Transitions in today's marketplace

March 21, 2012

With the economy in the state that it has been and little end in sight to the economic downturn, many dentists have been unable to sell their dental practices under terms similar to what those dentists in the past had been able to do. There was a day when the sale price was paid in full at the settlement table and there were no other segments attached to the transaction.

With the economy in the state that it has been and little end in sight to the economic downturn, many dentists have been unable to sell their dental practices under terms similar to what those dentists in the past had been able to do. There was a day when the sale price was paid in full at the settlement table and there were no other segments attached to the transaction.

Buyers are now incurring difficulties in arranging appropriate financing for a complete or partial acquisition and payment in a lump sum to a seller. Because of these problems, finding a suitable lender who will advance the amount necessary to complete the purchase, a trend has been taking place where sellers are delaying the sale of their practice and entering into a deferred sales arrangement with a buyer so that a full payment can be made for the sale price and no secondary financing by the seller has to be involved even though the transaction won’t be finalized until some time in the future.

How is a Deferred Sales Transaction Structured and Who is the Buyer?

This type of transaction creates a sale at a later date than normally would occur in the traditional sense. There is a known buyer and a period of time for that buyer to accumulate a down payment occurs so that when the actual settlement takes place, the financing arrangement will be accomplished more easily than under current conditions and payment will be made in full to the seller. A typical approach is that as a first step, an associate is hired by the selling dental practice. That associate becomes the buyer at a later agreed upon date. The associate, who rarely has a deposit available, will enter into an employment arrangement for a time period in which an amount will be withheld from each paycheck. The funds will be placed in an escrow account to be paid to the seller, assuming that all of the terms and conditions of the transaction are met. The associate pays tax on a current basis on those funds because they come from the salary paid by the owner/seller as compensation, which is ordinary income to the associate/buyer. A period of time is agreed upon for the employment arrangement and the escrowed portion of the associate’s salary. During this probationary period, the seller can keep tabs on the associate’s credit worthiness and also assist in finding a lender for the associate. The seller can also learn a great deal about the associate’s clinical skills and personality. The agreements should have language that specifies when the acquisition process begins and the seller can no longer terminate the associate’s services and negate the transition agreement. The escrow contract would have language penalizing or cancelling the transaction in the event of credit problems or other issues that would prevent the associate from being able to close the loan at the time agreed upon. If an event occurred where the agreement is cancelled because of a problem incurred by the buyer, appropriate language in the agreement would award the escrow funds to the seller. The escrow is forfeited by the buyer and earned by the seller if the settlement does not occur at the appointed date unless there were problems created by the seller. In the event that the transaction takes place and the terms are met according to the agreement, the escrow is released to the seller at the appropriate time and the lender acknowledges that escrow as the buyer’s down payment, since it is being held in escrow as the buyer’s deposit.

What is the Sales Price When a Deferred Sales Arrangement Occurs? 

The sale price that is used is the actual value of the dental practice at the time of the formal deferred sales arrangement plus an adjustment for the value of the dental equipment at the closing date, and an inflationary adjustment for the intangible value increase from the date of the arrangement until the actual closing. If the agreement is arranged today, hypothetically, the buyer and seller agree on the sale price for the dental practice now. An informed buyer and seller would be advised to obtain a valuation of the dental practice today as if the sale were occurring on a traditional basis. When the deferred arrangement is ready for completion, an additional appraisal is recommended to determine the value of the equipment at the time of the formal settlement because there may be additional equipment acquired prior to the closing or if no new equipment is purchased, there should be a reduction in the equipment value based on a depreciation factor. An inflation factor would be added to the value established when the deferred arrangement was signed so that the allocation of the goodwill value would have been adjusted typically, upward. The associate would not be paying for the increase in value that he or she has contributed to the dental practice but the seller has been guaranteed a buyer, with a down payment and the more than likely ability to finance the balance of the purchase price from an independent lender because of the down payment generated from the withheld compensation and placed in escrow. The seller would not have to be responsible for providing secondary financing similar to many transitions occurring in today’s market.

How Complicated and Expensive is the Preparation of the Documents?  

The preparation of the documents should be undertaken by an attorney with knowledge of dental practices in general and with the ability to understand the nature of the deferred sales arrangement. There are numerous issues involved with this type of transaction such as those related to tax considerations, contract law, questions involving escrow agreements and other legal areas that need expert attention. Sales agreements, promissory notes, escrow agreements and the like must be prepared and reviewed by the appropriate advisors for the seller and the associate/buyer. A CPA with expertise in representing dentists should also be retained for advice regarding this transaction as would be the case in the traditional transition where similar knowledge would be vital for buyer and seller to be advised of in a professional manner.