Business Succession Planning For Dental Practice Owners – Part II
How Buy-Sell Agreements Determine the Success of Your Transition
You spent years or decades building your dental practice from the ground up, recruiting talented associates and staff, cultivating a loyal patient base, and investing in the technology and infrastructure that have made it an enduring success. You made that happen, but what happens if something were to happen to you? What if you pass away suddenly and unexpectedly, you become disabled or incapacitated, or you simply want to call it a day and retire? Without a properly and thoughtfully drafted buy-sell agreement in place, your departure or absence could be the beginning of the end for the practice and the legacy you spent a career building.
A buy-sell agreement, sometimes called a buyout agreement or a business continuation agreement, is the defining document of your practice’s business succession plan. It is the key to every transition, no matter the nature of the business or industry, but having a buy-sell agreement in place is particularly critical for dental practice owners. Professional licensing requirements, patient relationships, and practice goodwill create layers of complexity that most other business owners don’t face. As we discussed in our first post in this series on succession planning, now is the time to work with your counsel to get this done, before circumstances deprive you of the opportunity to plan for your future and that of your practice.
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What Is a Buy-Sell Agreement?
A buy-sell agreement is a legally binding contract between co-owners of a business, or between an owner and the business itself, that governs what happens to an ownership interest when a triggering event occurs. Common triggering events include the death of an owner, permanent disability, retirement, divorce, personal bankruptcy, or the voluntary decision to sell.
In the dental practice context, these events carry additional stakes and greater potential risks or disruptions. Unlike other business owners, who can choose pretty much anyone they want to take over their ownership interest – a family member, a company executive, employees – state laws typically prohibit non-dentists from owning a dental practice. That means if a co-owner dies and their ownership interest passes to a non-licensed spouse or heir, a practice could face serious legal and regulatory exposure. A well-structured buy-sell agreement prevents that scenario by dictating exactly who can own an interest, under what conditions, and at what price.
Cross-Purchase vs. Entity Redemption
There are two fundamental structures for buy-sell agreements, and the right choice depends on the number of owners, your tax situation, and your long-term objectives.
- Cross-purchase agreement. In this arrangement, the remaining owners purchase the departing owner's interest directly. This structure works well in smaller two- or three-dentist practices and offers the surviving owners a stepped-up tax basis in the acquired interest, which can reduce capital gains exposure if the practice is later sold.
- Entity redemption agreement. Here, the practice itself buys back the departing owner's interest. This is simpler to administer in larger group practices and avoids the logistical challenge of each owner carrying separate life insurance policies on every other owner.
The Valuation Situation
Valuation of the practice is probably the single most contested issue in buy-sell disputes. When that triggering event happens, and a buyout time arrives, determining how much the practice and its ownership interests are worth, and agreeing on how to get to that figure, can be fraught with disagreement or conflict.
Dental practices have unique valuation challenges. Patient retention rates, the personal goodwill of the departing dentist, the transferability of key referral relationships, and the quality and age of equipment all factor into value. General business metrics and the dollars-and-cents on a balance sheet do not adequately capture these nuances. The agreement should specify the valuation method upfront, whether that is a fixed price updated annually, a formula based on collections or EBITDA, or a third-party appraisal conducted by a healthcare-focused business valuator. Leaving valuation undefined, or using a formula that made sense years ago but no longer reflects market reality, is a recipe for litigation.
Funding the Buyout
A buy-sell agreement is only as good as the funding mechanism behind it. The most common method is life insurance, which provides an immediate lump sum in the event of an owner's death. Disability buyout insurance is equally important and significantly underutilized in most funding arrangements.
For retirement or voluntary buyouts, installment payment structures are the norm. The agreement should specify payment terms, interest rates, and security arrangements, such as a promissory note secured by the practice assets, so that neither the buyer nor the seller is left in an untenable position.
Dental Practice-Specific Provisions
In addition to limitations on who can acquire ownership interests in a dental practice, other issues unique to the profession should be addressed in the buy-sell agreement. Restrictive covenants. Non-compete and non-solicitation clauses are subject to ever-changing state laws governing their allowable scope and enforceability, so they must be carefully drafted to withstand judicial scrutiny in order to protect the purchasing owners from having the departing dentist reopen two miles away and call every former patient.
Associate buyout pathways, if your practice uses them to attract and retain talent, should also be addressed to avoid disputes when an associate is ready to exercise their option. Additionally, if your practice operates under a DSO (Dental Support Organization) model or has any affiliation with a management services organization, those contractual relationships need to be accounted for in the buyout structure.
Do Not Wait for a Crisis to Start Planning
If you are a dental practice owner and you do not have a current, properly funded buy-sell agreement in place, you, your practice, and your retirement plans are all flying without a net. Don’t let all you’ve worked so hard for come crashing down. If you have questions or would like to discuss business succession planning for your dental practice, please call Grogan, Hesse & Uditsky at (630) 833-5533 or contact us online to arrange for your free initial consultation.
At Grogan Hesse & Uditsky, P.C., we focus a substantial part of our practice on providing exceptional legal services for dentists and dental practices, as well as orthodontists, periodontists, endodontists, pediatric dentists, and oral surgeons. We bring unique insights and deep commitment to protecting the interests of dental professionals and their practices and welcome the opportunity to work with you.
Jordan Uditsky, an accomplished businessman and seasoned attorney, combines his experience as a legal counselor and successful entrepreneur to advise dentists and other business owners in the Chicago area. Jordan grew up in a dental family, with his father, grandfather, and sister each owning their own dental practices. This blend of legal, business, and personal experience provides Jordan with unique insight into his clients’ needs, concerns, and goals.
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