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The orthodontic practice ownership transition
SPECIAL ARTICLES
The orthodontic practice ownership transition Carl M. Caplan, DDS, MBA Baltimore, Md.
An owner-orthodontist will want to maximize the value that can be received during a transfer of ownership interests. Crucial to any transition will be an ability to effect a smooth change to ensure the retention of referral sources. This calls for an extended period where a potential purchaser is introduced into the practice by the owner-orthodontist. The period of transfer will relate to the original owner's plans for retirement. In some eases, the strategy may be short term. In many others, however, the transition may be ~ne initiated by an associateship-to-ownership process where the doctors will maintain a long-term relationship. It is the latter situation that will be the subject of this article. Under any circumstances, an ownership transition is a change fraught with many complexities and questions to be addressed. At what point should an associate be considered? What is a fair level of compensation to pay the new doctor? Should the associate be an employee or an independent contractor? When can an ownership position be determined? How should the practice be valued? Will an associate buy into his or her own level of productivity? How do the partners (shareholders) become compensated once the transition takes place? These are but a few of the many questions essential to the practice transition decision-making process. The doctors will have to be absolutely candid with each other regarding their individual expectations and goals. Any unmet concern that serves to frustrate one of the parties will have a pernicious effect on their collective abilities to progress into an eventual co-ownership arrangement. This article will address a number of the germane issues necessary for ensuring an eventual successful outcome.
BEHAVIORAL COMPATIBILITY Any strategic plan should begin with a clear understanding of both economic and behavioral expectations and goals. Often overlooked during the process
Copyright 9 1993 by the American Association of Orthodontists. 0889-5406/93/$1.00 + 0.10 8/1/43111
of contemplating an associate is the willingness of the owner-dentist to delegate and the acceptance of responsibility by the associate. Never having had another person evaluate and treat one's patients can be unsettling. Loss of autonomy dealing with patient flow and staff management may be beyond the tolerance level of an owner-doctor who just cannot adjust to another person's involvement in practice operations. It is possible for doctors to have widely divergent life styles and opinions and still develop a harmonious professional relationship. It is not uncommon, however, to witness conflicts when there are marked attitudinal differences in the doctors' respective approaches to patient care. Owner-doctors often become frustrated with associates who are more laid back than they. Conversely, there are situations where an owner-doctor may feel overwhelmed by an assertive associate possessed with the initiative to take control. Taking guidance from an owner-orthodontist may be difficult for some associates, whereas others clamor for needed support and direction. In all instances, the doctors have to be willing to compromise and to have tolerance for the other's perspective. A mutual exchange of ideas must flow from one doctor to the other. An owner-orthodontist has to be willing to counsel an associate while enduring the learning curve inherent in the educational process of assuming management responsibilities. The associate must be willing to listen. Unfortunately, some doctors do not realize their inability to deal with this situation until the time arrives. Reality hits, and they are unable to surrender any control causing the existing relationship to deteriorate. Of the two doctors, it is generally the owner-orthodontist who has the greater struggle. Before hiring an associate, it is wise to explore thoroughly one's ability to loosen the reins. It immediately becomes obvious to all doctors entering into an owner-doctor/associate arrangement that regardless of the level of agreement they may have in servicing patient needs, their ability to dovetail their personalities will be a major determinant in driving their relationship to a successful conclusion. The hours spent practicing together will in most cases exceed those spent at home with a spouse. The relationship will have to
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Table I. Associateship agreement check list Term of employment Employment status of associate Compensation and benefits Duties and responsibilities _ _ Vacations and other time off _ _ Professional liabilitycoverage _ _ Payment of marketing and other business expenses Hold harmless clause Responsibility for billing and collections Conditions for dismissal Completion of treatment in progress Ownership of records Practice protection covenants _ _ Remedies for covenant vioIations Ownership option criteria _ _ Practice valuation formula Ownership compensationformula Associate representations Manner for giving notices
endure periods of frustration and exasperation. Not unlike a marriage, the doctors will have to work hard at ensuring that each maximizes his or her effort to understand the other's point of view. The physical layout of any dental practice, regardless of its size, is still not large enough to escape the contention emanating from personality conflicts. Deciding to consummate an arrangement based solely on curriculum vitae and technical abilities can be a major miscalculation. The behavioral aspect of any relationship cannot be ignored. Failure to recognize its importance can lead to misunderstandings, frustrations, and an eventual breakup. It is important to note that, although doctors may work well together on a technical level, this in itself will not suffice to ensure that their arrangement is sound. Doctors genuinely have to like each other. Wishing to practice independently is not a personality flaw. Many persons choose dentistry because of a desire to operate their own businesses--their own practices. Honesty with oneself may preclude the frustration that could occur once the relationship has been formed. A doctor's interest would best be served by a selfanalysis of the ability to delegate and share before rather than after the fact. DEFINING EXPECTATIONS AND GOALS
An owner-doctor bringing an associate into a practice has to be able to define the reason for the move. Without clarity of purpose, there exists a greater potential for misunderstandings to occur that could ultimately undermine their arrangement. The associate has to know if the potential exists for an ownership position.
American Journal of Orthodontics and Dentofacial Orthopedics December 1993
The owner-orthodontist requires feedback about the associate's practice objectives. If an associate is being hired only to expand available services and increase cash flow without the eventual opportunity for ownership, this should be made known before an agreement is signed. If there are plans for an eventual buy in, the criteria for obtaining a vested interest should be stated. An associate hired for patient care only, without the expectation of eventual ownership, need not be weaned onto the management aspects of the practice. One ostensibly being groomed for a buy in but trammeled in the performance of management duties, will not be prepared to assume a "realistic" ownership position. It is not in the best interests of the parties to assume immediately that an ownership interest for the associate is a foregone conclusion. There are a number of requirements to be fulfilled before ownership becomes a reality. The parties will need to effect a contract that clearly delineates the terms of the associateship agreement and outlines the criteria for an eventual partnership. The contract should include productive and behavioral expectations for ownership, the manner by which the practice will be valued, the terms of payment, and the compensation arrangement that will transpire once the associate becomes a partner. Both doctors should look at the associate period as a time to assess their ability to function together. For a relationship to progress to the next stage, an ownership position for the associate, all expectations will have to be fulfilled. Even if the associate becomes productive enough to afford to buy into the practice; even if there is a consensus on treatment philosophy; if the doctors cannot communicate freely to each other; if they are unable to trust one other; and if they do not like one another, the relationship will fail. To preclude any sense of misunderstanding, the doctors will want to have a comprehensively written agreement. Table I illustrates an inventory of areas to be considered in developing a thorough agreement. Table II illustrates an excerpt from an associateship agreement outlining the criteria for an ownership position. ASSESSING PATIENT FLOW
An addition of an associate means keeping that person busy without undermining the schedule of the owner-orthodontist. Much thought should be given to the aspect of patient flow. Can the present practice volume support another doctor? Perhaps, there is an opportunity for expansion as untapped potential sources of patients are not being explored. An owner-orthodontist might have reached a point
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Table II. Ownership option It is understood that in order for the Associate to gain an ownership position in the practice, both the Associate and the Employer must feel that there is a clearly demonstrated ability for each to work together with good rapport and understanding. Additionally, in the opinion of the Employer, the Associate shall have satisfied the following criteria: (a) The Associate must be productive enough to afford to buy into no less than a percent (to be determined and placed into the agreement) ownership interest in the practice; (b) The Associate must be accepted by patients, colleagues, and staff; (e) The Associate must be productive and efficient in handling patient matters; (d) The Associate must demonstrate a willingness and effectiveness in promoting the practice and him (her) self; (e) The Associate must accept sharing the administrative burdens of managing the practice; (f) The Associate must be willing to provide his (her) time in a fully committed manner.
in his or her career where personal time has become a priority as financial goals have been attained. In this case, the transfer of existing patient load may suffice to compensate another doctor. For many doctors, however, the priority is sustaining cash flow and practice growth. Where responsiveness to patient needs cannot be met by one doctor, the addition of an associate can provide an answer while generating an enhanced level of profitability. Some practices do to not have the financial resources to support an associate. A doctor who cannot take a decrease in income is not in a position to bring another doctor into the practice. In these instances, regardless of the compelling need is practice with another doctor, it is a wise business decision to maintain practice viability as a solo practitioner. Once all financial goals have been achieved and the owner-doctor is ready to proceed into a financial retirement mode, the existing practice income can then be shared by the owner-doctor and prospective buyer until the ownership transition is completed. COMPENSATION AND PROFITABILITY As the associate increases his or her productivity, the owner-orthodontist will realize an increase in income as a result of the excess earnings provided by the associate profit center. Associates are paid relative to their own levels of productivity. To assess the degree of financial risk and anticipated profit to the ownerorthodontist, a break-even analysis is performed. The process measures the additional fixed and variable costs imputed to the practice for the associate. The fixed costs of the owner-orthodontist are not included in the calculation. They remain the same as the owner-orthodontist maintains his or her level of productivity. Contemplate the following scenario: An associate is hired and offered a compensation package that provides for malpractice and health insurance, an entertainment allowance, dues, and a subsidy for continuing education courses. The associate will be paid 40% of
all collections related to services he or she generates. (The reader will want to concentrate on the concept of the analysis rather than on the actual numbers as associate first year productivity levels and compensation will vary among practices.) The assumption is made that the present and potential patient load in the practice can support an associate to the extent of an additional $100,000 in revenue during the first year of employment. Table III illustrates the calculation of a break-even point for an associate profit center. The associate profit center: Break-even analysis
(Table III) In the following example, a list is made of additional fixed costs incurred by the associate. They will vary with the needs of a practice. In this example, it is assumed that the physical plant is equipped to support another doctor. An additional staff member will be required. Fixed costs are expressed in a dollar amount. Variable costs such as the associate's compensation, dental, laboratory, and office supplies are a function of productivity and are expressed as a percentage because the actual costs will vary relative to different levels of revenue generated by the associate. Variable cost percentages are derived from previous practice Profit and Loss Statements. The break-even analysis illustrates the additional annual profitability of $ I 1,650 generated in the practice by the associate. The owner-dentist is at risk for the break-even amount. Profitability levels will either increase or decrease with changes in revenue levels. This analysis can be used to project a stream of anticipated earnings throughout the associateship period. It must be assumed that the owner-orthodontist will continue to maintain the level of productivity existing at the time of the associate's entry into the practice. Any decrease in services resulting in a diminution in cash flow will markedly affect profitability and invalidate the breakeven projections.
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Table III. Fixed costs incurred Projected annual expenditures Fired cost items
Staffing: (Salary + 21% for benefits, FICA and unemployment) Telephone and utilities Professional and accounting Letterheads, signage Associate benefits: Malpractice insurance Continuing education allowance Entertainment allowance for referral sources Health insurance Dues Total fixed costs:
$22,650 3,000 3,000 800
1,800 800 1,800 1,500 1,000 $36,350
Variable cost items
Laboratory, dental and office supplies Associate compensation Associate FICA + unemployment Total variable costs: Contribution margin: (100% minus total variable percentage) Break-even in dollars: (Total fixed costs divided by the contribution margin: $36,350/.48) Projected revenue: Projected associate's salary: Projected profit to owner-orthodontist (Projected revenue of $100,000 minus the break-even amount of $75,729 times the contribution margin of 0.48)
It is important to appreciate that the new doctor is not being limited to a salary of $40,000. The income will be in proportion to the productive effort of the new doctor and the patient load he or she is able to develop. To some associates, the lack of a guaranteed salary may be undesirable. To others, being paid on a percentage basis is an opportunity for increased income. Some practices pay an associate a salary. Others provide a combination of a base salary plus an incentive bonus. For many, the preference is a straight percentage. In all cases, whatever the choice, the package for the associate must be a fair one. MEASURING PRODUCTIVITY
One of the unique qualities of an orthodontic practice that sets it apart from other types of dental practices is the complexity in measuring the individual productivity of each individual doctor. Orthodontists often share in the treatment of their patients as well as delegating numerous duties to auxiliary staff. As previously stated, associates are paid in concert with the productivity of their own profit centers. A practical method of assessing the productive contribution of the
8% 40% 4% 52% 48% $75,729 $10o,000 $40,000 $ ! 1,650
associate is to calculate the increase in practice revenue once the new doctor is hired while adjusting for any future increases in fees. Once partnership status is achieved, both doctors will be compensated based on practice income. The associate will now share in the excess earnings generated by his or her profit center. Without this occurring, there is no financial incentive for ownership. An equitable compensation formula will recognize both the technical and administrative input of each doctor. THE BUY IN
Implementing the actual buy-in transition necessitates a keen understanding of practice economics. Doctors opting for graduated buy ins may find themselves in financial jeopardy without realizing what they have done. I have observed ownership transitions predicated on prospective earnings rather than actual cash flow. In this type of scenario, an assumption is made that practice productivity and profits will grow. A value is placed on the practice is based on the projected earnings. The new doctor begins at a given pe.rcentage of income and gradually reaches parity with the "owner-doctor.
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At the end of a prescribed period of time, the associate becomes a partner and receives increasing percentages of income until ownership parity is established. The differential in the doctors' salaries provides for a portion of the buy-in amount. This is well and good provided practice productivity escalates at the pro: jected rate; however, there is no guaranty thai this will occur. In a situation where productivity and profit fail to keep pace with the associate's escalating income,
the owner-doctor may, in effect, be subsidizing the buy in without realizing what is occurring. In actuality, he or she may be giving away the practice. Establishing criteria for an eventual buy in that requires an already established level of achieved practice productiyity is safer and provides a clear picture of distributable earnings and funds available for servicing the debt of the transition process, as well as giving a forecast of each doctor's income. In short, the practice valuation is established, the amount of available earni'ngs determined, the debt service calculated, the compensation formula agreed upon. There are no assumptions of productivity. There is only what exists and what is economically feasible. THE VALUATION A major area of consideration involving practice valuation is whether an associate should buy into the full value of a practice at the time of ownership entry. I have found that most arrangements are economically sounder and behaviorally satisfying when the buy-in price is discounted for the amount of practice growth directly generated by the associate. This is a moot point and most probably one that will continue to have a profound, if not confounding, affect on the success or failure of transition arrangements. Some owner-orthodontists have no compunction about surrendering a portion of the buy in. Others believe that the associate's success is an extension of the goodwill that the practice has built up over the years. In all cases, there will be an amicable solution only if the owner-orthodontist and the associate agree, from the onset of their relationship, on the criteria that will be used to determine the valuation and ultimate buy-in amount. There are a myriad of techniques used to assess the value of a practice. I prefer a measurement of income rather than revenue as a more reliable bench mark for assessing practice value as practices with similar revenues can be worlds apart in profitability. It is the earnings and an appraisal of the tangible assets of a practice that provide a sound basis for determining the amount of a buy in.
FINANCIAL INDEPENDENCE As with most things in life, there are exceptions to the rules. An orthodontist, having reached a level of financial independence and aspiring to more personal time and leisure, may have less rigorous requirements for maintaining personal income and be willing to accept the trade-off of cash flow for personal needs. The parties will then have greater flexibility to form their arrangement. It is not unusual to witness transitions where, in lieu of a buy in and future buy out of ownership interests, the associate and owner-doctor assume role reversal positions after having worked together a short period of time. The owner is now the employee, and the associate the owner. It becomes evident when exploring the various transition spinoffs, that there are many different forms to fulfill the needs of the respective doctors, both owner-orthodontist and associate. EMPLOYMENT STATUS Not to be neglected in the transition process is the influence of the federal and state governments. Audits of dental practices, relating to the independent contractor-employee issue, have been occurring with increasing frequency. In the past, many owner-doctors have freely classified their associates as independent contractors. The owner-orthodontist was unfettered from the responsibility of paying the associate's matching social security taxes and the other payroll obligations of withholding federal and state taxes. Times have dramatically changed. One needs only to explore 1RS Publication 937, which, ironically enough, in its description of the criteria for determining the definition of employee or independent contractor status, uses the occupational examples of two health care professionals--a dentist and a hygienist. If there were ever a beacon of caution to be observed, Publication 937 sends the message. Why the big brouhaha over this issue? It is quite simple. The federal and state governments want to be paid as soon as possible so as to maximize the eamings on the cash flow. Although independent contractors make quarterly payments, employee-withheld payments are paid to the government on a more frequent basis. OWNERSHIP FUNDING Throughout in the taxation This has had a for exchanging
the years, there has been a major shift of ordinary and capital gains income. marked affect on the transfer of funds business interests. Consideration must
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be given to the value placed on shares of stock in a corporation or the amount of a note for a partnership. Should a portion of the buy in be effected through differential income? What will Uncle Sam's response be to the respective values placed on a buy in? These and many other areas will have major tax consequences to both buyer and seller affecting the affordability of a buy in to the associate and the ultimate value received by the owner-orthodontist. Today's laws may not apply a few years down the line, though debt service may still be in effect.
SUMMARY
Any orthodontist contemplating a transfer of ownership interests would be well served ensuring that the decision-making process is handled objectively and analytically and that appropriate advice is acquired before entering into an arrangement. Boiler plate agreements and rules of thumb do not work any more effectively than developing a single diagnosis and treatment plan for all patients.
BOUND VOLUMES AVAILABLE TO SUBSCRIBERS
Bound volumes of the AMERICAN JOURNAL OF ORTHODONTICS AND DENTOFACIAL ORTHOPEDICS are available to subscribers (only) for the 1993 issues from the Publisher, at a cost of $58.50 ($73.60 Canada and $69.50 international) for Vol. 103 (January-June) and Vol. 104 (July-December). Shipping charges are included. Each bound volume contains a subject and author index and all advertising is removed. Copies are shipped within 60 days after publication of the last issue in the volume. The binding is durable buckram with the journal name, volume number, and year stamped in gold on the spine. Payment must accompany all orders. Contact Mosby, Subscription Services, 11830 Westline Industrial Dr., St. Louis, MO 63146-3318, USA; telephone (314)453-4351 or (800)325-4177. Subscriptions must be in force to qualify. Bound volumes are not available in place of a regular Journal subscription.
The orthodontic practice ownership transition Carl M. Caplan, DDS, MBA Baltimore, Md.
An owner-orthodontist will want to maximize the value that can be received during a transfer of ownership interests. Crucial to any transition will be an ability to effect a smooth change to ensure the retention of referral sources. This calls for an extended period where a potential purchaser is introduced into the practice by the owner-orthodontist. The period of transfer will relate to the original owner's plans for retirement. In some eases, the strategy may be short term. In many others, however, the transition may be ~ne initiated by an associateship-to-ownership process where the doctors will maintain a long-term relationship. It is the latter situation that will be the subject of this article. Under any circumstances, an ownership transition is a change fraught with many complexities and questions to be addressed. At what point should an associate be considered? What is a fair level of compensation to pay the new doctor? Should the associate be an employee or an independent contractor? When can an ownership position be determined? How should the practice be valued? Will an associate buy into his or her own level of productivity? How do the partners (shareholders) become compensated once the transition takes place? These are but a few of the many questions essential to the practice transition decision-making process. The doctors will have to be absolutely candid with each other regarding their individual expectations and goals. Any unmet concern that serves to frustrate one of the parties will have a pernicious effect on their collective abilities to progress into an eventual co-ownership arrangement. This article will address a number of the germane issues necessary for ensuring an eventual successful outcome.
BEHAVIORAL COMPATIBILITY Any strategic plan should begin with a clear understanding of both economic and behavioral expectations and goals. Often overlooked during the process
Copyright 9 1993 by the American Association of Orthodontists. 0889-5406/93/$1.00 + 0.10 8/1/43111
of contemplating an associate is the willingness of the owner-dentist to delegate and the acceptance of responsibility by the associate. Never having had another person evaluate and treat one's patients can be unsettling. Loss of autonomy dealing with patient flow and staff management may be beyond the tolerance level of an owner-doctor who just cannot adjust to another person's involvement in practice operations. It is possible for doctors to have widely divergent life styles and opinions and still develop a harmonious professional relationship. It is not uncommon, however, to witness conflicts when there are marked attitudinal differences in the doctors' respective approaches to patient care. Owner-doctors often become frustrated with associates who are more laid back than they. Conversely, there are situations where an owner-doctor may feel overwhelmed by an assertive associate possessed with the initiative to take control. Taking guidance from an owner-orthodontist may be difficult for some associates, whereas others clamor for needed support and direction. In all instances, the doctors have to be willing to compromise and to have tolerance for the other's perspective. A mutual exchange of ideas must flow from one doctor to the other. An owner-orthodontist has to be willing to counsel an associate while enduring the learning curve inherent in the educational process of assuming management responsibilities. The associate must be willing to listen. Unfortunately, some doctors do not realize their inability to deal with this situation until the time arrives. Reality hits, and they are unable to surrender any control causing the existing relationship to deteriorate. Of the two doctors, it is generally the owner-orthodontist who has the greater struggle. Before hiring an associate, it is wise to explore thoroughly one's ability to loosen the reins. It immediately becomes obvious to all doctors entering into an owner-doctor/associate arrangement that regardless of the level of agreement they may have in servicing patient needs, their ability to dovetail their personalities will be a major determinant in driving their relationship to a successful conclusion. The hours spent practicing together will in most cases exceed those spent at home with a spouse. The relationship will have to
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Table I. Associateship agreement check list Term of employment Employment status of associate Compensation and benefits Duties and responsibilities _ _ Vacations and other time off _ _ Professional liabilitycoverage _ _ Payment of marketing and other business expenses Hold harmless clause Responsibility for billing and collections Conditions for dismissal Completion of treatment in progress Ownership of records Practice protection covenants _ _ Remedies for covenant vioIations Ownership option criteria _ _ Practice valuation formula Ownership compensationformula Associate representations Manner for giving notices
endure periods of frustration and exasperation. Not unlike a marriage, the doctors will have to work hard at ensuring that each maximizes his or her effort to understand the other's point of view. The physical layout of any dental practice, regardless of its size, is still not large enough to escape the contention emanating from personality conflicts. Deciding to consummate an arrangement based solely on curriculum vitae and technical abilities can be a major miscalculation. The behavioral aspect of any relationship cannot be ignored. Failure to recognize its importance can lead to misunderstandings, frustrations, and an eventual breakup. It is important to note that, although doctors may work well together on a technical level, this in itself will not suffice to ensure that their arrangement is sound. Doctors genuinely have to like each other. Wishing to practice independently is not a personality flaw. Many persons choose dentistry because of a desire to operate their own businesses--their own practices. Honesty with oneself may preclude the frustration that could occur once the relationship has been formed. A doctor's interest would best be served by a selfanalysis of the ability to delegate and share before rather than after the fact. DEFINING EXPECTATIONS AND GOALS
An owner-doctor bringing an associate into a practice has to be able to define the reason for the move. Without clarity of purpose, there exists a greater potential for misunderstandings to occur that could ultimately undermine their arrangement. The associate has to know if the potential exists for an ownership position.
American Journal of Orthodontics and Dentofacial Orthopedics December 1993
The owner-orthodontist requires feedback about the associate's practice objectives. If an associate is being hired only to expand available services and increase cash flow without the eventual opportunity for ownership, this should be made known before an agreement is signed. If there are plans for an eventual buy in, the criteria for obtaining a vested interest should be stated. An associate hired for patient care only, without the expectation of eventual ownership, need not be weaned onto the management aspects of the practice. One ostensibly being groomed for a buy in but trammeled in the performance of management duties, will not be prepared to assume a "realistic" ownership position. It is not in the best interests of the parties to assume immediately that an ownership interest for the associate is a foregone conclusion. There are a number of requirements to be fulfilled before ownership becomes a reality. The parties will need to effect a contract that clearly delineates the terms of the associateship agreement and outlines the criteria for an eventual partnership. The contract should include productive and behavioral expectations for ownership, the manner by which the practice will be valued, the terms of payment, and the compensation arrangement that will transpire once the associate becomes a partner. Both doctors should look at the associate period as a time to assess their ability to function together. For a relationship to progress to the next stage, an ownership position for the associate, all expectations will have to be fulfilled. Even if the associate becomes productive enough to afford to buy into the practice; even if there is a consensus on treatment philosophy; if the doctors cannot communicate freely to each other; if they are unable to trust one other; and if they do not like one another, the relationship will fail. To preclude any sense of misunderstanding, the doctors will want to have a comprehensively written agreement. Table I illustrates an inventory of areas to be considered in developing a thorough agreement. Table II illustrates an excerpt from an associateship agreement outlining the criteria for an ownership position. ASSESSING PATIENT FLOW
An addition of an associate means keeping that person busy without undermining the schedule of the owner-orthodontist. Much thought should be given to the aspect of patient flow. Can the present practice volume support another doctor? Perhaps, there is an opportunity for expansion as untapped potential sources of patients are not being explored. An owner-orthodontist might have reached a point
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Table II. Ownership option It is understood that in order for the Associate to gain an ownership position in the practice, both the Associate and the Employer must feel that there is a clearly demonstrated ability for each to work together with good rapport and understanding. Additionally, in the opinion of the Employer, the Associate shall have satisfied the following criteria: (a) The Associate must be productive enough to afford to buy into no less than a percent (to be determined and placed into the agreement) ownership interest in the practice; (b) The Associate must be accepted by patients, colleagues, and staff; (e) The Associate must be productive and efficient in handling patient matters; (d) The Associate must demonstrate a willingness and effectiveness in promoting the practice and him (her) self; (e) The Associate must accept sharing the administrative burdens of managing the practice; (f) The Associate must be willing to provide his (her) time in a fully committed manner.
in his or her career where personal time has become a priority as financial goals have been attained. In this case, the transfer of existing patient load may suffice to compensate another doctor. For many doctors, however, the priority is sustaining cash flow and practice growth. Where responsiveness to patient needs cannot be met by one doctor, the addition of an associate can provide an answer while generating an enhanced level of profitability. Some practices do to not have the financial resources to support an associate. A doctor who cannot take a decrease in income is not in a position to bring another doctor into the practice. In these instances, regardless of the compelling need is practice with another doctor, it is a wise business decision to maintain practice viability as a solo practitioner. Once all financial goals have been achieved and the owner-doctor is ready to proceed into a financial retirement mode, the existing practice income can then be shared by the owner-doctor and prospective buyer until the ownership transition is completed. COMPENSATION AND PROFITABILITY As the associate increases his or her productivity, the owner-orthodontist will realize an increase in income as a result of the excess earnings provided by the associate profit center. Associates are paid relative to their own levels of productivity. To assess the degree of financial risk and anticipated profit to the ownerorthodontist, a break-even analysis is performed. The process measures the additional fixed and variable costs imputed to the practice for the associate. The fixed costs of the owner-orthodontist are not included in the calculation. They remain the same as the owner-orthodontist maintains his or her level of productivity. Contemplate the following scenario: An associate is hired and offered a compensation package that provides for malpractice and health insurance, an entertainment allowance, dues, and a subsidy for continuing education courses. The associate will be paid 40% of
all collections related to services he or she generates. (The reader will want to concentrate on the concept of the analysis rather than on the actual numbers as associate first year productivity levels and compensation will vary among practices.) The assumption is made that the present and potential patient load in the practice can support an associate to the extent of an additional $100,000 in revenue during the first year of employment. Table III illustrates the calculation of a break-even point for an associate profit center. The associate profit center: Break-even analysis
(Table III) In the following example, a list is made of additional fixed costs incurred by the associate. They will vary with the needs of a practice. In this example, it is assumed that the physical plant is equipped to support another doctor. An additional staff member will be required. Fixed costs are expressed in a dollar amount. Variable costs such as the associate's compensation, dental, laboratory, and office supplies are a function of productivity and are expressed as a percentage because the actual costs will vary relative to different levels of revenue generated by the associate. Variable cost percentages are derived from previous practice Profit and Loss Statements. The break-even analysis illustrates the additional annual profitability of $ I 1,650 generated in the practice by the associate. The owner-dentist is at risk for the break-even amount. Profitability levels will either increase or decrease with changes in revenue levels. This analysis can be used to project a stream of anticipated earnings throughout the associateship period. It must be assumed that the owner-orthodontist will continue to maintain the level of productivity existing at the time of the associate's entry into the practice. Any decrease in services resulting in a diminution in cash flow will markedly affect profitability and invalidate the breakeven projections.
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Table III. Fixed costs incurred Projected annual expenditures Fired cost items
Staffing: (Salary + 21% for benefits, FICA and unemployment) Telephone and utilities Professional and accounting Letterheads, signage Associate benefits: Malpractice insurance Continuing education allowance Entertainment allowance for referral sources Health insurance Dues Total fixed costs:
$22,650 3,000 3,000 800
1,800 800 1,800 1,500 1,000 $36,350
Variable cost items
Laboratory, dental and office supplies Associate compensation Associate FICA + unemployment Total variable costs: Contribution margin: (100% minus total variable percentage) Break-even in dollars: (Total fixed costs divided by the contribution margin: $36,350/.48) Projected revenue: Projected associate's salary: Projected profit to owner-orthodontist (Projected revenue of $100,000 minus the break-even amount of $75,729 times the contribution margin of 0.48)
It is important to appreciate that the new doctor is not being limited to a salary of $40,000. The income will be in proportion to the productive effort of the new doctor and the patient load he or she is able to develop. To some associates, the lack of a guaranteed salary may be undesirable. To others, being paid on a percentage basis is an opportunity for increased income. Some practices pay an associate a salary. Others provide a combination of a base salary plus an incentive bonus. For many, the preference is a straight percentage. In all cases, whatever the choice, the package for the associate must be a fair one. MEASURING PRODUCTIVITY
One of the unique qualities of an orthodontic practice that sets it apart from other types of dental practices is the complexity in measuring the individual productivity of each individual doctor. Orthodontists often share in the treatment of their patients as well as delegating numerous duties to auxiliary staff. As previously stated, associates are paid in concert with the productivity of their own profit centers. A practical method of assessing the productive contribution of the
8% 40% 4% 52% 48% $75,729 $10o,000 $40,000 $ ! 1,650
associate is to calculate the increase in practice revenue once the new doctor is hired while adjusting for any future increases in fees. Once partnership status is achieved, both doctors will be compensated based on practice income. The associate will now share in the excess earnings generated by his or her profit center. Without this occurring, there is no financial incentive for ownership. An equitable compensation formula will recognize both the technical and administrative input of each doctor. THE BUY IN
Implementing the actual buy-in transition necessitates a keen understanding of practice economics. Doctors opting for graduated buy ins may find themselves in financial jeopardy without realizing what they have done. I have observed ownership transitions predicated on prospective earnings rather than actual cash flow. In this type of scenario, an assumption is made that practice productivity and profits will grow. A value is placed on the practice is based on the projected earnings. The new doctor begins at a given pe.rcentage of income and gradually reaches parity with the "owner-doctor.
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At the end of a prescribed period of time, the associate becomes a partner and receives increasing percentages of income until ownership parity is established. The differential in the doctors' salaries provides for a portion of the buy-in amount. This is well and good provided practice productivity escalates at the pro: jected rate; however, there is no guaranty thai this will occur. In a situation where productivity and profit fail to keep pace with the associate's escalating income,
the owner-doctor may, in effect, be subsidizing the buy in without realizing what is occurring. In actuality, he or she may be giving away the practice. Establishing criteria for an eventual buy in that requires an already established level of achieved practice productiyity is safer and provides a clear picture of distributable earnings and funds available for servicing the debt of the transition process, as well as giving a forecast of each doctor's income. In short, the practice valuation is established, the amount of available earni'ngs determined, the debt service calculated, the compensation formula agreed upon. There are no assumptions of productivity. There is only what exists and what is economically feasible. THE VALUATION A major area of consideration involving practice valuation is whether an associate should buy into the full value of a practice at the time of ownership entry. I have found that most arrangements are economically sounder and behaviorally satisfying when the buy-in price is discounted for the amount of practice growth directly generated by the associate. This is a moot point and most probably one that will continue to have a profound, if not confounding, affect on the success or failure of transition arrangements. Some owner-orthodontists have no compunction about surrendering a portion of the buy in. Others believe that the associate's success is an extension of the goodwill that the practice has built up over the years. In all cases, there will be an amicable solution only if the owner-orthodontist and the associate agree, from the onset of their relationship, on the criteria that will be used to determine the valuation and ultimate buy-in amount. There are a myriad of techniques used to assess the value of a practice. I prefer a measurement of income rather than revenue as a more reliable bench mark for assessing practice value as practices with similar revenues can be worlds apart in profitability. It is the earnings and an appraisal of the tangible assets of a practice that provide a sound basis for determining the amount of a buy in.
FINANCIAL INDEPENDENCE As with most things in life, there are exceptions to the rules. An orthodontist, having reached a level of financial independence and aspiring to more personal time and leisure, may have less rigorous requirements for maintaining personal income and be willing to accept the trade-off of cash flow for personal needs. The parties will then have greater flexibility to form their arrangement. It is not unusual to witness transitions where, in lieu of a buy in and future buy out of ownership interests, the associate and owner-doctor assume role reversal positions after having worked together a short period of time. The owner is now the employee, and the associate the owner. It becomes evident when exploring the various transition spinoffs, that there are many different forms to fulfill the needs of the respective doctors, both owner-orthodontist and associate. EMPLOYMENT STATUS Not to be neglected in the transition process is the influence of the federal and state governments. Audits of dental practices, relating to the independent contractor-employee issue, have been occurring with increasing frequency. In the past, many owner-doctors have freely classified their associates as independent contractors. The owner-orthodontist was unfettered from the responsibility of paying the associate's matching social security taxes and the other payroll obligations of withholding federal and state taxes. Times have dramatically changed. One needs only to explore 1RS Publication 937, which, ironically enough, in its description of the criteria for determining the definition of employee or independent contractor status, uses the occupational examples of two health care professionals--a dentist and a hygienist. If there were ever a beacon of caution to be observed, Publication 937 sends the message. Why the big brouhaha over this issue? It is quite simple. The federal and state governments want to be paid as soon as possible so as to maximize the eamings on the cash flow. Although independent contractors make quarterly payments, employee-withheld payments are paid to the government on a more frequent basis. OWNERSHIP FUNDING Throughout in the taxation This has had a for exchanging
the years, there has been a major shift of ordinary and capital gains income. marked affect on the transfer of funds business interests. Consideration must
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be given to the value placed on shares of stock in a corporation or the amount of a note for a partnership. Should a portion of the buy in be effected through differential income? What will Uncle Sam's response be to the respective values placed on a buy in? These and many other areas will have major tax consequences to both buyer and seller affecting the affordability of a buy in to the associate and the ultimate value received by the owner-orthodontist. Today's laws may not apply a few years down the line, though debt service may still be in effect.
SUMMARY
Any orthodontist contemplating a transfer of ownership interests would be well served ensuring that the decision-making process is handled objectively and analytically and that appropriate advice is acquired before entering into an arrangement. Boiler plate agreements and rules of thumb do not work any more effectively than developing a single diagnosis and treatment plan for all patients.
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