Orthodontic Practice Succession Specialists

By: Doug Copple
Chief Financial Officer, CPA, CVA

Many recent graduates question whether they can afford to buy a partial or total ownership interest in an orthodontic practice. Most young orthodontists have incurred substantial amounts of school debt and often have a family to support. Many question whether the additional debt created from such a purchase is justifiable and can be managed with existing student loans, various expenses and other debts created from beginning a new life (new home, cars, insurances, possible relocation, etc.). Many orthodontists therefore conclude that it would be more rational and cost effective to work as an employee/associate orthodontist for several years to become established and pay down current debt. Then, in a few years, once he/she is more financially stable, he/she will then consider purchasing or buying into a practice.

However, many orthodontists do not realize that building equity in one’s own business (orthodontic practices are in actuality businesses) is critical. If the purchase price of the practice is reasonable, based on an objective valuation, and the buy-in or buy-out is structured correctly, cash flow produced from the ownership interest should be equal to or, often, significantly exceed the per diem rate or annual salary one would receive as an associate or independent contractor.

Buy into an Existing Practice versus Work as an Employee:
Let’s put this into perspective through an example. Assume you are considering whether to work as an associate or to purchase a 50% ownership interest in a particular practice with annual collections of $1 million and an overhead rate of 50%1 . This practice is therefore producing $500,000 of net income for the current owner. Further, assume the total value and/or purchase price of this practice is determined to be 80% of collections or $800,0002. Therefore, the purchase price for a 50% ownership interest in the practice is set at $400,000, which is the debt or other obligation you would be liable to repay through the income generated from the practice. If this obligation were financed over a seven year period at 8.0%, the annual principal and interest repayments would total slightly less than $75,000 per year.

Now that you have purchased a 50% interest in the practice, you should receive 50% of the practice’s net income/profits, or $250,000 per year3. You now have $250,000 in income to repay $75,000 in interest and principal. How does this compare to the salary you expect to receive as an associate? In addition, now that the practice has two doctors, the practice should grow4, which will increase your annual income. You are also building equity, which will provide you with future monetary benefits when your ownership interest is sold.

The above example is an extremely simplified version of a practice buy-in. The effects on your compensation will vary based on how the transaction is structured, the method by which the loan is repaid, and the deductibility (for tax purposes) of the purchase price. However, the transaction can and should be structured such that it is fair to the buyer and seller and as tax beneficial to both parties as possible.

Buy into an Existing Practice versus Start a New Practice:
Orthodontists may also consider whether it would be better to start their own practice from scratch (or to work for a couple of years then start their own practice) versus buying an existing practice. The benefits of buying into or purchasing an existing practice can be significant and include the following:

• Provides you with an established patient base,
• Helps you develop goodwill in the community more quickly,
• Provides you with a mentor to assist in treatment options and management of the practice,
• Allows you to take advantage of an assembled and experienced staff and the practice’s established business procedures,
• Enables you to practice in a facility that you may not be able to afford for years.

Generally, you would expect to incur a greater amount of debt to purchase an existing practice compared to starting your own practice (debt incurred to purchase equipment and supplies, lease the facility and pay the staff until you reach positive cash flow). However, the net income provided by the existing practice is generally significantly more than the income provided by a start-up practice, particularly during the first few years of operation. Even when you become successful with your start-up practice, it could take a significant amount of time to recoup the lost income during the start-up years, if in fact it is ever recouped.

How to Pay for the Purchase:
You may be wondering where you are going to get the money to buy an existing practice that may cost several hundred thousand dollars. Commercial lending or some type of seller financing are the most common forms of financing. In larger transactions, it is not uncommon for a portion to be financed by a commercial lender and the remainder financed by the seller. Bentson Clark has relationships with lending institutions in the dental community that understand the specialty and often provide the buyer with 100% financing.

Buying into an existing orthodontic practice is one way to jump start your success. Although you will incur debt to purchase an ownership interest, the financial reward is realized quickly, and the equity you accumulate in your own practice could one day grow to become your most valuable single asset. With many options, you must make a decision based on what suits you best. Consider what is more important, debt or ownership. Seek out advice from other orthodontists and learn from their experiences. Explore all your options and remember, what works for one orthodontist may not work for you.

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