Buying and Selling a MEDICAL / Dental Practice

Buying or selling a medical, dental or other health care practice is a complex process.  Legal, tax, accounting, valuation and psychology issues are all involved. This outline introduces certain basic matters to you.  Do not think that you can rely on this outline (or any other resource material) and go it alone, however.  You need help from a lawyer, an accountant and if necessary, a business broker and an appraiser, all of whom must have experience in the sale of practices.

1. Finding a Practice for Sale / Finding a Buyer for Your Practice.  Consider a combination of the following approaches to find a buyer for your practice or a practice for sale:

        1.1 Talk to Other Doctors.  You should talk to doctors on a constant basis. This is a particularly good way to find win-win acquisitions.

        1.2 Advertisements.  Check out the classified section of your local journal for doctors.

        1.3 Brokers.  Brokers are possible contacts.  A good broker can be invaluable.  But keep in mind:

• The broker takes a fee out of the sales price (up to 10%).

• Buyer beware.  From the buying doctor’s perspective, the broker’s fee means that (i) the selling doctor might increase the sales price to cover the broker’s fee, and (ii) even though the buying doctor may have contacted the broker, the broker will still try to drive up the price.

• Seller beware.  The selling doctor must be very careful when agreeing to the broker’s terms for representation. Review the contract carefully concerning the broker’s fee, and pay special attention to sliding scale fees.  Watch out for administration and other fees.  Be sure that you can fire the broker after 1–3 months.

        1.4 Accountants, Attorneys and Bankers.  Frequently a doctor will tell his or her accountant, attorney or banker of a desire to sell the practice, long before making any formal attempt at sale.  The accountant, attorney or banker can then introduce possible matches.

2.  Non-Disclosure Agreement.  Early in the process, the selling doctor should require that the buying doctor sign a non-disclosure agreement to protect the selling doctor’s confidential information.

3.  Timing.  Most small deals take around 3 months.  You will need 1 month for initial negotiations and to get to the letter of intent, 3 weeks for due diligence, then 1 month to close.  Selling doctors usually want to speed up the process, while buying doctors like to slow it down.

4.  Letter of Intent.  When the buying doctor has identified a target practice and has agreed to basic terms with the selling doctor, the parties may consider entering into a letter of intent.  The letter of intent should not be a binding agreement.  It should only confirm the basic deal terms, and obligate the selling doctor to (i) cooperate with the buying doctor in its due diligence, and (ii) not accept other offers for a stated period of time.

5.  Due Diligence.  An open, orderly and professional due diligence benefits both sides.  The buying doctor performs due diligence to understand the practice.  The selling doctor prepares for the buying doctor’s due diligence to mitigate (but not to hide) any problems that can reduce the purchase price.  It is very important that the selling doctor determine the levels and timing of information and access that it will give to the buying doctor.

            What Should Buyer Look For?  In general, a due diligence review for a practice should focus on the following:

• Why?  The first question is, why is the practice for sale?  The selling doctor should have a good answer, e.g. retirement.

• Goodwill and Patient Base.  Goodwill is the selling doctor’s (good) reputation.  Health care is an intensely personal practice, and the buying doctor should appropriately discount for the loss of patients if and when the selling doctor leaves the practice. 

• Employee Base.  The buying doctor should make sure that the key office managers and hygienists will come along, and perhaps that unwanted employees can be terminated.

• Financial Review. The buying doctor should insist that the selling doctor produce the practice’s financial and business records and income tax returns for the past few years.  These documents will shed light on whether the practice is and can be profitable.  Both sides should use accountants.

• Assets; Leases; Accounts.  The buying doctor should (i) inspect all equipment and fixtures, and be sure that the practice’s tradename can be transferred and protected; (ii) review all leases (including for lessor / landlord consent requirements); and (iii) get an aging of accounts receivable.

• Liabilities.  The buying doctor should check for liens, unpaid back taxes, current and potential lawsuits, unpaid bills, and unpaid vacation liability.

• Capitalization.  For a stock sale, the buying doctor should make sure that it will receive clean title to a majority (if not 100%) of the corporation’s stock. 

6. Valuation.  Most practices are valued using the discounted cash flow method, with comparable transactions used as a reference point.  The selling doctor should hire a professional appraiser early on in the process to put a value on the practice.  A bare bones appraisal will cost around $5,000.

7. Purchase Price.  The purchase price should take taxes into account, because it is your after-tax (not pre-tax) purchase price that counts.  This is one of the reasons why the legal structure of a deal is so important.  After fixing a purchase price, the next question is how will the buying doctor pay it?  The buying doctor (and the selling doctor if he or she takes a deferred purchase price) must be sure that financing the acquisition will not dangerously reduce the buying doctor’s liquidity.

8. Form of Purchase Price.  You mainly have 3 choices: cash up-front, a promissory note or an earn-out.  From the selling doctor’s perspective, cash is king.  When a selling doctor accepts a promissory note or an earn-out, he or she essentially becomes an investor in the buying doctor.

9. The Transaction.  Even though you may have settled on a purchase price, negotiations are not over. The structure of the transaction and the purchase agreement directly affect the bottom line risks and after-tax price of the deal. 

        9.1 Structure. Rule of thumb: buyers buy assets and sellers sell stock.

• Stock Sales.  Here the buying doctor purchases the stock held by the doctor / shareholders in the target corporation.  Of course, the first requirement when buying or selling stock in a corporation is to comply with California’s laws governing medical / dental corporations.  As you know, there are restrictions on who can be a shareholder in a medical, dental or other health care corporation.  Keep in mind when considering the stock sale of a corporation that the buying doctor keeps the corporation and all of its liabilities.  The buying doctor gets a carry-over basis in the corporation’s assets (usually lower than a stepped-up basis).  Seller’s shareholders pay taxes on the appreciation in their shares (with no double-tax).  For these reasons, sellers prefer stock sales.

• Asset Sales.  Here the buying doctor purchases the seller’s assets, and assumes only those liabilities that the buying doctor agrees to assume.  The seller remains liable for unassumed obligations.  If the seller is a corporation, then the corporation dividends up to its shareholders the proceeds of the sale.  This causes the double tax problem -- the corporation pays taxes on the asset sale, then the shareholders pay taxes on the dividend to them (exception for S corporations).  The buying doctor gets a stepped-up basis in seller’s assets (consisting of the purchase price plus assumed liabilities plus transaction expenses).  For these reasons, buyers prefer asset sales.

        9.2 Representations.  The selling doctor will make extensive representations about the practice.  This allows the buying doctor to recover back some of the purchase price if any of the representations is materially misleading, for example, the selling doctor did not disclose certain liabilities.  Representations are not a substitute for due diligence, but they do provide additional security.

        9.3 Holdbacks.  The buying doctor should try to holdback a portion of the purchase price, in case the selling doctor has made false representations.  Holdbacks can be structured as a promissory note, an escrow or an earn-out (which is a purchase price that is paid over time based on the post-closing performance of the practice).

        9.4 Post-Closing Adjustments.  Sometimes the parties agree that the buying doctor may adjust the purchase price before or after the closing. The buying doctor usually makes adjustments based on an accounting that he or she performs after taking over the practice, or for the gap period between the signing of the sale agreement and closing. 

        9.5 Collection of Accounts Receivable.  The buying and selling doctors must decide who of buyer or seller will collect the selling doctor’s existing accounts receivable.  Frequently the buying doctor will collect the receivables, especially if buyer is taking existing patients of seller.  In this case, buyer will own all accounts receivable that are outstanding as of the closing.  The purchase price will be increased by the amount of uncollected accounts receivable, less a discount for collection risks and expenses (5-10%).  Accounts that seller collects (and keeps) prior to closing are not included in the purchase price.

        9.6 Fixing Prior Work.  With respect to patients that stay with the purchased practice, the buying doctor ordinarily will want to re-do defective work done by the selling doctor.  The real issue is how the buying and selling doctors allocate the responsibility and costs for the re-do work.  One option is to permit seller to return and perform the fix-up work; or in the alternative, buyer can perform the fix-up work and charge seller 50-70% of buyer’s normal fee for such work.  In some cases, buyer’s charge can be set-off against a deferred purchase price payable by buyer.  The parties also must agree to the time period in which seller is responsible for fix-ups (e.g. 6-12 months after closing).

10. Non-Competition Agreements.   The buying doctor should receive non-competition agreements from the selling doctors.  Otherwise, the buying doctor is at risk that the selling doctors will set up a competing practice across the street.  Given the personal nature of health care, this is a significant risk.

11. Psychology.  Ego drives deals.  Be sensitive to your own and the other side’s psychology.

Call me to schedule a legal consultation: 510-796-9144