The Income Buckets
For 25 years, you have heard or read about my passion for transitions in a dental practice. No other strategy in dentistry can give you a 200 K 300 percent return on your investment. Done correctly, you can almost eliminate any downside to bringing in an associate leading to partnership. I plan to write a series of articles about different aspects of transitions, but I would like to begin with the end in mind. I want to create a word picture of exactly what the benefits are in taking this huge step into your financial future. With National Healthcare on the horizon, corporate practices continuing to flourish, and managed care becoming commonplace, you may find that in the next decade your practice may become virtually worthless. If you think that your practice will fund a retirement that will give you financial choices, think again. Heads up: Those times have passed. Regardless of your age or years in practice, this is the number one wealth building strategy in dentistry today. In fact, transitions are even more profitable if done in the first 3K10 years of practice.
Beginning with the end in mind, consider that you have cleared all the hurdles we will discuss in future articles, and you have a candidate who wants to buy in and is willing to pay your price. How would this play out as far as income from the finished transaction? We refer to this as the “Seven Income Buckets”.
1. The new partner’s monthly payment. If you plan to continue to practice with your partner for the next 5-10 years, I would recommend that you consider carrying the note. There are a lot of pluses to this and almost no downside. Carrying the note creates a larger pool of potential buyers. With young doctors graduating with $200,000 – $300,000 in school debt, few can afford much of a down payment and if they do get a loan, the bank will want you to coKsign. If you co-sign and take the money, pay the taxes, and the partnership fails, your operating agreements will create a remedy for that situation. The bad news is that the bank will come after you for the balance. If you do carry the note, I would charge the same as a bank or 2% above prime for an unsecured note. Currently that would be 6.5 K 7.5%. Even if they could pay you the entire amount, where could you get 7% on your investment with no risk? If they default, you can make the promissory note state that they own no fractional share of what they have paid for. It’s all or nothing. They default and you keep the money, the practice, and the non-compete is still enforceable. So the number one income bucket is the monthly payment plus interest from the new partner. In addition, you will place the entire payment (principle + interest) into a vehicle like a 401K or corporate pension plan that will also yield an interest rate of 5+%. If you got 7% from the payment and 5% from the investment, you’re getting 12% or more from your investment with little or no risk.
2. Accounts Receivable. Assuming that you have some accounts receivable, you will need to deal with it during the transition. My suggestion is that you, the owner of the current A/R, sell it to you and your new partner (which is a new business entity) at a discount based on the current aging of the A/R. I would expect a 10 – 15% discount on face value. For example: If there were $50,000 in the A/R and we discounted by 10% down to $45,000, and created a note at the same interest rate as the buy in, the new partnership would write you a check every month for the amortized payment amount until it is reduced to zero. In this way, if you transitioned your practice on Friday, on Monday every bit of money that came in would go to the new partnership and fund this new entity. It eliminates the need to use complicated bookkeeping to track payments and try to determine where they go. Just cut the check at the end of the month and get another principle plus interest check and place it in the same type of retirement account and earn interest on it until your retire.
3. Founding Father’s Fee. I would recommend adding a fee to the closing contracts that will be paid to you, the original doctor, to reward and recognize the years of sweat equity and risk you took to get the practice to where it is today. Generally I would try to get about 2 – 3% of collections. Keep in mind that you should ask for more and settle for the 2 – 3%. Always enter contractual agreements by asking for more than you are willing to settle for. Every lawyer and every young doctor wants to negotiate the final document. Know where you are willing to compromise. This creates a win/win transaction. Like the first two income buckets, we will also place this in a safe retirement vehicle to earn interest.
4. Life Insurance. In every partnership you need life insurance to create a remedy for settlement in case either party dies during the term of the contract. The idea would be to create a formula for death buy out that is funded by this insurance policy. Knowing how poorly doctors save, I would recommend an indexed policy with cash value and a floor on the interest paid on your policy. I know you’re thinking that term insurance is cheaper, but cash value insurance will create a forced savings account that you can exit the practice with at your retirement. With the proper care, this offers huge tax savings and would be great start at asset protection and estate planning strategies.
5. Disability Insurance. This insurance is needed to fund a disability to either party to the contract. If permanently disabled, this would pay the injured party for their share of the practice based on a formula determined at the time the buy/sell documents were drafted. My suggestion would be to track down a “return of premium” type of disability insurance. This requires the insurance company to return all insurance premiums at the time the policy lapses or you retire and cancel it. You get protection if you need it and your money back if you don’t.
6. Building equity increase. If you own a building, and are making payments to a bank or lease payments to yourself if it is paid off, once you have partners, the partnership will make the payments for you. Because the building is not included in the transition, you get all the increased value that is paid by you and your partners. My suggestion would be to speed up the amortization and pay it off as soon as possible. Once paid off you have created a huge income bucket that will go into your retirement and grow with the additional interest from your investments. Once you retire you can sell or continue to lease to the doctors that have continued to practice.
7. Equity run-up of the senior doctor’s remaining shares of the practice. If you are selling a fractional share of your practice (less than 100%), over time, you should find that increased production and lower overhead due to you and your partners diligence will make the next or even final sale worth more than what the original partner paid. In my case I sold 25% of my practice to three doctors over 15 years and finally sold the final 25% when I exited my main practice. Each fractional sale increased about 35% and yielded me millions over the term of my final 15 years in practice.
7.5 Remember: Selling does not mean you are retiring. This transition is a business decision based on current economic trends and practice facts that yield the best possible strategy to give you and your family financial security and more options upon retirement.
I look forward to fleshing out more details for the strategy of transitions in coming articles. From the phone calls I receive and the urgency I hear from many of you, I might recommend that you pick up my book, The Roadmap, as soon as you can. In addition to all the transition strategies, it includes contracts for your review and details everything from exit strategies to growth strategies.
Michael Abernathy, DDS