Contract Complexity
Lock in favorable terms by negotiating proper agreements
Jennifer Vishnevsky
Although many dentists can attest to having made a handshake deal at some point during their careers, the landscape of contracts in the dental industry has changed significantly over the years. Many corporate groups are buying dental practices and private equity, which has led to the development of more thorough contracts. And recently, the COVID-19 pandemic has brought about legal changes, many of which have organically trickled down to affect contracts.
The first thing that people need to know about contracts is that every contract comes with an ensuing negotiation." says David Cohen, managing partner of Cohen Law Firm, a practice that specializes in serving the legal needs of dentists. "There is an unfortunate misperception among many doctors that negotiations are adversarial, win-or-lose interactions. The reality is that negotiations are really about getting more of what you want and growing the pie, not taking more of the pie." Avoiding contractual issues is preferred; however, it's important to understand that a properly negotiated contract crafted using a team of professionals is one that will serve both parties should the need arise.
Buying a Practice
If you're interested in purchasing a practice, before you even start searching, Brannon Moncrief, a broker for sellers at McLerran & Associates, recommends getting your team in place and building relationships with a dental attorney, accountant, and potentially consultants and lenders. Even if you have the required experience to handle the transaction, Cohen recommends hiring an attorney who not only understands the spirit of negotiations but is also familiar with the customs of dentistry. Most transactions start with a letter of intent signed by both parties. The purpose of the letter of intent is to memorialize the major terms agreed upon between the parties, such as the purchase price, date of transfer of the practice, and inclusion or exclusion of accounts receivable in the transfer.1
Brian Hanks, a buyer advocate for dentists, encourages buyers to consider how the seller is approaching the sale. "How open was the seller in showcasing the office and letting you see the inner operations of the practice?" he asks. Once you've read the room, it's time to dive into the technicalities, which is where your team will play a major role. Start with an asset list and look into what's being sold and what isn't. When you buy a business, you're paying for multiple different types of assets, including supplies, equipment, goodwill, and more.2,3
Cohen recommends using blanket legal terms in addition to specific exclusions as opposed to a list of what you're getting. "Every once in a while, you'll have something such as a machine, a computer, or a piece of artwork that a buyer felt was coming with the deal, but the seller doesn't feel that way," he says. "As a buyer, you'll want to know exactly what you're getting."
Next, focus on the representations and warranties. These are the promises that the seller is making about the practice. Specifically, you'll want to verify that the financials are true and accurate and that the assets are free of liens. As a buyer, the representations and warranties will be your protection to ensure that you get what you paid for.4 "Make sure that the seller is making significant promises to you about the assets in the practice that you're buying," says Cohen. "The representations and warranties in the agreement need to be thorough. If they aren't, the seller will have many more loopholes to avoid legal recourse." The negotiation of these statements is an extremely important tool in the buying process that, together with due diligence, allows the buyer to learn more about the dental practice before the actual purchase and protects him or her from any untrue or incorrect statements.5
Finally, you should have a valid non-compete agreement in place, and it should be narrowly tailored to what the law permits. The non-competition/non-solicitation covenant is a main point of negotiation for the purchase or sale of a dental practice. If you are the buyer, a large portion of your purchase price will likely be allocated to goodwill, and goodwill is worthless unless you have a proper non-compete agreement in place.6 "It's a myth that non-competes have a universal standard," says Cohen. "The non-compete law governing a transaction will vary from state to state in terms of enforceability." For example, Washington, Maryland, and Massachusetts have begun to follow Louisiana's more employee-friendly approach to non-compete agreements by limiting situations in which an employer may legally restrain the trade of a former employee.7
As a buyer, you'll want to ensure that the practice you're interested in has an assignability clause in place for its employee non-compete agreements. These provisions permit the seller to assign the rights of the practice's non-compete agreements to the buyer so that any associates will not compete with the buyer after he or she becomes the new owner. Without assignability, your practice will have significantly less value. Because there is minimal incentive to the associates, these clauses are something that you want to have in place with your associates before it's time to buy or sell. "Any time we're working with a seller who has associate doctors, we verify that there are written associate agreements with non-competes in place. If not, we typically require the seller to do so prior to taking the practice to market," says Moncrief.
Although Hanks considers the asset list, representations and warranties, and non-compete agreements as the cost of entry when buying a business, he encourages potential buyers to go one layer deeper when assessing a practice. "What you're really buying isn't a list of equipment or a list of patients-you're buying the habits of those patients and the reputation of the office," he says. "To a lesser extent, you're buying the goodwill and relationships that are locked in the office. Those aren't things that will fit into a legal document."
The Seller's Perspective
Regarding the asset list, just as the buyer should be looking to ensure that everything that he or she believes is included in the purchase is actually included, the seller's objective should be to ensure that any assets that he or she believes should be excluded are excluded. These assets can include accounts receivable of the practice, which are not normally transferred in an asset sale, but also may include things like artwork, vehicles, cash, and investments.8
During the representations and warranties conversation, it's key for sellers to make sure that they aren't required to guarantee their success or make any other unrealistic promises. As a seller, the representations and warranties that you make in a purchase agreement will be the basis for your post-closing liability.4 One area that Moncrief highlights is making sure that there is a guarantee on the seller's work and an arrangement governing how rework will be handled post-closing.
Tax allocations can be complicated, so it's advantageous to work with a CPA who is well versed in the dental industry. The CPA will be able to guide the seller in determining how the purchase price is being allocated from a tax perspective to the assets that are purchased. "For buyers, the issue is how fast they can depreciate the purchase price of the practice," says Hanks. If you are a seller, you want as much of your income as possible to fall into an asset category where the IRS will tax it as capital gains instead of ordinary income.2 "Savvy buyers will allow sellers to ‘win' on tax asset allocation if they're willing to negotiate somewhere else, like non-compete issues or accounts receivable," says Hanks. "If it's done well, it can be a real win-win situation for everyone despite the fact that it looks like a win-lose one on the surface."
For an owner who wishes to sell his or her practice but continue to work, the work-back arrangement needs to be clear and mutual. You need to lock in the terms with a sale and purchase agreement that clearly outlines how much you'll be working, how you'll be paid, and what the benefits will be. Hanks recommends keeping the renewal periods short for both parties when there's an associate contract involved, allowing a review at 3 or 6 months to ensure that the arrangement is still working.
The sale of dental practices is at an all-time high, which is also driving the expanding dental service organization (DSO) market. Selling to a DSO is popular, but the process can be more complex than a dentist-to-dentist transaction. First, it's crucial to understand why you're looking to sell to a DSO. Do you want to continue working in your business? If so, a DSO could be a good fit. "Not all DSOs are created equal," says Moncrief. "They all have different philosophies, personalities, and levels of support that they can offer doctors."
A work-back agreement is standard practice when selling to a DSO, so any dentist who does not want to continue to work is better aligned with pursuing a private sale. "In a DSO transaction, there's typically some portion of the purchase price that's held back at closing in the form of retained equity or an earnout paid based on the seller working back and/or practice performance," says Moncrief. "Doctor turnover is the Achilles' heel of a DSO, so DSOs want the seller to stay on for as long as possible in most cases. That's in the best interest of the practice and the investment."
For Jeff Gray, DDS, a cosmetic dentist with Espire Dental in San Diego, California, selling his practice was something he would never have considered a year ago. Today, he touts it as one of the best decisions of his career. In the late ‘80s, Gray bought and grew a practice. He took on a partner, but after many years, the partnership soured. Gray stepped away in 2007 and then began building a new practice. Eventually, he was approached by a DSO and initially declined. Although he was honored that they were interested, his past experience lingered in his mind. Then the COVID-19 pandemic hit. "I began thinking about what would happen to my team if my wife or I got hurt," he says. After a few more conversations, he realized that this specific DSO was the right fit for him and his practice. "We would not have been open to selling to a DSO if another group had reached out," he says. "I was working with people that I had known and trusted and knew that their goal was to take care of us and create something amazing together."
Adding an Associate
On the surface, the decision to hire an associate or a partner may seem like it's just about finding the right fit for your practice; however, the contractual nature of this partnership is just as important to consider. Establishing an appropriate non-compete agreement with the candidate should be one of the first parts of the conversation. "A non-compete has to be enforceable in the state governing the transaction and enforceability in most circumstances requires reasonability," says Cohen. "Therefore, it is important for an employer to retain legal counsel to advise on a proper scope for the non-compete. If a non-compete is permissible in the particular jurisdiction, it is a major mistake for an employer to bypass including it. Not only is it a mistake from a legal protection standpoint, but it also preserves the value of the employer's practice because if they ever want to sell, they'll need to be able to prove that the non-compete rights of that associate can be assigned to the buyer."
For many associates, having an arrangement that provides some level of minimum guaranteed annual compensation is important to ensure that they will have sufficient income to meet their personal expenses.9 However, in a partnership, if the partnership guarantees a specific portion of revenue to each partner, it's important to establish that the revenue is dependent on the actual work being done by each provider. This can be clearly outlined in an operating agreement.
Hanks recognizes that the crux of the issue is establishing who does the work and how the partners are paid. "Most partnerships create three entities: a partnership that's jointly owned by both doctors and a separate LLC for each doctor that is paid by the partnership," he says. "There are two financial arrangements between the three entities. The partnership pays the dentists a percentage of their own production, just as if they were associates, and then the costs of managing the expenses of the office. A lot of business operations work has to take place that's not bringing dollars in. Both partners will then split the net income from the partnership. So, the partnership gets the money in, it pays the dentists some off the top, and if there's profit left over, then both partners will typically split that based on ownership percentage. That solves the problem of making sure both partners are being compensated for doing some of the heavy lifting in the business that doesn't necessarily immediately lead to dollars."
Becoming an Associate
There are specific nuances to consider in any agreement, but another time when it's imperative to properly negotiate is when contracting as an associate. "It's really critical to examine how much of a work schedule is being guaranteed," says Cohen. "Many contracts are vague on scheduling or allow an employer to change it if they want to." In addition, he encourages associates to consult a team and make sure that their non-compete agreement is fair and reasonable for the region that they're in. "A lot of contracts, particularly with contract groups, don't allow an associate to compete within a specific mile radius of an office they run," he says. "The non-compete should only apply to one office, more realistically the one the work is completed in." It's also important to formalize any exceptions to the non-compete agreement, such as to treat family members, start a second career, teach, or work on a locum basis. Although this subject can yield pushback, it's a key component of protecting the transaction as a whole.
As with any contract, it can be terminated, but there should be safeguards in place in the employee agreement to ensure that payment still occurs. "Payment for services rendered while employed should still be due to the associate doctor and this should be explicitly stated in every agreement," says Moncrief. He cautions that problems can occur that require legal recourse. "It is possible to sue," he says, "but you want to be sure you have that right, contractually, if they violate the agreement."
Contracts Support Relationships
Although the contract is a necessary component, Moncrief emphasizes that it is simply a reference point. "The relationship and communication between the parties is as important as the legal agreement," he says. "When I see things go bad, it's not typically because something was missed in the contract-it's because the relationship between the buyer and seller fell apart."
In that regard, Gray's first dental partnership was a case in point. He recognizes that although he did have a contract in place, the deal was mostly a handshake transaction. "We were planning for success, not for failures," he says. "Even though you hope for the best, you need to have a plan in place and a contract for the worst."
References
1. Law Offices of Barry H. Josselson, The Josselson Law Corporation. New strategies in successfully purchasing or selling your dental practice: part 1.DDS Match website. https://www.ddsmatch.com/Newstrategiespurchasingsellingdentalrpractice.html. Published October 7, 2019. Accessed February 2, 2021.
2. Hanks B. Negotiate the asset allocation when buying a dental practice. Practice Financial Group website. https://practicefinancialgroup.com/negotiate-asset-allocation-when-buying-dental-practice/. Published October 27, 2016. Accessed February 2, 2021.
3. Hanks B. Dental practice prices 2019 - how much is my dental practice worth? https://brianhanks.com/dental-practice-prices-2019-how-much-is-my-dental-practice-worth/. Published March 17, 2018. Accessed February 2, 2021.
4. Representations & Warranties. Thorsen Legal website. https://thorsenlegal.com/blog/representations-warranties/. Accessed February 2, 2021.
5. Buying and selling a dental practice. Blackburn Lawyers website. https://blackburnlawyers.ca/health-dental-law/buying-and-selling-a-dental-practice/. Published August 17, 2019. Accessed February 2, 2021.
6. Kutner M. Non-competition/non-solicitation covenants on the sale or purchase of your dental practice. Kutner Law LLP website. https://www.kutnerlaw.ca/non-competitionnon-solicitation-covenants-sale-purchase-dental-practice/. Published June 5, 2014. Accessed February 2, 2021.
7. Foley MA. Competing views on non-compete agreements: changes may be coming across the nation to employers' and business purchasers' ability to limit competition. The National Law Review website. https://www.natlawreview.com/article/competing-views-non-compete-agreements-changes-may-be-coming-across-nation-to. Published January 30, 2020. Accessed February 2, 2021.
8. Harris D, McMillan J. Shares versus assets - transacting an incorporated dental practice - part one. Oral Health Group website. https://www.oralhealthgroup.com/features/shares-versus-assets-transacting-an-incorporated-dental-practice-part-one/. Published June 1, 2005. Accessed February 2, 2021.
9. Bickers C. Associateships - everything you need to know. Dental Entrepreneur website. https://www.dentalentrepreneur.com/associateships/. Accessed February 2, 2021.
