Solo practice was once the predominant mode of practicing dentistry, with over 67% of dentists in 2001 choosing that option. However, the trend continues to be negative and as of 2017 only 50.6% of dentists were in solo practice. In fact, this downward trend is supported by a recent survey of the American Dental Association indicating that only one in five dentists under the age of 35 desires to be a solo practitioner. So practicing in some form of group is now the preferred choice. Maximizing income is also not the primary driver for many recent grads when measuring their professional success and satisfaction. It is achieving quality of life that often supersedes earning maximum dollars. So, partnerships can become a major vehicle to provide greater lifestyle flexibility for two or more dentists. Economies of scale with potentially higher profit margins 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 solo 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 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 have business entities which 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 business entity has certain characterizes regarding tax issues which must be considered. As a result of the recent tax law changes, the corporate tax rate(for C Corps) was lowered substantially and pass-through entities such as S Corps and LLCs have received some substantial tax breaks as well. 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 the alternative PC business entity, the “S” Corp., has become the primary PC choice.
Once your business entity has been selected, the next steps to consider are the tax consequences of an equity transfer. For example, if the current business entity is a PC, many advisors for the practice owner will recommend that the entire transaction be structured as a stock sale. Although this is the most optimal tax outcome for the practice owner, it can be a very costly choice for a new partner to agree to. For example, if a young doctor were to purchase a $600,000 partnership interest and it is structured as a 100% stock purchase, (assuming the new partner’s effective tax rate was 25%) he/she would have to generate approximately $800,000 in personal income to pay for this ownership interest! Fortunately, there are alternative strategies which 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 or Operating Company.
This Management/Operating Company will bill and collect patient fees, employ staff, pay rent, 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% 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 new partner will be paramount. 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, regardless of clinical performance. In today’s world, that model does not work. There are numerous ways to share partner income. The most important consideration is for partners to share a portion of their income based on their relative clinical production. For example, most partners prefer being paid a portion of their overall compensation based on individual partner clinical performance.
A commonly used method is 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 clinical production related payment, can be based on each partner’s ownership percentage and shared accordingly. The bottom line in partnership compensation is that any income sharing formula selected has to be fair to the parties. 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 that is selected, 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 prepared. For a LLC or PLLC an operating agreement and membership interest purchase agreement must be prepared. In closing, here are several key components that must be addressed ins any partnership contract.
1. Establishing Minimum Days finally 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 future 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 feel being taken advantage of. One consideration is to require a partner to work a minimum number of days and/or hours annually, to maintain 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 partnership status.
2. 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, assessing a reduction in goodwill value for a partner who leaves within in the first five years is worthy of consideration. For example, if a partner decides to leave after three years, there should be a reduction of the goodwill value that the departing partner is entitled.
3. Management Responsibilities Not all partners share management responsibilities equally, and, in fact, some partners have no interest in managing the practice, only desiring to be involved as a partner only on a clinical level. 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, for example, can be a fixed salary or payment of a small percentage of practice profit or gross practice gross receipts. This payment should be considered a practice operating expense and have no ties to any ownership or production compensation.
4. 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 Operating or Shareholder 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% of the available goodwill in the partnership’s value. Calculating the average relative clinical production ratio over the last two or three years for that retiring partner is a fair way to determine the goodwill percentage. For example, if the average ratio was 45% for the retiring partner, then only 45% of the total goodwill would be the amount to be paid. Tangible assets (i.e. equipment, technology, etc.) should, however, should be valued based on the departing partner’s ownership interest.
In conclusion, it is obvious, partnerships have many “moving parts”. In all the years that I have been consulting in this area, I have never found two partnerships that have been completely identical. There are always circumstances that require careful thought and planning. So take the appropriate time in discussing and negotiating all key points in your partnership at the outset and seek expert advice from your advisors and/or practice transition consultant. If you follow this prescription, chances are you will have a successful and long standing partnership.