Congratulations, you’ve worked hard and have built a profitable dental practice, but the thought of retiring comes up more frequently than not. One major questions that practice owners will have to think about is how do you retire while cashing out on the business you’ve spent years developing?
Many dentists don’t have a proper exist strategy in place, and that could mean losing out on hundreds of thousands of dollars. This article will detail several exit strategies used by dentists to successfully retire.
Traditional Buyout Plan
The expectation for retiring dentists is that they’ll be able to sell their practice for a significant amount of money. However, it’s not that simple. Many retiring dentists are often disappointed by the low bids for the buyout of their practice. The reason is simple: it’s not guaranteed that the new dentist or practice will retain all the clients, therefore a lower price will be offered.
Another alternative option that is often used is the passing down of the practice to a junior dentist. The patients will be more familiar with the dentist and will be more willing to continue to use their services once the senior dentist retires. This ensures a higher payout and a smoother transition into retirement.
However, plans have to be put in place to ensure a smooth transition from a senior dentist to a junior dentist.
Contracts are Key
To ensure that there is a smooth transition between a senior and junior dentist you want to have stipulations in writing. Although a lawyer can be expensive, the cost of not having a written agreement in place could cost thousands of dollars in legal fees after the fact.
Why Chose to Sell to a Junior Dentist
Choosing to sell to a junior dentist rather than selling to a third-party can be a better option especially for single owner practices. This is because a better relationship exists for a smoother transition into retirement. Additionally, the buyout process can take several years, which defers the retirement process and ensures that no major disruptions arise that may cause patients to leave the practice altogether.
If you are a single owner practice and don’t have a junior dentist, then the best option is to have a test period. You can hire a junior dentist for a year or two who has prior experience and is interested in buying out a practice. After the period of employment you can set stipulations for a buyout period.
For example, let’s say after a year of employment you (as well as your staff) agree that the new junior dentist is the right fit for the practice. You can then put in place an agreement for the eventual buyout of the practice. This usually involves an upfront buyout of a portion of the practice – let’s say, 10%.
The initial buy-in ensures that the junior dentist is serious about the proposition and will eventually buyout 100% of the practice.
Selling to Existing Dentist
The easiest buyout method is the payout from the existing dentist within the practice. Agreements will be set in place for the eventual buyout, but complex calculations will have to be made to ensure that the retiring dentist will be properly compensated while ensuring the existing practice will continue to operate as usual.
This can be difficult but a buyout agreement ensures that the new dentist can buyout the retiring dentist while maintaining a cash flow requirement. The buyout will take several years and will work as an annuity for the dentist leaving the practice.
Employee Stock Ownership Plan
The strategy that has the most tax advantages which can be used in succession planning for retiring dentists is an employee stock ownership plan – more commonly referred to as an ESOP. These plans are set up for two major reasons.
- They function as a retirement plan for current and future employees.
- They work as an exit strategy for owners while maintaining the current state of the business.
How does it work?
For starters, ESOPs work best in C-corporations and have tax advantages for S-Corps as well. If the business is structured as a professional partnership, then using an ESOP is just about impossible. Setting up an ESOP is complex, and involves several outside parties. The following is a simplified explanation of how an ESOP is established and how it functions.
Step 1: ESOP is established with the help of lawyers and other professionals. An ESOP is considered a trust, so a trustee will have to be put in place (usually a lawyer, banker, or accountant specializing in ESOP transactions).
Step 2: The ESOP will obtain a loan to purchase stock in the retiring shareholder’s practice.
Step 3: The company and its employees will make retirement contributions into the ESOP and the ESOP will share the practice’s income and losses. The ESOP will pay the existing loans with these proceeds.
Why Chose an ESOP?
Smooth Transition: An ESOP is a great option because it maintains the integrity of a dental practice. This works great for closely held practices, or practices with a retiring dentist who has a large share of ownership. The retiring dentist gets their retirement proceeds up front and the dental practice isn’t strapped for cash.
Tax Advantage: For practices structured as a C-Corporation, the retiring dentist can reinvest their share of the sale of their business interest, and defer taxes. This means that no tax will be paid up front if it is rolled over into a retirement account. For owners with a sizable gain from the sale of their interest, this could mean thousands, if not millions, of dollars in tax.
An S-Corporation does not have such an advantage but any portion of ownership held by the ESOP will be tax-free. For example, let’s say the ESOP holds 25% of the shares of a practice and the net income for the year was $1,000,000. This means that $250,00 of that income will be tax-free.
The most notable disadvantage is the high cost to establish an ESOP plan. Simple plans can start out anywhere from $30,000 to $50,000 and more complex plans for larger practices can go upwards from there.
The time to plan for retirement is now, and establishing a secession plan is the first step to a successful retirement. Choosing the best plan for you or your practice can be complicated, so it’s best to consult with your trusted advisor.