Doyle Watson, DVM
Simmons Southeast –
Some advisors recommend selling the practice to an associate in small increments — maybe 5-10% annually, until some point when the remainder is sold as a block, maybe a full partnership interest at one time to remain in effect for the long term. Although there may be good reasons to do so, there are also reasons to reconsider this approach.
From the seller’s perspective, a major reason to sell a portion is for the purpose of exit in a situation when the practice is somewhat less desirable and unattractive to the open market of buyers, such a mixed practice in a rural setting taking emergency calls. Since there are few buyers for this type of practice, the associate /partner becomes the exit for the ultimately retiring owner.
However the “golden handcuff” rationale is totally unnecessary in the case of a practice which is more attractive and saleable on the open market, such as medium to high grossing, small animal practice in Suburbia, USA with an emergency referral center available. These practices are in great demand and will sell rather quickly on the open market. In this case, a reason to sell a portion to a prize associate may be a desire to retain that person in recognition of the quality he/she offers to the clientele and in satisfaction of the desire to eventually turn over the practice and clientele to a known entity —- i.e. a desire to perpetuate the good name so long-created and cherished by the founding owner.
Nevertheless, as the title of this article implies, from the seller’s perspective, there are major negatives to a partial sale.
One — With 100%, the owner has total access to the net income (cash flow) of the practice. So let’s just say this figure is $220,000. Let’s also say that $130K of this is considered earned salary for being the managing doctor (not for being the owner), leaving $90K as “earnings”. Keeping it very simple, it is this $90K figure that would be divided amongst the owners as a “return on investment”. Continuing, assume a 50% partial sale with the owner financing the all or a great majority of the purchase price for a period of 10 years.* The new partner is now entitled to 50% of earnings, or $45K, a portion of which (say $30K) is returned to the seller as purchase money (note) repayment for 10 years. So the purchase has been made essentially from a portion of what was formally the seller’s personal income, and the seller has now lost 50% of his/her asset forever and $15K in personal income for 10 years until the note is retired, then $45K forever. The same general scenario exists regardless of the portion sold. Hence the Great Giveaway.
(*An obvious assumption is that the second doctor should create growth. However to avoid complicating this scenario with a growth factor, let’s just assume no growth and both partners now equally productive on a part-time basis. Nevertheless, the second doctor could come as a hired associate rather than as a partner, and the asset and earnings preserved. )
Two — The original owner now has partner to consider in making management and expense decisions, especially as it relates to discretionary personal perks and fringe benefits run though the business as operating expenses.
Three — In the unlikely event of the seller’s need to sell his/her remaining portion, and the partnership agreement not having not addressed this issue, and the new partner unable or unwilling to buy the remainder, the original owner now has a very limited (if not zero) market for the sale of the balance of his/her practice asset.
As an ancillary from the buyer’s perspective, considering a minority purchase less than 50% , a minority position in a closely held business leaves itself open to many potential pitfalls, not the least of which is lack of control. It is even conceivable that the minority partner could be discharged from employment but still retain ownership. Philosophically speaking, if an owner thinks highly enough of someone to make him/her a partner, why not make him/her real “partner”, not just a figurehead of ownership, and bestow the full responsibility and privileges that go with it.
So, before entering into this kind of a purchase or sale, it is important to consider all of the ramifications. An incremental purchase is not the only way it can be structured, and may not be the best way for either party.