Selling the cow & keeping the milk!

Transcription

1 Jonathan R. Martin, CPA Selling the cow & keeping the milk! SITUATION: Immediate Buy-Out w/ Post-Sale Employment o Annual income of approx. $1M o Overhead rate < 45% (well below avg) o Purchase price well above avg o Seller wanted guaranteed post-sale employment for 10 yrs. o Seller wanted $1,500 per diem with minimum 100 days per year ($150,000 per year minimum) PROBLEM: o Practice isn t large enough for two full-time docs o Buyer paying higher price for additional profitability that he/she isn t getting 1

2 Expecting someone to buy the cow when they can get the milk for free! SITUATION: Buy-in Following an Associateship o 1 Year associateship leading to buy-in o Seller made an offer that the buyer couldn t refuse: o Drastically reduced purchase price o Above market associate compensation PROBLEM: o Associate makes more as an employee than they stood to make as a partner o Why would a buyer take on the risk of ownership while signing up for a pay-cut? Expecting someone to buy the cow when they can get the milk for free! (Scenario 2) SITUATION: Delayed Buy-Out by Existing Associate o 1 Year associateship leading to sale o Both parties agreed to terms and conditions in advance o Associate never signed an employment agreement or covenant not to compete o Seller was in their mid 70s o The practice was located in an underserved area PROBLEM: o Associate realized they could open up a location next door at a substantially lower cost 2

3 Putting a square peg into a round hole! SITUATION: Intra-Family Buy-in Following an Associateship o Father promised son a place to work and an eventual partnership o Annual income of < $600k o Little to no growth potential PROBLEM: o Practice was too small for multiple doctors o Unrealistic expectations Shotgun weddings! SITUATION: Immediate Buy-in w/ NO Associateship Period o Rapidly growing practice in rural area o Owner had difficulty finding candidates and became desperate o Buyer had substantial experience as an employee and wanted ownership PROBLEM: o The doctors didn t have adequate time to evaluate the potential for conflict o No time for the practice to grow 3

4 Stepping over dollars to pick up pennies! SITUATION: Buy-in Following an Associateship o 2 year associateship leading to buy-in o To avoid the cost of professional services, the seller offered a hand-shake deal o After 2 years, the seller proposed terms to the associate PROBLEM: o Neither seller or buyer knew what to expect o The associate was shocked by the price and terms and backed out of the deal o Seller back at square one Fair Market Value (FMV) Taxes Purchase Price Allocation Sale Structures Other Considerations How to Fix the Aforementioned Scenarios 4

5 I. FAIR MARKET VALUE FAQ: Someone told me that a practice is worth 70% of a year s gross collections. Is that true? 5

6 Percentage of Income as Value Practice A $1 million revenue 3 operatories vintage equipment Practice B $1 million revenue 6 operatories current technology Are They Both Valued at $700,000? Percentage of Income as Value Practice A $1 million revenue 55.0% overhead Practice B $1 million revenue 65.0% overhead Are They Both Valued at $700,000? 6

7 General Valuation Theory Cost Comparable Sales (Market) Earnings Earnings Based Approaches Basic Value Equation $ Financial Reward = $Fair Market Risk % Value 7

8 Risk Rate / Required Rate of Return 1. Average Market Return 2. Premium for Size (Illiquidity) 3. Risk Specific General Specialty 4. Discount Rate = ( ) 5. (Long Term Growth Rate) 6. Capitalization Rate 4.94% Risk-free Rate (Long-Term Treasury Bond Yield) 6.50% Equity Risk Premium (Stocks over Bonds) 11.44% Average Market Return at Valuation Date 6.50% Risk Premium for Size (Small Stocks Risk Premium) 1.46% Subject Practice - Additional Risk Factors 19.40% Discount Rate -2.50% Long-Term Growth Rate 16.90% Capitalization Rate 8

9 Projected Professional Income $1,000,000 Costs of Professional Services (225,000) Operating Expenses 58.0% (580,000) Profit Before FIT $195,000 Estimated Taxes ($68,250) $126, % Fair Market Value $750,000 II. TAXES A. Buy-Out 9

10 Financial Structure Simultaneous Objectives Affordable for Associate/Purchaser Fair/Equitable for Owner/Seller Push / Pull in Tax Code Solving Financial Structure: Two Alternatives 1. Stock Sale 2. Asset Sale 10

11 Stock Sale Best Scenario for Seller Capital Gain (15% to 20%) Worst Scenario for Buyer Can t deduct interest on loan Can t write-off stock Exposure to existing liabilities (e.g. taxes, personal injury, creditor and other claims) Asset Sale Majority of sale proceeds to seller taxed as capital gain (15% to 20%) Buyer Can: Deduct interest paid Depreciate/amortize assets 11

12 o Allocation of Purchase Price Order of Allocation: Receivables Consumable Supplies Fixed Assets Patient Records Covenant Not to Compete Personal Goodwill Corporation Sells Doctor Sells Three (3) Types of Receivables 1.Contracts Receivable 2.Accounts Receivable 3.Prepaid Accounts 12

13 o Allocation of Purchase Price Order of Allocation: Receivables Consumable Supplies Fixed Assets Patient Records Covenant Not to Compete Personal Goodwill Corporation Sells Doctor Sells Tax Effects to Tax Effects to Asset Category Seller Buyer Supplies Ordinary Expensed Immediately Furniture & Equipment Ordinary Section 179; Balance over 5 to 7 Years Accounts Receivable Ordinary Collected Tax-Free up to Amount Allocated Orthodontic Contracts Capital Gain* Amortizable Over 15 Years Patient Files & Records Capital Gain* Amortizable Over 15 Years Leasehold Imrovements Ordinary Amortizable Over 39 Years Corporate Goodwill Capital Gain* Amortizable Over 15 Years Personal Goodwill Capital Gain Amortizable Over 15 Years *Although these items are capital assets, if retained in a C Corporation, they will be taxed at the corporation s ordinary rate, and again when distributed to the shareholder(s). 13

14 Buy-Out: Tax Reduction Strategies Reduce Ordinary Income Taxes on Proceeds Pay Sale Expenses Through Corp Legal Fees Commissions Accrued Expenses Payable Maximize Retirement Contributions When Should I Sell? Weigh Several Issues Marginal Tax Rate in Year of Sale There is No Flat Tax Increasing Tax Rates (2013) 14

15 II. TAXES A. Buy-Out B. Buy-In Solving Financial Structure: Two Alternatives 1. Stock Sale with Earnings Shift (Sweat Equity) 2. Asset Sale 15

16 Stock Sale: Affordable and Tax Efficient Assign Portion of Value to Stock (Tangible) Remainder Paid with Pre-Tax Earnings Shift (Intangible) Typically Paid Over 5-7 Years Management Fee Stock Purchase Tangible Net Worth Intangibles (Pre-Tax Income Shift) Capital Gains Tax Ordinary Income Tax 16

17 ASSET SALE STRUCTURE (After Buy-In) $ Income (Overhead) $ Allocable Profit 50.0% of Fixed Assets/Supplies/ Receivables Seller s Entity Partnership or LLC 50.0% of Fixed Assets / Supplies / Receivables 50.0% of Intangibles 50.0% of Intangibles Purchaser s Entity Seller (Individually) III. OTHER CONSIDERATIONS 17

18 (A) Trigger Point Sufficient Collections No Decrease in Earnings (B) Income Distribution Formulae: Basic Types (1)Equity (Ownership) (2)Days Worked (3)Multi-Tiered 18

19 Days Worked 50.0% Productivity Diff. 50.0% 100.0% S E L L E R 90.0% 10% 80.0% 20.0% 70.0% 30.0% 60.0% 40.0% 50.0% 50.0% (5 Years Illustrated Can Be Varied) P U R C H A S E R 19

20 (C) Associate Compensation o Term o Compensation Salary Per Diem IV. Converting Lose-Lose to Win-Win 20

21 Stepping over dollars to pick up pennies! (MOST COMMON PROBLEM) Moral: o Address financial expectations prior to hiring an associate o Associate s decision to join practice based not only on compensation, but also: o Purchase price o Sale structure o Income distribution o timing o NO SURPISES! FAQ: I am hiring a new associate and plan to sell a partnership interest after several years. When should the practice value be established? 21

22 Timing of Partnership Valuations 1. Fundamental Concerns A. Senior Doctor Wants Growth Included B. New Doctor Wants to Exclude Created Growth 2. Problem: A. There is NO WAY to determine each party s contribution Timing of Partnership Valuations 3. Solution A. Establish value prior to associate s arrival B. Update value at end of associateship C. Split the difference in intangible value D. Tangible value is what it is 4. Benefits of This Protocol A. Gives both parties credit for growth B. New tangible items included C. NO DIVISIVE ISSUES 22

23 Putting a square peg into a round hole! Moral: o Don t let your mouth write checks your tail can t cash! o Have your practice evaluated prior to making promises in order to determine: Buyer and seller cash flow and the financial impact of hiring an associate Your Trigger Point (Is this achievable?) o Evaluate related party transaction tax ramifications Shotgun weddings! Moral: o Always date before you get married! o The practice typically needs this time to grow income, referring sources, etc. 23

24 Selling the cow & keeping the milk! Moral: o Decision to Sell is made on 2 levels: 1. Financial 2. Emotional Eliminate the financial aspect and make sure your personal finances are in order and that you can afford to sell o Make sure you have something to retire to Expecting someone to buy the cow when they can get the milk for free! Moral: o Don t eliminate the incentive to own by overpaying o Have your associate sign an employment agreement with a covenant not to compete 24

25 Jonathan Martin Phone: (877)