Often the practice buyer is already working in the practice. Alternatively the practice owner may be looking to hire an associate with the objective of selling the practice to the associate down the road. The sale to the associate does not have to be all at once, it could be in installments over time. Bringing an associate in as an owner often improves the gross revenue and net income for a practice. If the associate is purchasing in installments there needs to be a set date for future purchases as an established price that does not penalize the associate for their contributions to the profitability of the practice. The entity typically used in an associate buy-in is a Limited Liability Company (“LLC”). Normally, but not necessarily, a Practice Acquisitions specialist is hired by the practice to develop the pricing and the structure for an associate buy-in.
The steps in developing an associate buy-in are as follows:
There are a number of ways to value a professional practice. We utilize the cash flow method because it is the most likely method that will produce a value that is fair to both the buyer and seller. The purchasing associate shouldn’t be required to pay a purchase price that can’t be supported by the practice cash flow. In other words, the associate shouldn’t have to take a pay cut to buy into the practice. Under this method the normalized earnings need to be enough to pay the debt service on a 10 year loan in the amount of the purchase price, on an after-tax basis. To determine normalized earnings we obtain three prior years tax returns for the practice and have a conversation with the owners about expenses that a buyer may not incur (commonly referred to as add-backs ) to arrive at normalized earnings. Fair compensation to the associate must be deducted as part of the normalized earning calculation. We have developed a proprietary tool to demonstrate that the purchase price will cash flow over ten years on an after-tax basis assuming that the practice achieves normalized earnings each year. Note that for CPA practices a portion of the purchase price will be conditioned on client retention.
We will work with the practice owner to determine the percentage interest to be offered to the associate. We recommend that the practice owner never own less than 51% unless it is a sale of 100%.
While there are multiple owners rules need to be established regarding which operating and management decisions can be made unilaterally by the majority owner and which decisions need the agreement of all owners. Additionally cross purchase provisions need to be established in the event of death or disability of one of the owners. These terms and conditions are memorialized in a document referred to as an Operating Agreement. We will recommend specific terms and conditions subject approval by the parties. We also recommend that the parties prepare a business plan for the practice. The business plan will help you formalize plans to operate and grow the practice including the services that will be offered and how it will be marketed. Contact us for a free template.
If the current practice owner also owns the real estate, a tenant representative should be consulted to get an idea of what market based terms would be for the lease. The parties will also need to agree on whether and on what terms the associate could become an owner of the real estate. The lease payments will affect the value of the practice.
We will draft a MOU that contains the provisions agreed to by the parties. Usually we will confer with the current and prospective co-owner of the practice and may consult with the practice’s CPA and attorney for the purpose of preparing the MOU. Once complete we recommend that each of the parties consult with an attorney. Any changes recommended by the attorneys and agreed to by the parties will be incorporated into a final draft which will be signed by the parties.
Banks will finance full or partial associate buy-ins. If for some reason the associate is unable to obtain financing then the practice owner need to decide whether to accept a promissory note from the associate and under what terms.
Normally the attorney for the practice (and current owner) will prepare the transaction documents to be reviewed by the associate’s attorney.
Note that bankers, CPAs, lawyers and tenant representatives are listed in the Professions section of our web site.