You might be ready for retirement and a long anticipated journey of new pursuits, or in mid-career and looking to sell one of your multiple practices. Either way, the sale of a practice represents the zenith of years of effort, skill and patient relationships. This is the first of a two-part series focused on preparing a dental practice for sale.
The moment you begin to consider a practice sale is the moment you begin to realize the benefits of preparation. Well-laid groundwork can almost guarantee peace of mind, the highest value for your sale and a smooth transition experience for your patients and staff. The alternative is rife with pitfalls that can have negative domino effects on the ultimate sale, from missed opportunities for proper tax planning to a poor experience for all.
Proper planning should start as early as three to five years prior to practice sale. A common starting point is to obtain a valuation of your practice. Not only will this give an indication of the current value, but it can identify areas which need improvement. Consider that at the time of sale, a typical buyer will be looking at the most recent three year history of revenue and expenses. It makes sense to implement new processes well in advance so that future profits reflect these improvements.
Every $1 increase in profit could translate into an additional $6 increase in practice value (based on common metrics in the marketplace today).
Hiring a practice management consultant at this stage can be a wise investment. Dale Tucci, of TMFD Financial Tucci Management Practice Consultants, has a history of helping dentists identify revenue opportunities within a practice. According to Dale, “One of the cornerstones of practice revenue is a strong hygiene program.” Dale and her team focus on uncovering dormant hygiene revenue, which can be addressed by allocating hygiene hours to when demand is greatest. In addition, Dale’s team works productively with staff to assess hygiene care intervals, so that patient recall frequency stays current and does not slip over time leading to lost revenue. A general dental practice with 40% hygiene production is at an optimal level, which translates into a better practice value.
Within the three to five year window prior to sale, it’s also important to turn your attention to the premises lease. The lease is arguably the most important legal document for any practice since the goodwill value is so closely tied to the location. There are a number of items to review referring to the ability to assign a new tenant, termination, relocation and non-competition clauses to name just a few. It’s crucial that the terms for renewal extend at least ten years; banks are willing to lend for up to ten years but not beyond the final lease renewal, so it’s important to plan ahead as each term renewal comes up for negotiation.
Tax planning also requires substantial timelines of preparation to achieve the lowest tax payable.
Ideally, you will want to sell shares to reap the tax benefits; it’s in your favour to set up a Professional Corporation and transfer the business into the company. The Lifetime Capital Gains Exemption (LCGE) allows the capital gains to be received tax-free upon the sale of shares in a private company, such as a dental practice, subject to certain limits. For 2016, the LCGE is $824,177 and tax savings could be as much as $220,500 for Ontario residents (2017 rates not available at time of writing). Since this exemption is available per shareholder, the structure of the company is so important prior to a sale. Consider adding your spouse and other immediate family members as growth shareholders as soon as possible so that others can utilize their personal LCGE and potentially “multiply” the benefit of tax-free proceeds.
As an example, let’s say a dentist purchased shares of another practice years ago and amalgamated the old company into the new Professional Corporation. The existing practice sells for $1.1 million. The Capital Gains is now determined between the sale price and Adjusted Cost Base (ACB) of the Professional Corporation. Let’s also assume the ACB is nominal ($1), which reflects the value at the time his company was established. The taxable gain would be $275,823 (the difference between $1.1 million and the first $824,177). However, if both spouses had been growth shareholders from inception, each spouse would qualify for the LCGE and no tax would have been payable.
There are rules to heed in order to qualify for the LCGE, so it’s wise to review your corporate structure well in advance and ensure the company is “purified” of passive assets such as cash and investments. Two years prior to sale, no more than 50% of company assets can represent passive assets, and no more than 10% at the time of sale.
A simple way to “purify” is to withdraw all cash and investments from the company prior to sale. However, according to Stive Farronato, CPA, CA with TFMD, “this is rarely a good solution since the withdrawals are fully taxable. The immediate tax impact could far exceed the savings.” Due to RCDSO rules, only a dentist is permitted to own controlling shares of a Professional Corporation. This limits the tax planning opportunities available to dentists. Stive works proactively with clients to assess and advise on solutions to minimize the tax impact upon sale.
The advice here may seem daunting at first blush, but remember, you don’t navigate practice sales waters alone. At TMFD Financial, we work closely with dentists preparing for sale to ensure a positive and productive outcome. Please contact us for a complimentary initial assessment. In our next article, we will explore other elements of preparing a practice for sale, such as managing practice management software, staff contracts and things to do upon closing.
CHRIS MOLLOY, B.A.Sc., CFP, is Senior VP, Advisory Services at TMFD Financial. Chris has over 20 years of experience at TMFD Financial as a Financial Advisor working in the Ontario area. Chris specializes in tax, estate and investment planning for dentists and dental specialists. For a complimentary initial consultation with our team, we can be reached at email@example.com or by toll-free at (844) 311-8633.