The sale and/or acquisition of a dental practice can be an overwhelming feat. However, the aim of this article is to highlight some of the pitfalls that can and should be avoided by buyers and sellers alike during this process. If parties avoid these mistakes, they are likely to enjoy a successful transition into the next exciting chapter of their professional journeys.
Failing to Plan: It takes time to sell a business. Therefore, not planning for the sale of a Dental practice can cause business owners to miss valuable opportunities with the right buyer. To avoid this mistake, sellers should maintain updated records and keep a sales portfolio on hand. Buyers and/or brokers will notice when a seller has been planning ahead, and this will give him/her confidence in the purchase, not to mention an assurance that the sale was not driven out of desperation.
Rushing into Contractual Negotiations: Rather than immediately incurring the expense of negotiating and drafting a contractual agreement, both parties should consider entering into a letter of intent (“LOI”). An LOI is a document that outlines the preliminary agreements and understandings between the parties to the transaction. It is not a legally binding contract, and should simply describe the essential business terms of the deal, including the monetary terms, and deal contingencies. A well-drafted LOI mentally and emotionally commits the parties to the fundamental terms of a deal. Further, because less is left open to negotiation, the likelihood of the deal’s success is increased.
Engaging in Inadequate Due Diligence: A deal should not close until the buyer is satisfied with the due diligence conducted. A thorough due diligence process should include (1) a detailed accounting of the practice assets and liabilities, and (2) an inspection of the premises, assets, inventory, financial statements, accounts receivable, employment agreements, leases and contracts, insurance policies and benefit plans, and any government approvals required to operate the practice. The buyer should also run a search against the seller and its owner to make sure there are no liens against the practice assets, such as judgments, tax liens, lawsuits, or UCC financing statements that create collateral liens on the property of the seller.
Waiting To Begin Lease Negotiations: A tremendous amount of goodwill attaches to the location of a dental practice. Where real estate is not being purchase in connection with the sale, the buyer should not make the mistake of assuming that a lease is satisfactory simply because the seller has been in the location for a long time. Buyers should request a copy of the lease immediately upon taking an interest in a practice, and begin a dialogue with the landlord early in the process. The seller should anticipate a sale and where appropriate, they should give the landlord notice. In some circumstances, it is advantageous for the buyer to negotiate a new lease directly with the landlord. However, when the seller already has a favorable lease and a term with renewal rights, a simple assignment can also be negotiated. In either case, the two parties will, in most cases, need the landlord’s consent to the new tenancy.
Failing to Address Accounts Receivable: There are a variety of ways to manage accounts receivable (“A/R”) The most common are:
- The seller keeps the A/R and the buyer collects them as a courtesy or for a fee;
- The seller keeps the A/R and collects it themselves;
- The buyer pays additional consideration and collects the A/R post-closing; and
- The purchase price includes the value of A/R, which the buyer will collect post-closing.
Buyers should determine early in the negotiation how much A/R the seller has, and its aging. If the parties agree that the seller will keep the A/R, next, the parties must determine who gets paid first when monies come in – will the funds be applied to new or older balances? Alternatively, if the buyer agrees to let the seller collect the A/R, the buyer will want to consider the risk of the seller adopting aggressive methods for collecting on open accounts, and what effect this may have of the practice’s goodwill.
Overlooking Restrictive Covenants: For buyers and sellers alike, it is very important to understand the seller’s post-closing plan. Will the seller retire? Does the seller intend to enter into a new business venture? Knowing this detail can help both parties negotiate a reasonable and enforceable restrictive covenant, but, more importantly, it can prevent the parties from making a mistake about the status of the business and the owner’s intentions after the closing. These are the type of misunderstandings that lead to disputes and litigation. When selling a practice, it is reasonable to require the seller to enter into a post-closing restrictive covenant with a substantial time and geography limitation. The seller is receiving significant consideration – the purchase price – and the buyer is acquiring all of the goodwill and, in most cases, taking on significant debt to buy the practice. So the seller should be prepared to remove themselves from the marketplace.
Ignoring Purchase Price Allocation: The purchase price that is allocated in a practice transition can have significant tax implications for both parties. Typically, in an asset purchase, sellers want to allocate as much of the purchase price as possible towards goodwill in order to receive capital gains treatment, which is a significantly lower tax rate than ordinary taxable income. Conversely, if allocation is applied toward furniture, fixtures and equipment (“FF&E”), to the extent the seller has already depreciated such FF&E, he or she will have to recapture the prior depreciation, which is subject to ordinary income tax treatment at a higher tax rate. Buyers prefer FF&E treatment because they will depreciate the FF&E on an expedited basis and get a faster tax benefit, as opposed to goodwill, which is depreciated over 15 years.
Once you decide to sell or acquire a practice, avoiding these mistakes should help make that transition in your career an exciting and rewarding journey.