A new surge of buyers and not enough sellers have contributed to a seller’s market for dental practices over the last few years.
As a buyer, this guide will help you understand how to prepare, incorporate your business, secure financing, and navigate the buying process to make a strategic purchase.
PLANNING TO PURCHASE
To build important rapport with the seller, you must be able to honestly answer, “Why do I want to buy this practice?” You can also build early rapport by clearly outlining your reasons for buying and your dental practice philosophy in the introduction of your offer’s cover letter.
WHAT TO LOOK FOR
Financials
Cash earnings (also called adjusted net income) is one of the most important factors in the decision to buy. Generally, you want to see a practice operating at 40% profitability.
Look for other trends in the seller’s financials:
● steadily increasing production;
● similar production and collections;
● a healthy hygiene program (~40% of collections);
● low rent (~5% of production) for an extended time;
● controlled staff wages and benefits (~22–25% of collections);
● consistent expenses; and
● controlled supplies expenses (~6% of collections).
Location
Look for locations that are easy to access and have heavy foot traffic. For example, the ground floor of a mall or on a busy intersection of a city. Nearby residential areas could also supply new clients.
Physical space
A good size for a dental practice is roughly between 800–1,000 square feet for a 3-op; 1,200–1,500 square feet for a 4-op; and 2,000–2,200 square feet for a 5-op.
Look for spaces with room for the practice to grow. Note if all the physical space is being used, if another op can be added, and if the practice is currently open all hours or days for patients.
Patients
New and existing patients are essential for the success of a practice. You want to see a diverse patient demographic in terms of age and ethnicity. You should also know the seller’s average revenue per patient.
Additionally, examine the following patient metrics:
● the number active patients (returning patients, especially for hygiene);
● the flow of new patients (ideally 20–30 per month);
● the amount of patient departures;
● the percentage of non-assignment patients (higher is better); and
● the percentage of assignment or social welfare patients (lower is better).
Adding treatments
Consider finding a practice that could grow by adding treatments. For example, you can increase the cash earnings of a primarily preventative (40–50% hygiene) and restorative practice by adding complex surgeries, extractions, and specialties.
Staff contracts
Employee agreements
It is best if the seller’s employees are under contracts to ensure that your liability is limited and that termination terms are clear. You also want to ensure that staff contracts have strong non-compete clauses.
Ideally, staff should be under contract 2–5 years before a sale to limit your liability when you buy the practice. If the seller’s current staff are not under contract, they may have to offer generous termination benefits in exchange for signing the agreement.
Employment contracts should indicate how much notice (in time or payment) must be given when terminating an employee. Under the Ontario Employment Standards Act, employees are entitled to a minimum of 1 week of notice for every full year of service up to a maximum of 8 weeks. If staff are not under contract, then a longer common law notice requirement may apply and be inherited when you buy the practice.
Associate Agreements
Like employment contracts, strong associate agreements for dentists from the seller’s practice will help prevent a loss of business after your purchase. Associate not under contracts with non-competition and non-solicitation clauses can pose a serious risk if they decide to leave and open a competing practice. Note that the RCDSO obliges sellers to notify patients where they went if they leave.
Negotiations in the absence of contracts
If the seller’s practice has many employees or associates not under contract, then you could negotiate to have the seller (1) put all the employees/associates under contract, (2) absorb the liability for termination after the sale closes, or (3) lower the purchase price.
Talk to your lawyer about how to draft and implement effective employee and associate agreements.
INCORPORATING TO BUY
Dentistry professional corporations
Under Ontario’s Business Corporations Act, a dentistry professional corporation (DPC) can be created to own and operate a dental practice under certain requirements. DPCs have many benefits to consider for buying a practice.
Partners/shareholders
When incorporating a practice into a DPC, it is important to form a shareholder agreement between the dentist shareholders. A shareholder agreement is a private contract between the shareholders that clarifies the rights and obligations of each business partner before potential conflicts arise. Shareholder agreements provide guidance on various practical issues (e.g., when and how to hold meetings, how shares can be sold, etc.) and plan how to address the future “what ifs” of operating a practice.
Various types of clauses are commonly found in shareholder agreements.
Operation of the DPC
These provisions include specific requirements for the DPC to enter contracts, issue shares, borrow money, amend its articles, etc. Consider requiring special majorities or unanimous agreement for key management decisions such as determining the officers of the DPC and maintaining proper financials.
Restrictions on share transfers
Share transfers from a DPC can be permitted or restricted in several ways.
• A consent sale clause requires that shareholders obtain consent from a certain number of other shareholders.
• The right of first refusal requires shareholders who receive a share purchase offer from a third party to first offer the other shareholders the opportunity to buy those shares on the same terms.
• Shot gun buy-sell terms mean that shareholders can determine a price for buying or selling their shares and present that offer to the other shareholders who have a limited amount of time to accept.
• Call options give shareholders the right to purchase shares after a certain triggering event, whereas put options give shareholders the right to sell in certain circumstances.
Dispute resolution clauses
Clauses addressing potential conflicts help reduce the uncertainty of litigating disputes. To try to preserve the relationship between disputing shareholders, it may be best to require disputes to first proceed through mediation and then arbitration if the mediation fails. The right of first refusal, call options, and put options can also serve despite resolution as exit strategies.
Confidentiality clauses
Since the dental profession involves handling sensitive patient records, consider including clauses that restrict what parties can do with confidential information when they receive it.
Non-competition clauses
To prevent dentist shareholders from starting their own competing practice when they are bought out, include non-competition clauses that restrict the ability to practice within a set period of time and geographic radius of your DPC’s office.
Termination clauses
Avoid termination clauses that allow other partner dentists to be removed without cause upon a majority vote. Instead, limit termination to certain circumstances (e.g., malpractice). Consider also including the right for the remaining shareholders to purchase the shares of a deceased or permanently disabled partner. Additionally, partners should decide if they want to add a clause that allows them to leave a portion of their shares to their family members upon their death.
Family shareholder clauses
DPCs allow family members to receive dividends through Dividend Only Shares as non-voting shareholders. However, the DPC can typically repurchase and cancel these shares. A well-crafted shareholder agreement is essential to structure Dividend Only Shares that are not redeemable by the DPC.
Benefits of incorporation
Limitations on liability
In an unincorporated business, you are exposed to substantial personal liability. Incorporation creates a separate legal entity that takes on more liability from your purchased practice. Shareholders of a corporation are not personally liability for commercial debts – unless they personally guarantee those debts.
Stability and ease of transfer
The continued legal existence of a corporation provides more long-term stability for your practice. The ability to sell and purchase shares of your purchased practice as a DPC can also facilitate an easier transfer of ownership.
Flexible structures
DPCs allow you to share the ownership of the corporation while remaining in control of the business.
Limitations of incorporation
Operating a corporation such as a DPC also includes some limitations.
● DPCs are restricted to conduct business in the practice of dentistry and ancillary services.
● Members of the Royal College of Dental Surgeons of Ontario (RCDSO) can be voting shareholders in a DPC, whereas family members can only be non-voting shareholders.
● Incorporation does not protect a dentist from all liability claims (e.g., malpractice claims).
The incorporation process
(1) Form a corporation
Create a corporation with a name that complies with regulations and restricts its activities to the practice of dentistry and ancillary services.
(2) Create a shareholder agreement
A shareholder agreement protects you and your business by outlining a clear structure for the rights, obligations, and relationships between the parties.
(3) Apply for a Certificate of Authorization
Your DPC must have a Certificate of Authorization from the RCDSO to practice dentistry. You want your seller’s DPC to have a Certificate until you either (1) amend your corporation’s name and get an amended Certificate for your new DPC, or (2) amalgamate with their DPC under your own name and get a new Certificate.
Even if the seller forms a DPC only for the purpose of the sale, it is still best to require them to obtain a Certificate of Authorization so that their DPC does not illegitimately operate in the time between the sale and the new Certificate. Note that receiving a Certificate from the RCDSO requires substantial paperwork.
(4) Purchase the seller’s shares
Next, your DPC will enter into a share purchase agreement to buy the shares from the seller’s DPC.
(5) Amalgamate the two corporations
When the seller is another DPC, your corporation will purchase their shares. This involves an amalgamation (or joining) of the two corporations into one new DPC. Your new DPC will then need to obtain a Certificate of Authorization from the RCDSO to practice dentistry.
Talk to your lawyer for guidance on how to form a stable and protected corporation.
ASSET VS SHARE PURCHASES
Types of purchase agreements
DPCs and other corporations allow you to create and sell shares for your business. During the sale of a practice, you will enter into an asset purchase agreement, a share purchase agreement, or a hybrid of both.
Asset purchase agreements
In an asset purchase agreement, you buy the assets of the practice (e.g., equipment, fixtures, etc.) without its liability from the seller. This form of purchase might be preferable if the seller has liabilities that you do not want to accept. As a buyer, you can pick and choose the assets to purchase while limiting your liability.
Consult your accountant to see if you could owe a provincial land transfer tax when registering your purchased land interest on the Land Titles system.
Share purchase agreements
Shares can be sold from the seller’s corporation to your DPC in a share purchase agreement. Note that buying shares also means that you are acquiring the liabilities of the seller’s practice. There are also tax benefits for selling and owning shares (see below).
Hybrid agreements
There will usually be separate purchase and sale agreements for the assets and property respectively.
When a sale is made to a dental service organization (DSO), the share purchase agreement often involves a two-step process:
(1) The buying dentist purchases the professional goodwill (e.g., patient charts) as an asset purchase transaction. Since dentists can only be engaged by other dentists, the dentist partner of the buying corporation would engage the seller as an associate. The proceeds from the goodwill asset purchase are then put into the seller’s corporation.
(2) The buyer’s DSO would purchase the shares of the seller’s corporation (minus the value of the professional goodwill) in a share purchase agreement.
Tax benefits of shares
Lifetime capital gains exemption
If you buy practice as a DPC and later sell any of its shares, you may be able to use your lifetime capital gains exemption (LCGE) to reduce your capital gains taxes on the sale. When you sell the shares of your practice, the gain on the sale (proceeds from the sale minus the original purchase price) is taxed as capital gains. If you qualified for the exemption in 2021, you may have been eligible for $892,218 in LCGE.
Qualifying for the capital gains exemption
To be entitled to the LCGE, your corporation’s shares must be considered qualified small business corporation shares (QSBCS) by meeting all the following conditions:
● at the time of sale, it was a share of the capital stock of a small business corporation, and it was owned by you, your spouse or common-law partner, or a partnership of which you were a member;
● throughout the 24 months immediately before the share was disposed of, while the share was owned by you, a partnership of which you were a member, or a person related to you, it was a share of a Canadian-controlled private corporation and more than 50% of the fair market value of the assets of the corporation were
○ used mainly in an active business carried on primarily in Canada by the Canadian-controlled private corporation, or by a related corporation
○ certain shares or debts of connected corporations
○ a combination of these two types of assets; and
● throughout the 24 months immediately before the share was disposed of, no one owned the share other than you, a partnership of which you were a member or a person related to you.
Talk to a tax expert for guidance on how to best leverage the tax benefits of incorporation.
FINANCING & LOANS
Many dental practice buyers finance their purchase with a bank loan. Banks will assess your lease and require that you purchase insurance policies and sign certain agreements.
Lease requirements
Banks will ask you to confirm the proposed location for your practice by providing a copy of the signed lease agreement and the landlord’s consent. Once the purchase is finalized, banks will want your purchase documents to prove your ownership.
Lease duration and clauses
Almost all lending banks will ask for the lease term to be at least 10 years long (either as a single term or an aggregate of terms). However, even with a 10-year term, banks will not provide financing if the lease includes a demolition clause (see “Reviewing the lease” below).
Leasing your purchased property
A bank may require you to form a lease for your purchased property that will govern how your purchased practice will use the premises – even though you will effectively be your own landlord. The purpose of this lease is for the bank to amortize your loan or protect their stake in your business if you end up selling the property.
Insurance requirements
General liability insurance
Banks mitigate risks from future lawsuits by requiring general liability insurance to cover your legal costs and potential damages.
Fire insurance
Banks often require the amount of fire insurance coverage to be no less than the value of the loan. Fire insurance does not take very long to acquire, and it is often included in your property insurance policy.
Life and disability insurance
Generally, lenders want you to have life insurance equal to the amount of the loan, and disability insurance equal to the amount of your monthly loan repayments.
Malpractice insurance
All dentists in Ontario are automatically insured for malpractice through the Royal College of Dental Surgeons of Ontario (RCDSO). You will only need to write to the RCDSO to obtain proof of this insurance for your lender.
Additional insurance requirements
Your lender may require you to get additional insurance beyond the above coverage.
Other requirements
To ensure that you do not evade liability by hiding behind your DPC, some lenders will ask that you sign a guarantee stating that you are personally responsible for the DPC’s debts and obligations.
Banks will also ask you to sign a general security agreement (GSA) that gives the bank interest in and recourse to all your assets as collateral for the loan.
Talk to your lawyer and accountant before signing any loan documents from a bank.
MAKING AN OFFER
Finding sellers
Contact practices and brokers to let them know you are in the market to purchase. Most dental practice sales will host an open house to allow buyers to view the practice and office.
It is best to research the target practice by reading its appraisal, knowing the practice’s basic metrics, and preparing follow-up questions with your team. You likely will have to sign a confidentiality agreement before you can view the appraisal.
Asking the right questions
● Why do they want to sell? Knowing their key interests behind the sale can reveal which terms of the deal may be more flexible in negotiations.
● Does the seller own multiple practices? If you are interested in owning multiple practices, then presenting a credible offer to the seller could make them consider you for another practice in the future.
● What is included in the sale? The seller might also be offering the property that hosts the practice. If the seller is offering the property of a strip plaza or condo, see if the lease allows for expansion.
Evaluating the practice
Professional appraisals
Obtain a professionally prepared appraisal for the practice you are interested in buying. Appraisals provided by the seller are biased against their interests, so it is important to seek a second evaluation.
Many appraisals assume that you will have 100% patient retention. However, a more accurate forecast should account for losing some patients, which is inherent in any owner transition. Lending banks may also require an independent appraisal to approve your loan.
Valuations based on EBITDA
Dental clinic valuations are almost always a product of the seller’s earnings before interest, taxes, depreciation, and amortization (EBITDA). A stable EBITDA means lower risk for you as a buyer.
THE BUYING PROCESS
(1) Letter of Intent
Submitting and negotiating a letter of intent ensures that you and the seller are on the same page about the terms of the deal.
A letter of intent needs to answer essential questions.
● Is bank financing involved?
● Will there be a chartered accountant audit?
● Will the sale result in an association between the seller and buyer?
● Will any staff be terminated?
● Are there leaseholds?
● Is HST included in the purchase price?
Talk to your lawyer to draft any letters of intent to a seller.
(2) Due Diligence
After the letter of intent, the seller’s business and financial documents need to be investigated and reviewed with your lawyer to ensure that the dental practice is what is represented to you and aligns with your interests. All important information needs to be up to date and verified.
You need to know if the practice is financially sound and what liabilities you are taking over. It is also helpful to meet with key employees to learn the state of the seller’s practice.
Reviewing the lease
The quality of the lease plays a significant role in the purchase price. Landlords may demand guarantees, conditions, and compensation for their consent to transfer the lease. The lease and the landlord’s conditions should be reviewed 1–3 years in advance of the sale.
Review your lease with your lawyer to assess how its terms and clauses could affect the value of the practice and your ability to secure financing. There are several kinds of problematic clauses.
● Demolition clauses allow the landlord to end the lease and remove the dentist if they decide to demolish or tear down the building. Banks will almost never tolerate a demolition clause to finance a loan for a buyer.
● A lack of renewal terms also makes it harder for you to secure financing because most banks require the lease to have at least a 10-year term.
● Assignment clauses determine how leases are transferred in a sale. These clauses can be a problem if they require onerous assignment conditions.
● Relocation clauses allow the landlord to move a practice to another location on the premises. Relocations can disrupt your practice and add unanticipated costs.
● Termination clauses give the landlord the right to terminate the lease when the seller tries to sell the practice.
For buyers, the best leases have a low and fixed rent for at least a 10-year term, favorable 5-year renewal options, no demolition or relocation clauses, and easy transferability.
(3) The Final Agreement
The purchase agreement outlines the terms of agreement between the parties for the deal. The agreement will include representations and warranties related to the seller’s practice. If you are not satisfied with the seller’s decision to not make or qualify certain statements, you could use this to negotiate the purchase price.
You may negotiate to include one or more conditions in the agreement that must be satisfied for the deal to close. It is important to draft any conditions clearly and concisely. The asset purchase agreements and/or share purchase agreements are formed at this stage.
HST considerations
Agreement on whether HST is included in the purchase price or not can affect the deal by thousands of dollars. And not specifying who will pay HST can result in conflict between you and the seller.
Review the price allocation with your accountant to determine exactly how much HST will be payable upon closing.
(4) Closing Documents
There are certain closing documents that give effect to the transaction depending on whether it involves an asset or share purchase agreement. You should negotiate for other contracts or covenants to increase the value and security of your purchased practice.
Pre-closing covenants
Pre-closing covenants are promises for the seller to do or not do something to ensure that you receive the purchased practice without any changes up until closing. Negative covenants prevent sellers from making changes to the practice without first receiving the buyer’s consent. Positive covenants obligate sellers to take certain actions before closing.
Restrictive covenants
You want to ensure that adequate restrictions are placed on the seller to protect your interests. Restrictive covenants limit the seller’s ability to compete and solicit your new patients and employees.
For example, you should have the seller sign a non-competition agreement that limits their ability to practice for a period of time following the sale. You should also consider geographic restrictions on where they can practice after the sale and a predetermined amount of money damages should they regain a patient from their sold practice.
Talk to you lawyer to draft or review any closing documents before the sale.
CONCLUSION
The current seller’s market means opportunities to make valuable deals. With proper planning and guidance from your lawyer and accountant, you can buy a dental practice for the right price and plan the next stage of your professional life.
The contents of this article are not to be construed as legal advice. Contact Emerge Law’s lawyers for legal assistance