Smooth Running: A Guide to Practice Transitions by Thomas F. Ziegler, DDS, MS, JD

Smooth transitions could occur on a handshake deal, but that is highly unlikely.

Whenever I hear about orthodontists whose partnership disintegrated into a bitter, expensive split, I ask them what their partnership agreement says regarding dissolution. The answer is almost always, "We don't have one." The same is said for a buyer who thought the plan was to purchase the practice after the associate period was completed, but who was never given the opportunity—"We didn't have a purchase agreement."

Practice transitions specialists exist to help orthodontists design and implement a solid transition plan that will accomplish the doctors' goals, given the financial realities of the practice. With a proper set of transition documents in place, whenever disagreements arise, the doctors need only to consult those documents for the remedy. Smooth transitions are a result of planning, not simply adopting the attitude of, "Let us just start working together and we will figure it out as we go."

Types of practice transitions
Associate Only. This is when an orthodontist/owner wants to hire an orthodontist/employee to provide clinical treatment. It is totally clear between the parties that nothing other than an employer/employee status will ever come of this relationship. In addition to base pay, bonuses and benefits, pay attention to requirements to quit and penalties for not giving proper notice, as well as covenants not to compete, which must be agreed upon.

Associate Followed by 100 Percent Sale. The associate period is usually relatively short (six months) and then the closing occurs and money is exchanged for ownership, usually via third-party financing. In this case, the associate period exists merely to allow the buyer to move to the area, settle in and get a feel for how the practice works before taking over as the owner.

100 Percent Sale Up Front. There will not be an associate period for the buyer prior to sale.

In any type of transition, when the seller is no longer an owner of the practice, there is the possibility that he/she may be hired back by the new owner to work on a per-diem basis. In this particular type of transition, that almost always occurs. The purpose of hiring the seller to continue working after the closing is to lessen the shock on the new owner, staff and patients, and allow everyone to gradually get used to the new situation.

Whether the buyer is an associate before the sale, or the seller is hired after the sale, there is a period of 6 months to 12 months during which the seller and buyer are present in the practice together. During this time, it's usually a good idea for the doctors to refer to one another as "partners." The seller states that he/she has no immediate plans to retire and that some days, patients will see him/her and other days, they will see the new "partner."

This conveys to patients that the two doctors are equals, and it gives patients, parents, staff and referring doctors a reasonable opportunity to adjust to the idea that there is a new doctor involved. It does not matter that the two doctors are not true "partners" in the legal sense. The general public understands business partners to mean a variety of different things, but one thing it always means is that the two are in it together. The success of the practice and the patients' care is a goal shared equally.

Partnership. True partnership occurs when there are two owners at one time—no one doctor is a 100 percent owner. In orthodontic practices, the typical way to structure the buy-in to an ownership position is for there to first be an associate period for the buyer, after which the buyer will begin acquiring ownership interest. A unique feature of partnerships is that the buy-in occurs on the first day of a new corporate year.

In 100 percent sales, the transfer of ownership can occur at any time, but that is not the case with partnerships. As a result, the associate period will end on the last day of a corporate year. Typically, this results in an associate period of longer than one year—from the date of hire through the end of that first year and all of the second year; then the buy-in begins.

The buy-in is usually done at the rate of 10 percent interest per year for a five-year period, after which the two doctors will be equal partners. To determine the price that is to be paid over those five years, the practice must be appraised before the buy-in begins. In fact, it is usually done before the associate period begins.

The buyer and seller each know the plan and the amount to be paid ahead of time, and there is no disincentive for the buyer to grow the practice prior to completing the buy-in (a five-year or more process). The purchase price is determined and then divided by two, because only 50 percent is being sold.

That price is then allocated to two categories—a small amount for stock and the remainder for management fees. The stock purchase occurs on the first day of each corporate year, and the management fees are handled on a monthly or quarterly schedule via a pretax income transfer from the buyer to the seller.

Their compensation arrangement shall be based partially on the amount of work each doctor is performing, and partially on their amount of ownership. The compensation is split, the income is shifted for payment and then W2 income is tabulated. The tax consequences during this buy-in period favor the buyer, but there will be an even-up when the buy-out occurs.

Once the doctors are equal partners, they will remain operating as such until one of three events occurs: the total disability of a partner, the death of either partner, or the voluntary retirement of either partner. If there is a conflict that results in the two parties wanting to split, that will be governed by a certain agreement within the documents, but any of these three events will then point to the buy-out agreement for resolution.

For the buy-out, the practice will be reappraised and the new value will be divided by two to determine the purchase price of the second 50 percent. Since the buyer was given the tax advantages during the buy-in, the seller will be given the tax advantages during the buy-out. There will still be a small amount allocated to stock; however, the remainder will now be allocated to the seller's personal goodwill. Stock is a requirement anytime a fractional interest is being transferred, but is a major negative to the buyer (completely non-deductible), so we keep the value as low as possible.

The management fees during the buy-in are entirely deductible by the buyer (excellent), but are ordinary income to the seller (not great). During the buy-out, the seller will receive capital gains treatment on the entirety of the price (stock and goodwill), while the goodwill must be amortized over a 15-year period by the buyer (100 percent deductible, but it takes 15 years to do it—not great).

The entire partnership plan is designed to share the sugar and the poison as equally as possible because, after all, we are talking about a venture that is supposed to be an equal partnership.

Practice appraisal
Once the orthodontist/owner makes the decision to enter in to some type of transition, the first step is to have the practice appraised. It not only determines the price of a buy-in or 100 percent sale, but also provides the owner with an acute understanding of the financial aspects of the practice, which are essential in determining what is possible, given the owner's goals.

Working with a practice transitions specialist is key to assessing an accurate value and assisting in devising a transition plan that meets the owner's goals, while also maintaining a practical likelihood of success given the practice's finances.

It is often this step that is glossed over by orthodontists. Whether they have their CPA "come up with a number" or they guesstimate a value based on a lecture they attended or a newsletter they read, the orthodontist is, more often than not, making a big mistake. Guesstimate values can be off by hundreds of thousands of dollars, and much more costly than the professional advice on how to design a plan that will work and that will accomplish the owner's goals.

Practice appraisals are often provided in a bound, written report, in addition to an electronic version for easier transfer and storage. The appraisal is an essential component in conveying the practice value to a potential associate, partner or buyer. The owner must be able to provide evidence of value upon which the associate compensation, buy-in price, or 100 percent sales price will be based. The appraisal should be made available for use by advisors, banks and the junior doctors themselves.

The moment the senior orthodontist starts thinking that he or she wants to take more time off, hire an associate, retire, etc., he or she should start consulting with an orthodontic practice transition specialist. Transition specialists will help the senior doctor through the many possibilities and to formulate a plan to accomplish his or her goals.

As part of that analysis, the practice should be appraised, and once a path has been chosen and a candidate is selected, the documents required to implement that plan should be negotiated, drafted, discussed, modified and finalized—all before any formal action takes place. It is far easier to deal with issues that arise during the negotiation process than to breeze through that part and discover the problem after the junior doctor has arrived and both parties have committed to the deal.

This is one of the largest financial decisions an orthodontist will make. Proper effort and consideration will make the difference between success or failure.

Dr. Thomas F. Ziegler received his dental degree from The Ohio State University in 1965 and served as a general dentist in the United States Army (stationed in Munich, Germany) for three years before returning to The Ohio State University for his orthodontic training. He received his Master of Science degree and orthodontic certificate in 1970 and then returned to Cincinnati, Ohio where he maintained a successful orthodontic practice until his retirement in 2000. In 1978, he became a diplomate of the American Board of Orthodontics.
In his 30 years of orthodontic practice, Ziegler has operated as a sole proprietor, an LLC, a C-corporation and an S-corporation. He has been an associate, a partner, and sole practitioner, and has both bought and sold practices. In 1995, he graduated from Northern Kentucky University's Salmon P. Chase College of Law and then founded Ziegler Practice Transitions, Ltd. Since 1995, the company has been involved in thousands of orthodontic practice transitions in all 50 states. Ziegler has given lectures for the American Association of Orthodontists, as well as several state and local component societies of the AAO and other state and local study groups.

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