Do I get to keep all the money from the sale of my practice?
Matt Arthur, CEO of Mayfield Practice Sales, questions what a sale and purchase agreement includes and who walks away with what after a dental practice sale.
I’d like to expand on one of them here as it serves as a potent reminder of why being unprepared before selling can end with painful results…handing money back to the buyer.
Splitting payment into three parts
For practice owners whose business sits within a limited company, the monies from the share sale can split as follows:
- Initial consideration
- Deferred consideration.
To illustrate this, let’s look at an example. A practice might sell for £1,300,000. Although the ratios can vary, a typical sale might split as follows:
- Initial consideration – 70% (£910,000)
- Deferred consideration – 30% (£390,000).
The initial consideration is payable upon completion. However, the buyer often withholds a small amount (retention). The retention is essentially a down payment awaiting the result of the businesses ‘net asset value’ calculation. This process I’ll explain later.
The buyer will assess the balance sheet of the business and make a judgement as to how much to retain.
In our example, the buyer decides to retain £50,000. So, in reality, upon the completion, the seller would actually receive: £910,000 – £50,000 = £860,000.
The deferred consideration is then payable in the future and is dependent on meeting certain criteria. For example, hitting future revenue targets.
Cash free, debt free
An acquiring party will typically expect to buy a practice ‘cash free, debt free’. In essence this means that the seller can retain the cash built up by the business before the sale.
However, the seller will need to settle any debts, such as outstanding bank loans and hire purchase agreements.
After a sale, typically within 30 to 90 days of completion, a set of completion accounts will need producing. These will include the all-important ‘net asset value’ calculation. This key number shows the businesses’ financial position at the point of sale. In other words, what assets and liabilities (debts) did it have at that exact moment in time?
This is a key point of the sales process and one that many sellers overlook. Up until this point, all focus is on the practice’s historic financial performance.
The sale and purchase agreement (SPA)
When selling a dental practice, the sale and purchase agreement sets out the agreed price. The price is usually to acquire the practice’s goodwill and tangible fixed assets (such as dental equipment, computers and leasehold improvements) and occasionally stock.
The net asset value considers all other assets and liabilities: net asset value = assets – liabilities.
If the resulting figure is positive, the seller will receive additional payment. This is because the value of the net assets the buyer is receiving is higher than those they acquire as part of the sale.
If the figure is negative however, the buyer will recover some of the sale proceeds from the seller to compensate them for taking on the debts. This often comes as a shock to the seller.
Back to our example
Let’s imagine the business in our example has run a very successful marketing campaign. This results in a large number of deposits taken.
Even though the practice receives the money, it doesn’t carry out any work. Therefore, the business has increased its patient creditors (a liability). The incoming buyer will not want to carry out the treatment for free, so will look to recover the deposits.
It also increases its unpaid supplier balances, the increase can be excessive when the business is sold because it is short of cash.
The practice may also hold large associate retentions, which are substantial for practices working with implants etc. The associate retention is money withheld from an associate when they leave to cover the costs of repairs or replacements.
The SPA may also stipulate that patient debtors (monies owed by patients for work carried out) that are older than a certain age, are automatically written off when calculating the net asset value.
If the practice bills in such a way that they allow patients to pay for work over a longer period of time (eg when they don’t want to use finance companies) then genuine debtors end up getting written down and reducing the net asset value balance further.
As a result of the above, let’s assume it produces a negative net asset value adjustment to the sum of £90,000. The retention originally withheld by the buyer (£50,000) is not enough to cover this. The seller will therefore need to pay back £40,000.
This means, the seller will not receive the full initial consideration of £910,000. Instead, they will only receive: £910,000 – £50,000 – £40,000 = £820,000.
This is £90,000 less than the buyer expected to receive when they agreed upon a price for the sale of their business.
Reduce the risk
So, in the end, the proceeds from a sale can be far less than the seller expected. This can really sting.
Careful financial planning and management in the run up to selling a dental practice can reduce the risk of completing the sale and then having to hand back a portion of the sale proceeds in this way.
Maintaining accurate books of account is one such method of obtaining an accurate picture of a practice’s financial position at any point in time and not just the financial performance.
If you are interested in discussing any of the topics covered with one of our experts or are in need of support, please contact us and one of our experienced team will be happy to help.