The Income Buckets
Over and over I see doctors overlook the most sensible investment that they could make in their dental careers. They will try real estate, the stock market, limited partnerships, gold…, only to fall short of their financial goals which in turn limits their future. Time passes, and 97% of these dentists end up being unable to retire. Statistically at age 65, you will be dead or dead broke. Only 3 or 4 percent of dentists ever become financially independent. Financial security and growth are in your own backyards. Why would you search any further than your chosen profession to invest in? Sure, you might get returns of 10% in the stock market, or even lose 20%, but how would you like a 300% return on every dollar with little or no risk? We spend our entire lives chasing that “home run investment” and you really need look no further than your own practice. The neat thing about this strategy is that you can do it today. It has little or no upfront costs. It is even a better strategy when done early in your careers rather than as an exit strategy. Almost every penny I have made was accumulated thru the decision to strategically remove equity in my practice beginning at age 40 thru fractional sales of my practice. In addition, I gained enough knowledge to build other practices that made money and were later sold to my partners. I never lost a penny and never felt stressed or worried about my investment. You can do the same thing today. There are only two potential problems with this strategy: One, you will wish you had started in your third year of practice. Two, you wish there was a low cost way to not make the mistakes or leap frog the learning curve it took me twenty years to perfect (I know how and just finished writing the book “The Roadmap to Wealth and Security:Your Complete Guide to Dental Transitions ”). Oh, wait, there is one more problem. If the Democrats and Obama have their way, your practices will be unsalable or worthless within the next decade. You decide. Start now and profit or wait for the Democrats to come up with a plan guaranteed to make your future care free.
I thought I would take a small snippet from the book on how this strategy can create at least 9 income buckets leading to wealth and security. It is not the only reason to do this, but it has to be in the top 3. Hope you enjoy the article. We will let you know how you can get your copy at the end. MA
The Income Buckets
While growth and profitability are all part of the strategy for bringing in additional providers while removing equity through fractional sales, I would like for you to keep in mind the long term strategies of wealth building afforded by this rather straight forward sale. I will refer to these income producing, wealth building strategies as “Income Buckets”. The more buckets, the more strategies and money. There are at least 9 primary strategies you should consider.
1. Money received from the resultant sale of the practice: While the traditional sale will be about 60-70% of the last twelve months production or 1.5-2X the net for the last 12 months, we are suggesting a fractional sale: A sale of 50% or less. This in turn means that at some point you intend to sell more shares. Also, the formula represents what an entire practice would beworth. We are only selling a percentage, so the price would represent that percentage times the overall value. In other words, if the entire practice was worth $600,000 (60%-70% of the last 12 months production of a $1,000,000 practice), and we were considering a sale of one third of the practice, the price would be about $200,000. One of the interesting things about fractional sales is that you can often charge a little more than the traditional percentage or appraisal for the fractional portion. Think about it this way. You are going to carry the note; therefore the applicant need not seek financing from a bank. You are taking all the financial risks during the trial partnership. You will be willing to set the final sales price at the time of the start of the trial partnership. Therefore, the trial partner knows the investment up front. It eliminates them feeling “taken advantage of” by increasing the price with the expected increase in productivity from the trial partner. You are willing to make the trial partnership very short. In fact, you are willing to do it as soon as possible. I would even consider starting the buy-in at 4-6 months by allowing them to pay interest only on the note for the first 6 months or so. In that way you will be able to pin them down and begin the buyout strategy. You will carry the note for 5-10 years if necessary. The longer the term, the more passive income you will make. Once again, let the fact that the term of the note will vary help you in planning for retirement. You are willing to let them do the buy in with “no money down”. In reality, they are going to have very little (if any) money to put down. You have no risk, because you are carrying the note. If they default, you will find it easier to find another applicant due to the increased demand created by the initial trial partner, you get to keep all the money paid by the trial partner, and the non-compete is still in force. If they had borrowed from a bank and paid you the entire sum, the bank would own an undivided percentage of your equipment and supplies, and will likely go after you to satisfy the outstanding balance of the defaulted loan. As a matter of fact, most banks are requiring the senior doctor to co-sign the note. This means you will be totally responsible for its repayment in the event of a default. Bottom line: Carry the note if you are planning to be around until the end of the loan. If not, carry it for the length of time you plan to be in the practice and then attach a “balloon note” or final payment that cancels out the debt. Selling a fractional share also increases the pool of applicants that could produce enough to service the note. If you sold 50% for $500,000 at 8% for seven years, that would create a monthly payment of $7,793.11 with $154,620.93 being the total interest paid for the term of the note. That would mean that to service the debt the young doctor would have to produce in the $45,000-$60,000 per month to just make the payment in a 50% overhead office. So, if the fractional sale is smaller, then the payment will be less, therefore more candidates could afford to buy in with less production or in an office with a higher overhead percentage. The last plus that will allow you to charge a larger percentage for the sale price is that they are paid based on production, rather than percentage of ownership. While there are many ways to structure the division of profits, we feel this structure will enable the greatest profitability for the practice. The first income bucket will be the repayment of debt from the purchase price.
2. The second income bucket would be the interest income from the sale price. They pay you the monthly payment that includes the interest paid on the note for the term of the note. Most notes carried by the senior doctor will be prime lending rate for an unsecured note plus 2%. This would create a starting interest payment of $3,333.33 and a total interest payment of $154,620.93 for the term of a 7 year note for a total of $654,620.93 on a $500,000 sale price. Do not get this confused with a “secured note”. That would be money loaned with collateral that would cover a default. It will be several percentage points more when no collateral is involved. I frequently get questions that revolve around: “What if they want to pay cash?” We want to discourage not only outside loans, but relying on some “sugar daddy” coming up with the entire amount up front for anything other than a walk away sale. Consider this: If you are paid the entire amount in theabove example, and this did not work out, you would be faced with following the procedures outlined in your buy/sell agreements as to the disposition of a failed partnership. This might include buying out their share, or facing a hostile takeover, or even partnering with someone else that they sold their portion of the practice to. Remember also that they own whatever percentage of the practice they purchased in your equipment and supplies at the final payment of the total note. There is no non-compete now because they have paid you off. They could set up next door to you. Take their undivided 1/3 of the equipment (in a 33% fractional sale) and leave. While most contracts provide a provision of allowing any current partner “first right of refusal” of any sale (they must offer you that portion for the same amount they are selling it for), you no longer have the money paid to you by the trial partner due to paying the taxes on the sale. There could be a short fall of $100,000 that was paid in taxes. Carrying the note not only gives you passive income with no real risk, but also allows you to control the practice. Your contracts should stipulate that failure to pay the entire amount of the loan results in no partial ownership of the buy-in. In other words, if they fail to pay you, or leave at year 3 or any time short of a 7 year obligation, they get nothing, the non-compete is still in force, and you get to keep all the money while you broker your practice for sale again.
3. The third bucket is the passive income from investing the sale price, and the interest. Because you should not need the sale money, you will be able to place it in a tax deferred account. Hopefully you did a stock transfer or a Seller favored allocation to have a greater net sale. Currently you can get about 5% after tax return from even Tax Free Municipal Bonds. Very safe and not very exciting, but they pay the interest and you get your money back. Try that in the Stock Market. So we are getting 8% on our loan and at least 5% on our investment of the funds for at least a 13% return in a tax deferred entity. It could be even more, but I caution you to consider the risk of trying to hit a homerun with your long term investments. This rarely works, and the myth that you should take risks when you are young is just that, a myth. Losing money early in your career only hurts you more, because you had the most to gain from time and compound interest. Losing money late in the game means you will never have options. The rule of “72” states that you can determine the length of time it takes to double your money by taking the interest rate and divide it into 72. In this example: 13% combined interest rate return divided into 72 equals 5.53 years, the earlier you do this the more money you will have. Given enough time and planning, your initial sale can double, and double again, and continue to double until it is retrieved from your asset fund.
4. The Fourth income bucket comes from the Life Insurance included in your Buy/Sell Agreements. Every partnership contract contains the remedy for death and disability. In other words, the partnership will purchase life insurance on each partner to fund their unlikely death or disability. It generally is based on a formula of a certain percentage of the last 12 months production. The percentage is arbitrary, but keep in mind that it should be fair to both Senior and Junior doctor. I would suggest a percentage of 70 + percent of the last 12 months production. In this way we have a formula to review each doctor’s contributions to the practice yearly and adjust the insurance to reflect that number. The idea is that we insure against the surviving partner having to come up with the money out of their own pocket. This in turn creates security for the heirs of each doctor and insures that if this were to occur prior to meeting a debt obligation on the purchase buy in, the senior doctor will be paid, the practice is free and clear, and the remaining sole owner can dispose of another partnership if they so choose. There is a great product out there that is called Equity Indexed Universal Life. Basically they guarantee you a 3% return on your money with a 14% ceiling. The actual percentage is based on the average return for the S&P 500. Not great right now, but even if it went to a negative return, you can continue to make at least 3%. The other neat thing is that you can put money into it tax free, and later remove it in the form of a loan tax free. Free going in and free coming out plus you have a life insurance value in the policy. This will also escape inheritance tax if you have done wise estate planning. The cost of this would be paid by the partnership as a line item expense prior to dividing up the net profits at the end of the month.
5. The fifth bucket concerns the Disability Insurance provisions of your Buy/Sell Agreement. In addition to death, you will need to have the partnership carry disability insurance on each partner. This should also fund the buy-out in case of a permanent disability. For the same reasons given in Life Insurance, the amount must cover the buy-out price. There are some companies that actually have something called “a return of premium” rider. If you are not disabled during the time of coverage, you get all the money back. That’s right, it costs you nothing and is sort of a forced savings plan couched in the disguise of a buy-out instrument. The bad news is that they don’t pay any interest, but you will get your entire investment back. I spent almost $900,000 for disability insurance in my 33 year career and got nothing back. The cost is minimal, so you need to look into this. The expense of this policy is paid by the partnership entity as an expense item prior to dividing up the net profit.
6. The sixth bucket concerns a “Founders fee or management fee”. We always suggest that the senior doctor consider placing this fee in the contract. It would be somewhere between 1-4% of the total collections of the practice. An example: If the office produced $100,000 in the month of January, you would be paid $1,000-$4,000 (depending on the percentage that you placed in the contract) as an expense item that would be paid prior to dividing up the net profits for the month between you and the other doctors. This rewards you for all the years of struggle and financial risk you have taken to get you this far. It doesn’t sound like much, but if you will place this into a tax differed account it could be hundreds of thousands of dollars at the time of retirement. Starting earlier makes even more sense here.
7. Accounts Receivable note. At the moment of the sale, the new entity or partnership has no working capital. Imagine if you will, that on Friday at 5 PM you and your trial partner become legal partners and you form a new entity. You are not going to leave any money in the bank and on Monday the new entity has bills to pay. I would suggest that you run your accounts receivable, take off all non-collectible accounts over 5-6 months old and create a note for the remainder. It should be at the same percentage as the note to the young doctor (8% in this example) and the new entity (Dr. Senior + Dr. Junior) would pay you the note payment over a specified time until paid off as an expense line item each month. It would be paid like the insurance and would be done prior to any division of profits between the doctors. By doing this note, on Monday after the sale Friday, you will have money coming in to act like a capitalization loan. This money now belongs to the two of you to pay bills without incurring further debt. Once again, I would save it, the interest paid on it, invest it and keep all of it in a tax differed account.
8. The increase in equity and the eventual value of your building if you own it. This may not apply to everyone, but it is an incredible wealth building vehicle. If you own your own building, make sure you increase the lease payment to retire the note on it in 10 years or less. If not very much remains and you are a later term doctor looking to retire in a few years, make sure the retirement date and payoff coincide. Every month the partnership pays you a lease payment that either goes to retirement of debt or to put money in your pocket. If it is just profit, be sure and reinvest it in some way to be tax advantaged and super safe. We mentioned this before in a walk-away sale, but think about the building not only being paid off, but actually being an increasing valued asset. At your final retirement you can lease it to the remaining partners for 3-5 years along with a contract to sell. In this way you will have the income of the building lease along with a built in buyer at its terms end. To take advantage of this, be sure to create a triple net lease in order to put the burden of taxes, maintenance, and repairs or improvements on the partnership and not you the owner. I have even seen younger aggressive doctors who timed a facility expansion with bringing on a partner to take advantage of this very strategy.
9. The final bucket will not be realized until there is another partnership sale. Whether this is the final 50% or an incremental sale of less, the value of the fractional share will most likely increase due to increasing the production of the practice with multiple providers. Keep in mind that if you know that you will have more than one partner, it would be poor planning to sell the first partner 50%. If you are equal owners, bringing in a third partner would generate income from the sale but would be split between the two of you. Example: $1,000,000 practice would be worth $600,000-$700,000 for the entire practice. Dr. A and Dr. B are 50/50 owners and decide to bring in a third doctor. This third doctor pays one third of the appraised value or $200,000-$233,000. Dr. A and Dr. B would split this sale price equally. On the other hand the same $1,000,000 practice sold a third of the practice to the same junior doctor for the same price, but in this example Dr. A knew he always wanted multiple doctors. Because of this, he only sold 33% to the first doctor. At this sale, Dr. B retains his 33% ownership, and Dr. A sells half of his 67% (or 1/3 of the practice) to the young doctor and receives 100% of the sales proceeds. You need to remember that because the sale takes place at some time in the future, the price or value of the next sale will have increased because of the total increase in the value of the practice due to increased production. Now we have Dr. A, Dr. B, and Dr. C all owning 33% with Dr. C making payments to Dr. A for his portion. This could be done with any percentage you want. It would be prudent to begin with the end in mind and decide in advance the most prodigious route for you. You might decide or be undecided as to the future. In this case go ahead and sell 50%, then if in the distant future the two of you decide on bringing in another partner, you can share in the sale price.
The 500 page book and accompanying CD not only explains how to position your practice, find candidates, create your business structure, but also includes:
AMENDED AND RESTATED BYLAWS
BUY AND SELL AGREEMENTS
DEFINITION OF FAIR MARKET VALUE
LETTER OF INTENT TO PURCHASEOPTION TO PURCHASE STOCK
PROMISSORY NOTES WITH BALLOON PAYMENT
PURCHASE AND SELL AGREEMENTS
STATEMENT OF CONFIDENTIALITY
TRIAL PARTNERSHIP AGREEMENTS
TERM OF ASSOCIATESHIP PERIOD
COLLECTIONS AND DEPOSITS
WORKING HOURS AND SCHEDULING
VACATIONS AND MEETINGS
HYGIENGE RECALL COMPENSATION
ASSOCIATE START-UP DRAWS
EQUIPMENT AND SUPPLIES
PARTY’S INDIVIDUAL EXPENSES
ASSOCIATE’S DEATH OR DISABILITY
TERMINATION AND WITHDRAWING PARY DEFINITIONS
TERMINATION FOR CAUSE
TERMINATION WITHOUT CAUSE
TERMINATION ACCOUNTS RECEIVABLE
DOWN PAYMENTS, ETC.
LIMITATION OF RESTRICTIVE COVENANT
PAYMENT FOR PATIENT RECORDSWITHDRAWING PARTY’S PATIENT RECORDS
EVENTS OF SALE
JUNIOR PARTY’S OBLIGATION TO PURCHASE
SENIOR PARTY’S OBLIGATION TO PURCHASE
SENIOR PARTY’S PURCHASE OPTION
RIGHT OF FIRST REFUSAL
STOCKHOLDERS’ OBLIGATION TO WITHDRAW (FORCE OUT)
BUY-SELL AGREEMENT FOR BUY-IN (PARTNERSHIP FORMATION)
DEFINITION, CLOSING AND REQUIREMENT
OWNERSHIP PERCENTAGE AND NUMBER OF OWNERS
PURCHASE DEFINITIONS, ETC.
PURCHASE PROMISSORY NOTE
JUNIOR BUY-IN INCENTIVES AND DISINCENTIVES
JUNIOR PARTY’S COUNSEL
ALTERNATIVE BUY-IN OPTIONS
PARTNERSHIP (OPERATING) AGREEMENT
OFFICE EXPENSES AND BANK ACCOUNT
PARTNERSHIP NOTE PAYMENTS
ORDER OF OBLIGATIONS
BUY-SELL AGREEMENT FOR SELL-OUT (FINAL SALE)
PURCHASE DEFINITIONS, ETC.
PURCHASE PROMISSORY NOTE
DECEASED SELLING STOCKHOLDER
CONTINGENT LIABILITIES, TAXES DUE
STOCKHOLDERS’ SALE OBGLIGATION
SENIOR PARTY’S OPTION TO PRACTICE
PROFESSIONAL TREATMENT FOLLOWING RETIREMENT
MEDIATION (DISPUTE RESOLUTION)
FAILED PROFESSIONAL TREATMENT
TRANSFER OR ENCUMBRANCE
AMENDMENT OR MODIFICATION
NOTICE OF BREACH OR DEFAULT
WAIVER OF BREACH
COMPETITION AND TRADE SECRETS
TIME OF THE ESSENCE
ENTIRE AGREEMENT (INTEGRATION)
ADDITIONAL PROVISIONS AND MODIFICATIONS
You should find everything you need to begin and work through your transitions. Every step is detailed with step by step actions to be taken along with roadmaps for every document. We will also offer a limited time offer of telephone coaching to accompany the purchase of the book and CD. At $1,995.00, this book is not for the doctor who just wants a light read. This is a full court press, let’s get it done strategy for those that are ready to reap the benefits of all those years of sweat and tears. This is the ultimate wealth building strategy in Dentistry today.