Oct 6, 2016
A Letter of Intent Should Include This When Buying a Dental Practice
Written By: Brian Hanks
When buying a dental practice, one of the most important documents in the process is the letter of intent (or LOI, for short). The letter of intent is the legally non-binding document that contains all the elements of the practice transition that you have negotiated with the seller. The letter of intent saves you money by allowing you to negotiate with the seller before you begin paying an attorney for drafting documents or other related services.
Getting the Letter of Intent Right is Crucial – But How Do You Know?
Getting the letter of intent right is crucial, and typically leads to much smoother transactions where everyone is happy – the buyer, seller, staff and patients.
If the letter of intent is so important when buying a dental practice, how do you know what it should contain? How can you be sure that you’ve negotiated the key elements and nothing is missing that might come back to bite you later on down the road?
Missing Elements in a Letter of Intent Can Be Disastrous!
I recently got involved helping a buyer purchase a dental practice after the initial negotiations and letter of intent had been signed. I asked the buyer to send me a copy of the letter of intent. The price of the dental practice was on the paper, but not much else. Over the next few weeks, the buyer asked for deal elements that would ensure a smooth patient transition and help his tax situation. The seller was offended that the buyer would “change the deal.” The seller assumed that because an LOI was signed, the buyer should just take whatever else was offered. The transition ended on a positive note, but not with some serious risk of the deal falling apart.
You need to get the letter of intent right the first time! Making sure the elements below are included is a key step in the process. A letter of intent for a dental transition should include at a minimum the following:
Included and Excluded Assets
One dentist I talked with recently told me about the first day she showed up at the practice she purchased, only to find every single piece of furniture and fixture gone. Every couch. Every painting. The chairs the front desk had used for years – gone. Even the little potted plants around the office had walked away. She just assumed those were part of the transition. She spent the first few days making Costco and Ikea runs instead of being focused on the staff, patients and processes in the office.
A good letter of intent will call out specifically which assets are included in the sale and which are not. Typically, included assets will be equipment, supplies, instruments, furniture, fixtures, computers, digital assets (website, phone number), etc.
Assets typically not included are cash, personal effects, employee benefits, liabilities of the seller and any cars the practice might own.
Less important is the actual list. More important is that you and seller are on the same page and that you won’t have any surprises.
Accounts Receivable and an A/R Purchase Schedule
You need to know if, and under what terms, you are purchasing accounts receivable. Not every seller wants to sell the accounts receivable, but many do. I recommend purchasing them if you can – if done correctly, it’s like buying cash at a discount.
Most importantly, you need to spell out under what terms you’ll purchase the accounts receivable. Typically, this looks like a table with the various aging categories and the value you will pay for them.
If you don’t purchase the accounts receivable, I recommend making it clear that you are willing to collect and remit payment on the selling doctor’s accounts. But you’ll do it for a fee of around 5% of the value of those accounts collected.
Purchase Price and Asset Allocation
Of course, you’ll include the price of the practice in the letter of intent with the breakdown of the allocation of that total price. When purchasing a business, the IRS gives different tax treatment to the various assets being purchased – dental supplies, equipment, patient records, goodwill, etc.
The asset allocation is one of those negotiating areas where a win/win arrangement is tough. Typically, if the seller wins, the buyer loses and vice versa.
As the buyer, you care about the asset allocation because how the purchase price is broken out will affect how quickly you can depreciate and write off the value of the practice you’re buying. Thus, potentially lowering your tax bill.
As of 2016, the assets can be depreciated as follows in the table below. Lower numbers generally are better for you as the buyer (but not always, so talk with your accountant to know for sure).
Due Diligence Period
Make sure you and the seller are clear on how long you and your dental accountant (you have one, right?) will need to review the practice and financial information. I typically recommend at least 30 days.
You’ll also want to be specific about what access you and your dental accountant will need in order to complete the due diligence.
Intentions Around Real Estate
Are you going to buy the real estate? Are you going to rent from the seller? If renting, would you like the right of first refusal on the sale of the building? Don’t leave those questions to chance and make sure they’re spelled out in the letter of intent.
Details Around the Seller’s Transition
Each situation will be unique, but you want to make sure the seller helps set you up for success as the buyer. You will want the seller to author a letter (that you help edit) informing patients from the last three or so years about the change in ownership and how amazing you as the buyer are. In fact, many state dental boards require this letter be written and sent. Spell out who is going to pay for the letter.
Also, you will want to talk with the seller about their availability post-transition to help understand the operations of the practice and possibly help with consultations in-person, or via telephone, email, etc.
One seller I know gave his employees all big raises between the time he agreed to sell the practice and the time the buyer actually took over. Staff compensation went from 28.5% of collections to 31.8%. I don’t know for sure the motivation for the change, but you can be sure that the buyer wasn’t able to show up on the first day and say: “Just kidding everyone! Let’s go back to your pay level from six months ago!”
Make clear to the seller that all accrued benefits (bonuses, paid time off, etc.) are the responsibility of the seller before you take over the practice. I strongly, strongly recommend making as few changes to the staff, pay, benefits, etc. as possible in the first few months of business (with the one exception being the 401k or another pension plan). Make it clear to the seller that you intend to keep all the staff, but that all accrued benefits and promises are their responsibility.
Redos and Rework
Decide with the seller up front how you will handle patient cases that were originally handled by the seller but come back to your office to be fixed after you’re the owner. Who will do the work? Who will pay for it?
If the seller hasn’t left town, I like to see the seller have the option to come back in and do the work (of course, paying for staff time and materials required).
Make sure you negotiated upfront in the letter of intent the restrictive covenant that the seller will be subject to. Include both the time and distance (e.g. 5 years and 15 miles) in the LOI. You will also want to include language around recruiting former employees and marketing within that same distance.
A good letter of intent is one of the keys to successfully buying a dental practice. You will minimize misunderstanding, maximize your use of time and energy, and even save money when you turn over a document to the lawyers that is complete and doesn’t require a lot of back and forth.
Need help evaluating your LOI? Reach out to me at firstname.lastname@example.org for a free consultation around your situation because this is an important decision!
Like what you read? Read more about successfully buying a dental practice:
How to Analyze a Dental Practice for Sale – The Quantitative Factors
How to Analyze a Dental Practice for Sale – The Qualitative Factors
Why You Should Buy a Dental Practice BEFORE Your Student Loans are Paid Off