Transition Danger Zones

How to avoid trouble spots when buying or selling a practice

Most often, transition problems are not the result of one major issue, but a buildup of several items that change the relationship. Transitions are inevitable for sellers and represent terrific opportunities for buyers. Transitions should be smooth as long as the buyer and the seller are willing to accommodate each other, are fully informed, and have advisers that want a fair deal for both parties. And yet, sometimes orthodontists find themselves regretting that they are taking part in a transition. How does a buyer or seller get to the point of thinking that a mistake has been made? Let’s review common danger areas so that it doesn’t happen to you.

Ruler of the Castle

There is a reason why the majority of orthodontic practices only have one owner, no matter what the age of the owner. Orthodontists are progressive, very independent, and entrepreneurial people. These are excellent qualities—except when it comes to working with each other in the same practice.

Most dentists (including orthodontists) are happy with only one ruler in the castle, and often do not enjoy sharing the castle with a knight (potential buyer). This affects the satisfaction of both parties to a transition, and may affect the purchase price. Can both of you work together for an agreed time period? If a seller and a buyer will be partners, the ability to work together and have a “business marriage” should be a prime consideration of both orthodontists.

In many cases, the selling orthodontist has never had an associate orthodontist work in the office, and the seller’s staff is not used to having another orthodontist prescribe treatment or suggest another way to perform a task.

An associate period before the actual sale gives both orthodontists an opportunity to establish good communication. In addition, patients and staff get used to having another orthodontist participate in providing treatment, so they will not feel abandoned when the seller’s visibility declines during the transition.

Compatibility is Crucial

A practice transition requires much more than a seller with a practice and a buyer with enthusiasm and financing. Matching of the buyer and seller is actually more important than the price structure, as the nonfinancial aspects of the practice will affect the buyer for a long time. The buyer should not be a clone of the seller, but certain compatibilities and similarities are reassuring to professional referral sources, patients, parents, and team. The goal is to have the seller be pleased with his or her choice and feel confident that the buyer is going to do well. The buyer wants to establish his or her identity and use the practice to launch into the future. What are the elements that a buyer and seller should consider?

1) Patient care and treatment philosophy: If the buyer does not understand or cannot condone the seller’s treatment philosophy or mechanics, then the orthodontists will not work well together. This compatibility extends to extractions, surgery, and archwire sequence. If the buyer wants to replace the appliances on all patients currently in treatment, this is an extra cost and perhaps this is not the right practice for him or her to purchase. More important, the patients will wonder if the older orthodontist was incompetent, or will wonder if the younger orthodontist doesn’t know what he or she is doing. If the buyer does not know enough about the treatment philosophy to competently finish treatment once the seller is gone, the buyer will have too many patients in extended treatment with the financial and referral consequences that this entails.

Treatment compatibility is very important if the seller and buyer treat the same patients. The last thing the patient needs to hear from the seller is, “I wonder why Dr Younger did that? It’s certainly not what I would have done.” This does not instill confidence in patients, and undermines the buyer’s credibility.

The seller and buyer need to spend time together before committing to a transaction. If there will be no presale associate relationship, then the seller and buyer must meet together to discuss treatment in detail. This is easily accomplished by two or three meetings with a review of active cases, as well as patients finished in the previous year. The orthodontist should review the records, treatment plan, and visit notes; and discuss how each would approach the case and finish treatment. Obviously, having many disagreements about treatment is a strong indication that the match may not be ideal.

2) Marketing style: The seller may be very visible in the community and to professional referral sources. If the buyer finds it difficult to meet and talk with people, then it is going to take much longer for the buyer to become established. On the other hand, if the seller was never very involved in marketing, didn’t take dentists out to lunch, and has not met the new dentists that have come to town in the last 10 years, then a visible and active buyer will be a positive change for the practice.

The biggest problem is the orthodontist whose practice is very much a reflection of the owner’s personality. Extremely outgoing, personable, and communicative orthodontists are more difficult to replace. If the buyer’s personality doesn’t easily adapt to such flair, or if the buyer doesn’t want to be so involved in the community, then a decrease in starts can be expected unless the buyer establishes a niche that has not yet been tapped by other orthodontists in the area. The buyer’s communication style and presence should be of interest to the seller as it will impact the transition, particularly if the seller plans to help finance the transaction.

3) Cultural fit: The United States is home to people from all over the world. Will the buyer fit into the neighborhood and be accepted? Knowledge of the potential patient base’s cultural and linguistic diversity is important when making the decision to buy a particular practice.

4) Personal priorities: All too often, a buyer purchases a practice in an area where he or she eventually wants to live. However, the housing is too expensive, so for now, the buyer commutes. The lengthy drive reduces the buyer’s willingness to commute when not treating patients, but the seller had hoped that the buyer would be involved in several community organizations, so both the seller and the buyer are unhappy with each other.

The buyer cannot become known if he or she is not visible in the community and to other dental professionals. It seems like common sense, but I have seen too many instances where details of community and professional involvement were not considered prior to the sale.

There can also be family, religious, and lifestyle considerations. This is often not discussed out of fear of appearing biased, but it can affect the orthodontists’ relationship, particularly if they are partners. If the seller plans to remain in the area, and the buyer enjoys some personal activities that could be a topic of conversation among staff or patients, then the practice’s reputation can be strained. Or the reverse may be true: If the seller is known about town for more than treatment quality and a quiet family life, any negatives could affect the buyer’s initial reputation.

A seller and a buyer each have their own goals for financial security. Will the transition make sense to both of them? Usually, the younger orthodontist’s financial aspirations are not yet realized, while the seller has attained many financial goals. However, if the sale is needed to fund the seller’s retirement, and the desired price is unrealistic, the seller may not be a positive and enthusiastic participant in the transition.

Equally important is honesty about the practice’s chance of growth. If the seller has “slowed down,” can the practice grow quickly enough to provide the cash flow to pay a loan and operating expenses? Therefore, demographic, school, family income, and employment research must be done so that facts about the practice’s potential future are available to the seller and buyer.

Finally, some sellers “want out” as quickly as possible; the departure can be more mental than physical, but it certainly affects the tone and success of the transition. If the buyer wants a practice where the seller wants to help the buyer develop management or marketing skills, then an “early exit” seller is not a good match. On the other hand, the buyer may want the seller to leave as soon as possible, and the seller may want to stay for 2 years on a part-time basis. An overly long transition becomes strained, so both parties need to be honest with each other from the beginning.

Are You Partnership Material?

There are various partnership arrangements, but they all require some form of working together and establishing leadership roles. Even if the partnership is only for 5–7 years so that the buyer can pay the seller, both orthodontists will be partners during this time, so attention to the details of the Partnership Agreement is necessary.

The Partnership Agreement becomes the working document for the owners. It should spell out many elements, including “hot-button issues” that the owners feel could cause dissent. Common issues include personal expense reimbursement, compensation if one orthodontist reduces the number of days worked, and compensation for various marketing activities.

How to dissolve the partnership and split the assets and patients should be detailed in the Partnership Agreement. This provides the separating owners more dignity during the difficult time of the business split. Another common problem is the retirement of the senior partner. Each partner should have the option to retire at a stated age. However, the Partnership Agreement should also clearly state the maximum age (or medical condition) at which the senior orthodontist is required to retire to bring in a younger orthodontist. The senior partner retiring from full-time practice often still consults and treats patients on a part-time basis, but is no longer an owner. The Partnership Agreement should describe the terms of the process, how the value is established, and the events that would trigger the sale. In the long run, this works out best for all owners of the practice.

Planning Is Paramount

Every older, established orthodontist needs to preplan a transition. Do not wait until you are ready to leave, only to say that, “if I had more time, I would add new technology and systems.” An attractive practice is easier to transition and easier to fairly evaluate. More importantly, good systems (particularly detailed and readable treatment plans and visit notes) make is easier for a new orthodontist to look and feel competent, knowledgeable, and in charge when the seller is not present.

If you are considering buying a practice, you should investigate your credit and clean it up before a possible lender pulls the credit report. Lenders are conservative and want individuals with conservative spending patterns. An expensive car, high balances on credit cards, and possibly a home purchase before saving for a practice purchase are not the best references. Lenders base their decision on the practice’s profitability and cash flow as well as the buyer’s credit qualifications. The lender wants to see if the younger orthodontist can handle all the loan payments and still have money to live on. Some lenders will offer “prequalification” based on limited seller income/expense information along with the potential buyer’s financial statement.

What’s Your Credit Profile?

Will lenders like you? Check your credit on a regular basis, and once yearly, obtain your FICO score (this is not part of the federally mandated annual free credit check program). Below are three Web sites where you can find your credit score. Equifax: www.equifax.comExperion: www.experion.com Trans Union: www.pirg.org

Any potential buyer needs to analyze the amount of money required each month for personal expenses, including expenses that can be reduced if cash flow declines. You should do this prior to looking for a practice so that you know whether to purchase a smaller practice or a larger practice. There are advantages and disadvantages to both, and they must be analyzed based on the specifics of the individual, the practice situation, and the potential buyer’s ability to work other jobs to increase personal income if necessary.

A complete practice evaluation is a crucial ingredient of any transition. Both the potential buyer and seller should be aware of the practice’s strengths and weaknesses so that negotiations can be conducted in an honest and fair environment.

When reviewing the trends of a practice, it is best to average the most recent 3 complete business years together to determine present value. If only the prior business year is evaluated, the numbers may appear artificially high or low. Reviewing data from previous and current years can also help confirm trends.

A primary goal of a practice evaluation is to establish a price for the practice. There is no one formula consistently used by all the various companies and individuals that provide evaluation and transition services. No matter what pricing method is used in the evaluation document, the buyer and seller need to be informed of the practice details. This includes a rundown of the following:

? income;

? expenses;

? patient fees;

? accounts receivable (current due and past due monies);

? contracts receivable (future money to be received); 

? payment arrangements most commonly used by patients;

? insurance participation;

? staff team;

? referral base;

? facility and equipment leases;

? computer systems and technology; and

? marketing.

Both the seller and buyer should pay close attention to the contracts receivable. This represents funds owed in the future for treatment of active patients. If patients pay ahead, pay in full when treatment starts (because of a cash discount or the use of dental financing companies), or if insurance is paying the total benefit within the first year of treatment, then the buyer will have expenses without adequate income, particularly if starts decline.

If a cash-flow analysis for 2–3 years postsale is part of the evaluation document, it is important to check the growth factor on which the cash flow is based. If a cash-flow analysis has not been included, the buyer’s advisers should help with this to ensure that the practice’s cash flow can support the expenses and loan payments. If not, further negotiations are needed before making the joint commitment to sell or to purchase.

Danger Zones

1. The buyer or seller has unrealistic expectations. 2. The advisory teams are not experienced in dentistry and orthodontics. 3. Insufficient details are available for the buyer or seller. 4. The senior partner or seller does not want to retire because orthodontics is still fun. 5. The buyer has little management or marketing  expertise, and ignores the recommendations of the seller or consultants. 6. Key staff are loyal only to the seller and cannot adjust to a new orthodontist. 7. The seller’s desire to retire is public knowl- edge, so referrals and new patients may have already declined. 8. The practice’s cash flow is not able to support the proposed transition. 9. The buyer and the seller are not well-matched. 10.The location of the office is not good for growth, leading to more immediate expense for the buyer.

Ignorance Is No Excuse

The details of the transaction are very important to a successful transition. There is no excuse for a buyer or seller not to be fully informed about the practice and how the orthodontists will work together to maintain the goodwill of patients, staff, and referral sources.

No matter how much is disclosed by the seller, the buyer (and an advisory team), must perform due diligence. This involves visits to the office to check on many of the details already mentioned. It should include a paperwork review, and the buyer should meet with the seller several times. Both orthodontists need to be sure that each is the right fit for the other. This time investment is very worthwhile.

Several documents need to be prepared for these transactions, but why go to the expense of document preparation if there is no agreement on the major terms? The purpose of a Letter of Intent is to describe these terms. It provides orthodontists and their advisers an opportunity to agree on major points, greatly reducing misunderstanding and aiding in a successful transition.

This process helps both orthodontists understand how much they will work together, how the new orthodontist will be introduced, the activities of the seller, financing, and other issues. If there will be a partnership, and the buyer will not be able to participate in decisions until he or she owns 51% of the practice, then there are control issues that need to be resolved before going any further in the relationship.

Embrace the Experts

There are many jokes about accountants, attorneys, consultants, and financial planners. But qualified, competent individuals are very important for practice transitions. Most sellers have excelled in their orthodontic practices, but they are not experts in these once-in-a-lifetime matters. Younger orthodontists are certainly not experts in lease negotiations, Letters of Intent, buy/sell agreements, purchase allocations, and tax implications.

The right advisers are important to successful negotiations and a successful transition. The seller’s and the buyer’s advisory teams should be experienced in orthodontic matters. Too many important elements are easily missed without qualified, competent transition assistance. The cost can also be higher if major parts of the agreements have to be drafted several times due to an adviser’s inexperience with the specifics of dentistry and orthodontics. The best advisers have previous experience with both sellers and buyers, so that no matter which party they represent in a specific transaction, the agreements will be fair to both parties.

Ellen M. Grady, owner of Ellen M. Grady & Associates in Pacific Palisades, Calif, has consulted with orthodontic practices throughout the United States, Canada, and Europe for more than 30 years. Since 1990, she has also represented orthodontists in various associate, partnership, and sale transactions. She is a part-time clinical assistant professor at the University of Southern California Dental School in the graduate orthodontic program, providing practice-management education to the residents and her expertise to the operations of the teaching clinic. She often speaks at national and regional orthodontic meetings, and can be reached by email at [email protected] or by telephone at (310) 459-3013.