Dental Practice Transitions and Earn Outs

May 31, 2016 News

By Bruce Bryen, CPA, CVA

 

There are too many times when a practice transition does not occur because the buyer and the seller can’t agree on the dental practice transition price. Even the best practice broker gets stymied and frustrated when the buyer and seller are close to an agreeable price and the last hypothetical $20,000, or an amount less than a few percentage points difference, keeps the transaction from occurring.

Sometimes a creative approach is needed to convince the buyer and the seller that the transition can occur. At this point, each side to the negotiations feels that he or she has compromised enough. Often the seller is sure that the revenue will be met, but the buyer is worried that if not met, the loan payment securing the sale price won’t be afforded. There is a solution called an earn out, where the seller is willing to wait for additional revenue if the buyer agrees. In essence, an earn out is an arrangement where the sale price is less than the seller wants, but if the buyer attains his or her goals, the seller may earn more than the asking price.

Let’s look at a hypothetical example. Suppose the seller insists that his or her dental practice is worth $500,000 and won’t sell it for a penny less. If the buyer can’t justify the $500,000 transition price but accepts $475,000, a negotiated earn out can give the seller the $475,000 now and reward him or her with an additional $40,000 later, and not just the $25,000 difference for agreeing to let the practice live up to his or her expectations. The selling dentist may feel that the $500,000 can be reached easily and won’t wait for the difference of the $25,000, but may wait if a bonus is awarded for reaching that goal. Of course these are all hypotheticals and actual amounts will be based upon negotiations.

How are amounts determined for earn outs?

In this writer’s 40+ years of experience, a seller won’t agree to accept what he or she wanted at the closing of the sale if there is a waiting period. Naturally, the seller will want a reward for the wait. In the event the revenue is not achieved, the seller would receive the $475,000 and nothing more. You might say, “Why won’t the buyer just not work hard to achieve the higher amount so as not to owe more to the seller? Wouldn’t the buyer be hurting himself or herself by under achieving?” Typically, a 1-year period passes before the finalized amounts are reported. If the buyer reaches the gross revenue goal, he or she would also have earned additional money since the original loan was hypothetically $475,000 and the monthly payments to the lender were based on that. If the revenue goal was reached, the buyer has had additional funds throughout the year to pay down the debt faster, withdraw the funds, or to use merely to pay the seller.

Is the buyer or the seller the winner in this scenario?

In analyzing who comes out ahead by using earn outs to complete a transition, both the buyer and the seller are winners. The buyer owns a practice that is producing more than originally thought. The buyer has the cash flow to afford the additional payment. The seller gets more than the original sale price because the buyer was able to produce the gross revenue the seller knew would be available. As the saying goes, “It’s a win-win situation.” That is the best transition of all for all.

Other measuring points can be used besides gross revenue, but it is the easiest to compute and there is very little anyone can do to manipulate it. It is a safe method to acquire a dental practice since the old “put up or shut up” approach is readily proven with earn out methodology. If the revenue is not there, there is no additional payment due.

How is this type of transition structured?

The best advisor for this type of transition is probably the dental CPA with the experience in advising difficult dental transitions. The dental CPA can assist the practice broker and the lawyers and CPAs who do not have experience with dental practice transitions.

About the Author

Bruce Bryen is a certified public accountant with more than 40 years of experience. He is the principal in the firm of RKG Tax and Business Services, LLC, located in Fort Washington, Pennsylvania. Mr. Bryen specializes in retirement planning design, income and estate tax planning, determination of the proper organizational business structure, asset protection, and structuring loan packages for presentation to financial institutions