Dental Practice Guide: Sellers

INTRODUCTION

A new surge of buyers and not enough sellers have contributed to a seller’s market for dental practices over the last few years.¹

As a seller, this guide will help you understand how to prepare for a sale, incorporate your business, and navigate the selling process to get the best value for your practice.

PLANNING FOR POST-SALE

To sell your practice at the right time and for the right price, you should plan what you want your professional life to look like following the sale. Do you want to fully retire, reduce your work hours, or continue full-time as an associate at your clinic?

Consider selling your practice several years before you retire. Agreeing to remain at your clinic for a number of years following the sale could help to increase the purchase price, whereas permanently leaving once the sale closes tends to significantly reduce the price.² Some owners have agreed to stay at their clinic for 5–7 years after the sale to maximize their purchase price.³

Talk to your lawyer and accountant to plan for your professional life post-sale.

PREPARING TO SELL

Important documents

Organize your business and financial documents with your lawyer and accountant to prepare for a sale. Prospective buyers will want to see various materials including:

the last 5 years of financial statements;
the last 5 years of production reports by provider and procedure;
team contracts and policy manuals;
leases;
HARP reports for the last 6 years;
corporate minute books if you have a dentistry professional corporation;
confirmation of any claims against you;
approved X-Ray floor plans;
a list of recent invoices and third-party suppliers to your practice; and
a copy of your driver’s license, SIN, and passport.⁴

Avoiding new equipment leases

Buyers and their lenders usually require that all debts and liabilities of the practice be paid out before the sale or at close. Thus, it is often best to avoid new equipment leases or loans that may not be paid off by the time of sale.

Before selling, review your current equipment leases to know your early buyout rights and penalties.

Understanding what buyers consider

Financials

Cash earnings (also called adjusted net income) is one of the most important factors for buyers.⁵ Generally, buyers want to see a practice operating at 40% profitability.

Buyers will look for other trends in your 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).⁶

Location

Buyers 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. Buyers are also interested in nearby residential areas that could 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.⁷

Buyers also look for spaces with room for the practice to grow. They will 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. Buyers want to see a diverse patient demographic in terms of age and ethnicity. They will also want to know your average revenue per patient.

Buyers examine the following patient metrics:

active patients (returning patients, especially for hygiene);
new patients (ideally 20–30 per month);
patient departures;
the percentage of non-assignment patients (higher is better); and
the percentage of assignment or social welfare patients (lower is better).⁸

Adding treatments

Buyers will also look to grow the practice by adding treatments. For example, they will likely be interested in a primarily preventative (40–50% hygiene) and restorative practice because they can increase cash earnings by adding complex surgeries, extractions, and specialties.⁹

Reviewing your lease

Selling a dental practice is also an opportunity to sell the commercial property hosting it. Generally, buyers prefer to purchase the property along with the practice. The quality of the lease plays a significant role in the purchase price. Some lease clauses can substantially reduce the value of your practice and property.

Review your lease with your lawyer to assess how its terms and clauses could affect your purchase price. 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 a buyer to secure financing because most banks require the lease to have at least a 10-year term.¹⁰
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. Buyers are aware that relocations can disrupt the practice and add unanticipated costs.
Termination clauses can give the landlord the right to terminate the lease when you try to sell the practice.

Buyers prefer leases that 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.¹¹

Reviewing staff contracts

Employment contracts

Buyers want your employees to be under contracts to limit their liability if they choose to terminate someone. You also want to ensure that staff contracts have strong non-compete clauses.

Ideally, you want to introduce staff contracts 2–5 years before a sale that limit your liability and the liability of a buyer. If your current staff are not under contract, you may have to offer generous termination benefits in exchange for signing the agreement.¹²

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.¹³ If staff are not under contract, then a longer common law notice requirement may apply and be inherited by the buyer.

Associate agreements

Like employment contracts, buyers may want strong associate agreements for your dentists to prevent the loss of business after the purchase. Associates 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.¹⁴

Talk to your lawyer about how to draft and implement effective employee and associate agreements.

Valuating your practice

Professional appraisals

Sellers should obtain an industry recognized professional appraiser to appraise and evaluate

their dental practice. If you are also selling commercial property, then you will require two appraisals: (1) for the goodwill and assets of your practice, and (2) for the value of your property.

Note that buyers often acquire their own professional appraisal to compare to yours.

Valuations based on EBITDA

Dental clinic valuations are almost always a product of your earnings before interest, taxes, depreciation, and amortization (EBITDA).¹⁵ A stable EBITDA means lower risk for the buyer and can be used to negotiate for receiving more of the purchase price when the deal closes, rather than receiving payment dependent on an earn-out mechanism.

Purchase price based on cash earnings

Some buyers will use a multiple of cash earnings to make an offer for the purchase price.

Owner-operator buyers have used an average multiple of 3.5x cash earnings for the purchase price.
Absentee-owner buyers have used an average multiple of 6x cash earnings.
Specialty practices have offered a price from 1x cash to 1x collections.¹⁶

INCORPORATING TO SELL

Dentistry professional corporation

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 selling your practice.

Partners and 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.¹⁷ 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 future situations involved in 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 allowed or restricted in several ways.¹⁸

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 dispute resolution as exit strategies.¹⁹

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.²⁰ 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.²¹ 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.²²

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 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 the practice. The ability to sell and purchase shares of your practice as a DPC can also facilitate an easier transfer of ownership.²³

Flexible structures

DPCs allow you to share the ownership of the corporation while remaining in control of the business.²⁴

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.²⁵
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.²⁶
Incorporation does not protect a dentist from all liability claims (e.g., malpractice claims).

The incorporation process

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.²⁷

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.²⁸

Apply for a Certificate of Authorization

Your DPC must have a Certificate of Authorization from the RCDSO to practice dentistry. Buyers will want your corporation to have a Certificate until they either (1) amend the corporation’s name and get an amended Certificate for the new DPC, or (2) amalgamate the corporation with their own name and get a new Certificate.

Even if your DPC was only created for the purpose of a sale, it is still best to obtain a Certificate of Authorization so that the 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.

Rollover your assets

Your DPC must then acquire the assets of your practice through a transfer (or “rollover”) of assets through an asset purchase agreement. In the agreement, the purchaser is your DPC and the vendor is the owner of the assets. In exchange for transferring the assets to your DPC, the vendor will receive shares equal to the worth of the assets, generally at fair market value.²⁹

Sell shares

Next, you will enter into a share purchase agreement to sell the shares from your DPC to the buyer.

Amalgamate the two corporations

When the buyer is another DPC, their corporation will purchase the shares of your DPC. This involves an amalgamation (or joining) of the two corporations into one new DPC.³⁰ The 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 sell the assets of your practice (e.g., equipment, fixtures, etc.) without its liability to the buyer. This form of purchase might be preferable if you do not qualify for the lifetime capital gains exemption (LCGE) (see below) or have liabilities that the buyer does not want to accept. As a seller, you would pay taxes when (1) the assets are sold and (2) when the net proceeds are distributed.³¹

Share purchase agreements

Shares can be sold from your corporation to the buyer’s DPC in a share purchase agreement. Note that selling shares is beneficial for you because you are also transferring your practice’s liabilities.³² 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:

The buying dentist purchases the professional goodwill (e.g., patient charts) as an asset purchase transaction.³³ Since dentists can only be engaged by other dentists, the dentist partner of the buying corporation would engage the seller as an associate.³⁴ The proceeds from the goodwill asset purchase are then put into the seller’s corporation.
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

Selling your DPC’s shares to a buyer can allow you 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.³⁵ If you qualified for the exemption in 2021, you may have been eligible for $892,218 in LCGE.³⁶

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.³⁷

Talk to a tax expert for guidance on how to best leverage the tax benefits of incorporation.

CHOOSING A PURCHASER

Consider the parties that you may have an agreement to sell to and the kinds of buyers that you would prefer to sell to.

Agreements with other dentists

Note if you have given another dentist the right to match any offer for the purchase of your practice. Recall if you had any discussions with dentists in or outside your clinic about their rights during a sale.

Selling to associates or other dentists

Selling your practice to another dentist usually requires lowering the purchase price for them to

secure financing. However, dentist buyers may be more flexible on the deal’s terms.³⁸

Owner-operator dentists buying a practice generally want the selling dentist to reduce their presence after the purchase to a 6–12 month associateship term.³⁹

Selling to dental service organizations

Larger dental service organizations (DSOs) typically involve non-dentist organizations partnering with dentists to buy and manage multiple practices.⁴⁰ DSOs leverage their network to better manage risk and usually offer a higher purchase price along with equity in their company. They will also offer high prices to keep your specialist practices (especially ortho, endo, and paedo).

DSOs may want a selling dentist to associate for 2– 5 years or more after the purchase to help manage the practice and their financial returns.⁴¹ They may offer you a higher price or other financial incentives to stay.

THE SELLING PROCESS

Once your practice is prepared for sale, confidently market it to get an offer from a serious buyer. Host an open house to allow buyers to view your practice and office. An open house also helps you to meet potential buyers face-to-face.

Letter of Intent

You may receive multiple offers after an open house in the form of a letter of intent. Take the time to meet with the best prospective buyers.

Negotiating a letter of intent ensures that you and the buyer are on the same page about the terms and conditions of the deal.

Do not sign a letter of intent unless it includes answers to 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 review and assess any letters of intent that you receive.

Due Diligence

The buyer’s lawyers will investigate and review your important documents to evaluate your business.

Since due diligence is usually an onerous process, ensuring well-organized business and financial records makes the process smoother and lowers your transaction costs. Ensure that your practice’s minute book, contracts, employment information, financial statements, and agreements are up to date. Keep an easily accessible copy of these documents in your records.

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 your practice. If the buyer is not satisfied with your decision to not make or qualify certain statements, they may use this to negotiate the purchase price.

The agreement may also contain one or more conditions that must be satisfied for the deal to close. Conditions usually benefit the buyer, so it is important to draft them 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.⁴² And not specifying who will

pay HST can result in conflict between you and the buyer.

Review the price allocation with your accountant to determine exactly how much HST will be payable upon closing.

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 may need to sign other contracts or covenants according to how the deal was negotiated.

Pre-closing covenants

Pre-closing covenants make you do or not do something to ensure that the buyer receives your practice without any changes up until closing.

Negative covenants prevent sellers from making changes to the practice without first receiving the buyer’s consent.⁴³ Positive covenants obligate sellers to take certain actions before closing.

Restrictive covenants

Buyers will want to ensure that they place adequate restrictions on you to protect their interests.

Restrictive covenants limit your ability to compete and solicit your patients and employees. ⁴⁴

For example, the buyer will likely have you sign a non-competition agreement that limits your ability to practice for a period of time following the sale.

Talk to you lawyer to draft or review any closing documents before the sale.

CONCLUSION

The current seller’s market brings opportunities to make valuable deals. With proper planning and guidance from your lawyer and accountant, you can sell your 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.