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Important Considerations When Forming Dental Partnerships

Important Considerations When Forming Dental Partnerships

January 11, 2021
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The Formation of a Dental Partnership

 
What is a partnership?
 
A partnership is a legal business entity in which each business partner has an equal or proportional ownership of a business. This typically means an equal ownership of the hard assets and may include intangible assets such as goodwill or profits.
 
Dental practices, or any business for that matter, goes through transition.  Often these transitions involve bringing on new partners, looking at all of the details in the business, and a variety of different emotions.
 
As advisors and planners by nature, we know that considering the possible partnership from every angle is a smart idea. We’ve pulled together some important angles to consider when considering a dental partnership opportunity.
 
Planning out a successful partnership is extremely important. Half of partnerships discussed fail to ever form. Of those that do form, studies show only 30% will survive.
 
Failed partnerships are often due to poor planning, differing expectations, and not formalizing an agreement in writing.  With this knowledge, and our experience, we have seen successful partnerships form from careful preliminary communication, careful planning and written agreements.Dental practices face specific challenges in partnership agreements.  A true legal partnership includes a very important, characteristic for a dental practice, which states all partners, to the full extent of their personal assets, are responsible for the acts of any of the partners.
 
Before any partnership agreements are put in place, there are a number of important questions to consider and think through.  Then, when the different parties are ready, it is wise to bring a trusted consultant and lawyer to help walk you through the process.  It is important to bring a third-party into the partnership agreement process to help you think through all of the important angles.
 
Important thoughts and questions to consider:
  1. What personality traits, strengths, experience do each of us bring to the partnership?
  2. What goals does each have for their career? For the partnership?
  3. What percentage ownership is the current owner willing to sell?
  4. What assets are included in the sale?

Important Aspect to a Partnership Agreement

Membership Interest

The partnership itself is an involved arrangement, but it has some clear pieces.  Most partnerships will involve the purchase of a membership interest. It is imperative that the value paid for the interest should not be the full amount paid for the practice. The purchase price is generally split between a small amount for the interest upfront and the balance to be paid as deferred compensation to the seller.  The justification for this type of approach requires precise wording in the “Membership Agreement” to pass IRS scrutiny.  Also, the most important inclusions in the arrangement are the warranties and hold-harmless provisions. Concurrent with the sale of membership interest, each doctor will get a new employment agreement. As equal or almost equal owners these agreements will be almost identical. A comprehensive look at the partnership of membership interest is vital to success.

Assets Acquired

Once the basics of the stocks are defined, the partnership agreement needs to take assets into consideration. One of the keys is to clearly define what are considered to be assets of the partnership.  Becoming a partner typically means ownership of all assets to run the practice. However, the valuation relative to the goodwill aspect is typically tied to the individual production of each owner.  Initially, the new dentist is buying access to the existing client base. This means they are to receive equal opportunity to see recall patients, present treatment needed, and provide the required services.  Also, they are buying the right to see an equal number of new patients.  Both of these aspects are referred to as “sharing” and should be thoroughly discussed between both parties.

Splitting the Income

Once a partnership is set up, income may look different for both parties.  A discussion needs to be had on how the practice net income (income after expense) remains for the owners.  You’ll want to talk about how both expenses and profits will be split.  Expenses may be split by production, but for the most part, rent and other facility related expenses are almost always split equally. Supplies, depending on the practice, could also be split based on production.  Profit splits are typically based on production, but profits are split by ownership. In some general dentistry and perio specialties, the hygiene revenue could be split based on production ratios or who conducted the exam.

Agreements

Ultimately the agreement needs to cover the “buy-in price,” which is based off a proposed purchase price.  This can be established when an associate first comes on or at a later date.  Then, a Letter of Intent (LOI) needs to be established.  A LOI spells out the preliminary terms of a buy-in/ buyout situation. Typically, it is a letter that is not binding, but includes important matters discussed and is written down.  The LOI, while not binding, is essential to form the framework for a successful partnership as it anticipates possible scenarios in writing.

Below Are Key Parts To A Letter Of Intent:

1)      Goals-“Employee Agreement”- detailing compensation, benefits, responsibilities, hours of employment, and probably a non-compete provision.

2)      “Non-compete Agreement”- a contract limiting a party from competing with a business after termination of employment or completion of a business sale.

3)      Worst Case Scenarios – The documents should provide worst-case scenarios, such as split partnership and a means to amicably separate the partnership.

4)      “Stock Restriction Agreement”- defines who can own an interest in the partnership

5)      Detailed Instructions:  The letter of intent should spell out details for all of the following items:

  • How the purchase price will be allocated
  • How the purchase price will be paid
  • How the partnership will be run
  • How the doctors will be compensated
  • How patients, expenses, and profits will be split
  • How future Buy-ins/Buy-outs will be handled
  • What happens in the event of death or disability
  • Conflict resolution
  • Management duties
  • Cross-purchase life and disability insurance

6)      “Stock Purchase Agreement”- terms of the sale. The agreement is fairly straight-forward, boilerplate-type content, with a lot of legal terminology

Whether you are considering a partnership right now, or know that you may someday, it is important to consider the questions and topics you should pay attention to in a dental partnership.  Asking good questions and getting sound counsel can set you up with peace of mind in a dental practice transition.

Commonwealth does not provide legal or tax advice. Please consult with a legal or tax professional regarding your individual situation.