Solo practice was once the predominant mode of practicing dentistry, with over 90 percent of doctors a generation ago selecting this option. However, times have changed, and now less than 60 percent of dentists desire to practice alone. In fact, it appears that many recent grads are not even interested in considering solo practice as a practice model. Maximizing income as a dentist is not the primary driver for many recent grads when measuring their professional success and satisfaction. It is attaining quality of life that often supersedes earning maximum income. As such, partnerships can become the vehicle to provide greater lifestyle flexibility for two or more dentists. Economies of scale can also certainly be achieved with multiple doctor ownership. This article reviews key points that doctors must consider when they are contemplating the formation of a partnership.
With the average general practitioner averaging approximately $700,000 per year in billings, it obviously takes considerably more revenue to support two doctors in a partnership relationship. This target revenue is predicated on the number of hours worked per week Partnerships: A Growing Trend for Many Practitioners Tom Snyder, DMD, MBA Business Fundamentals DentalEntrepreneur.com Dental Entrepreneur Spring 2018 11 If you have any questions, comments, or responses to our magazine, please connect with us on Dental Entrepreneur Magazine — our official Facebook page! Read us online at dentalentrepreneur.com Send your questions or comments to email@example.com dentalentrepreneur.com Please reach out to our authors and our advertisers. They care about you and keep us in print! for each partner. Most partnerships, however, begin as a solo practice. A successful solo practice needs about 1,200 patients on a 32-hour work week to be successful. Once that target patient base is reached, hiring an associate becomes a reality. So if your practice has been growing consistently, a full-time associate soon may become a reality and the partnership option now comes into play.
BUSINESS ENTITY SELECTION
Most partnerships are either a Professional Corporation (PC) or a Limited Liability Company (LLC). In some states, the latter is called a Professional Limited Liability Company (PLLC). In both instances, these business entities protect the personal assets of each partner. However, it is very important to understand that each entity has certain characteristics regarding tax issues that must be considered, so it’s critical that your CPA be consulted at the outset to help determine whether an LLC (PLLC) or “S” Corp. is your best business entity option. We have not mentioned a “C” Corp., as that business format was the entity of choice years ago. Over time, an alternative PC entity – the “S” Corp. – became the primary PC choice. Once your business entity is selected, the next step is to consider the tax consequences of an partnership interest sale. For example, if the current business entity is an “S” Corp., or even a “C” Corp., some advisors may recommend that entire transaction be a stock sale. Although this is the most tax-optimal outcome for the practice owner, it can be very costly choice for a new partner to agree to. For example, if a young doctor were to purchase a $ 500,000 partnership interest and it is structured as 100-percent stock purchase, (assuming the new partner’s effective tax rate was 33 percent) he/she would have to generate $746,000 in income to pay for this ownership interest! Obviously, most new partners and their advisors will not accept this strategy. Fortunately, there are alternative strategies that can be considered offering a better balance of the tax benefits between the owner and the new partner. In the end, a careful review of the buy-in strategies and tax consequences must be made before the parties get too involved in discussing terms of a partnership agreement.
Sometimes, multiple business entities are considered in a partnership arrangement. For example, if the host doctor is a professional corporation (either an “S” Corp. or a “C” Corp.), the new partner may elect to form his or her own LLC or “S” Corp. In this case, the “partners” are the respective business entities. In this scenario, a third entity needs to be formed, which becomes the Management Company. This Management Company will bill and collect patient fees and compensate the employees, as well as pay the majority of the practice’s operating expenses. This additional layer of complexity further underscores the need for sound financial and accounting advice at the outset.
FINANCING A PARTNERSHIP BUY-IN
After addressing tax issues, the next consideration is how the new partner will pay for the partnership interest. Will it be a total cash purchase for the equity interest or will it be a combination of bank financing and internal financing, or even 100-percent owner financing? The good news is that many lenders are now willing to finance partnership buy-ins. As in any business transaction, affordability for the purchaser will be key. Will the new partner be better off financially than they were as a former associate in the practice? The income available to the new partner to pay for his/her ownership interest as well as comfortably pay their personal expenses will be the key determinants for a new partner being able to afford the buy-in.
Historically, many dental partnerships were structured as general partnerships. In this model, partners shared all profits equally, irregardless of clinical performance. In today’s world, that model does not work. There are numerous ways to share partner 12 Spring 2018 Dental Entrepreneur DentalEntrepreneur.com income. The most important consideration is for partners to share a portion of their income based on their relative clinical production. For example, consider paying each partner a commission based on a percentage of clinical collected production minus lab/ implant supply expenses. The balance of available partner compensation, after this production related payment, can be shared based on each partner’s ownership percentage or the relative clinical production ratio of each partner.
Another approach considers the allocation of certain operating expenses to each partner based on their personal clinical production ratios, as well as certain expenses being allocated directly to each partner. The bottom line in partnership compensation is that any income sharing formula selected has to be fair to the parties.
Based upon the business entity you select, comprehensive legal documents must be prepared to formalize all terms and conditions of the partnership. In the case of a professional corporation, shareholder agreements, employment agreements and stock acquisition agreements are required. For a PLLC or an LLC, an operating agreement and membership interest purchase agreement must be prepared. Listed below are several components of any carefully thought out partnership agreement:
- Establishing Minimum Days
A partner’s health problem may result in a reduction in work days for a lengthy time period. Conversely, based on a partner’s personal financial situation, it may create a scenario where a partner is financially comfortable and thus desires to work less. Too much time away from the practice, however, can have a deleterious effect on the sustaining partner(s), with them feeling overworked, and perhaps being taken advantage of. One consideration is to require a partner to work a minimum number of days and/or hours annually, to maintain their partnership status. Another alternative to having minimum number of days or hours is to establish minimum production goals for each partner to sustain to retain their partnership status.
- Premature Retirement
One reason for becoming a partner is to enjoy a long-term relationship with the other partner(s). If a partner decides to leave prematurely, that individual should not expect to receive full value for their partnership interest. Hence, consider assessing a reduction on that departing partner’s goodwill. For example, if a partner decides to leave after four years, there should be a penalty on the goodwill portion of the partner’s value. Some partnerships even discount the departing partner’s goodwill if they elect to retire ten years prior to mandatory retirement.
- Management Responsibilities
Oftentimes, the partner who manages the practice is probably spending considerable “non-chair” time dealing with the business aspects of the practice. It is appropriate for that partner to be compensated accordingly. Compensation can be made by paying a fixed salary or compensating the managing partner with a small percentage of practice profit or revenue. This payment should be considered an operating expense of the practice and have no ties to any ownership or production compensation.
- Retirement of Partner
In most two-doctor partnerships, this can become a major issue! Should the junior partner be required to buy-out the senior partner? If so, should there be a formula written in the partnership agreement which calculates the percentage of goodwill value that a retiring partner is entitled to receive? If this is a 50-50 partnership and the retiring partner is not generating the same percentage of clinical production, then the departing partner should not be entitled to 50 percent of the available goodwill in the partnership’s value. Calculating the relative clinical production ratio for that retiring partner is a fair way to determine the goodwill percentage when retiring. For example, if the ratio was 45 percent for the retiring partner, then 45 percent of the available goodwill is what should be paid. Tangible assets (i.e. equipment, technology, etc.) would be paid out based on the departing partner’s ownership interest.
In conclusion, partnerships obviously have many moving parts, so take the time in outlining all the key points in your partnership and seek expert advice from your advisors. If you follow this prescription, chances are you will have a successful and long-standing partnership!