital gains tax rates would apply. An increase in the allocation of the sales price to equipment would not be beneficial to the seller, due to potential recapture of depreciation deductions previously taken on the equipment, in which case higher ordinary income tax rates would apply.
There are many other transactional considerations to be addressed when negotiating the sale of a dental practice, including responsibility for collecting accounts receivable and assumption of payables, the timing of the payment of the sales price, and any contingencies affecting the ultimate payment. Additionally, an employment agreement with the seller during a transition period subsequent to the sale may be a necessary aspect of the deal. Working through these issues with the help of a professional team, including a certified public accountant and an attorney, will help in achieving desired results and avoiding later conflicts.
Dental practice owners will have many questions and concerns when considering taking the big step of selling their practice. Just as great care should be taking in treating the patients of a continuing practice, similar care should be taken in addressing the multiple considerations of selling a dental practice, including valuation, taxation and transactional elements. A good first step in navigating these considerations is engaging qualified accounting and legal professionals to assist in guiding the transaction from initial stages to a close.