Presentation on theme: "Purchasing a Practice. The purchase of a practice can be an excellent way to begin your career as a private practitioner. It is also a necessary step."— Presentation transcript:
Purchasing a Practice
The purchase of a practice can be an excellent way to begin your career as a private practitioner. It is also a necessary step when associates and practitioners form partnerships. Therefore, the business and legal issues involved in a practice purchase are important to most optometry graduates.
There are several advantages to purchasing an existing practice: Immediate income is higher than that achieved in a practice starting cold Buying can entail a smaller investment than starting a new practice, if the price is reasonable A well-trained staff and established office procedures already exist An inventory of frames, tools, equipment, instruments, and supplies is already there and ready to go There is a transition period, during which the departing doctor introduces the incoming doctor to as many patients (and community members) as possible
There are also several disadvantages to purchasing a practice: The location of the office may not be ideal The design of the office and the instrumentation may not be appropriate for the new doctor The fee schedule and payment policies may not be optimal The office staff may be reluctant to accept a new doctor and new policies The patient flow may drop drastically (10% to 15% is expected) with the exit of the seller
The feasibility of purchasing a practice is determined by various factors, including the number of practitioners in a community or area: The southeast has the lowest optometrist-to- population ratio (10.2 per 100,000 in Alabama) An optometrist-to-population ratio of 1:7,000 is considered necessary to sustain life, but the type of setting also affects the ratio, with minimum requirements being: –rural: 4,000 to 6,000 –suburban: 12,000 to 18,000 –urban: 25,000 to 45,000 One optometrist for every 3 dentists or 3-4 MDs
Other important feasibility issues include: Growth rate of the area (is it going up) Population age (is it appropriate for the services offered) Income level (is it mostly Medicaid) Economic indicators –new business and new home starts –cost of homes –industry (dominant type) –social factors (you should live there)
If a practice is to be purchased, its value must be determined; value is decreased by: Significant reduction in the days the office is open (i.e., less than a full-time practice) Poor or neglected recall system Outdated equipment Low fees for services Low participation in available vision or medical reimbursement plans Failure to provide needed medical services to Medicare patients
Economic factors affecting practice value include: Gross income –3 preceding years tax returns needed –annual growth needs to be higher than the cost of living index –has income peaked because OD is so busy Net income –should be 25% to 35% of gross –costs of running the office should be reasonable –effect of loss of patients should be considered
Other factors affecting practice value: Scope of practice –primary eyecare or specialty practice Practice location and office lease –is lease assumable for next 2 to 3 years Patient records –2,200 exams a year, with 25% to 35% new patients Physical resources –usable equipment and ophthalmic materials Transition period –vital to effecting efficient transfer of ownership
What is the value of a practice? An accurate estimate can be made by considering 2 items: the fair market value of the tangible assets (equipment, instruments, building, inventories, records, other items of purchase) the intangible "goodwill" of the practice (which is represented by the true net income received by the seller, not just what is reported on the sellers tax return; this income should be averaged for the 3 years preceding the sale)
If the average net income for the 3 years preceding the sale and the fair market value of all tangible assets are added together (e.g., $300,000) and then compared to the gross income (e.g., $500,000), as a rule of thumb the percent is about 60% to 65% (rarely, up to 75%) for practice sales in the southeast
Accounts receivable (bills unpaid at the time the practice is transferred to the buyer) can be managed by allowing them to be: Discounted on the basis of age –less than 30 days, 70% to 80% of value –30 to 60 days, 50% to 60% of value –60 to 90 days, 20% to 40% of value –90 to 120 days, 5% to 15% of value Sold for an agreed-upon percentage of value (70%) Collected by the seller during the transition period
How are practice purchases financed? Most sales are financed by the seller. The buyer makes a down payment and the balance is financed by the seller over a period of years (usually 5 to 10). The seller holds a promissory note; interest is charged on the unpaid balance. The assets being sold must be allocated value for tax purposes
The value attributed to each of the items being bought determines the depreciation deduction that the purchaser can claim: There are 5 basic types of items being purchased that are subject to depreciation: –electronic equipment (computers, copiers) and vehicles: 5 year depreciation deduction –equipment, instruments, furnishings and other capital assets: 7 year depreciation deduction –patient records: 15 year depreciation –intangible assets (covenant not to compete, goodwill): 15 years amortization/depreciation –office building: 39 years depreciation
In addition, computer software can be depreciated over 3 years. Land cannot be depreciated, only the things on it (e.g., buildings). Supplies and inventory purchased as part of the sale cannot be depreciated; its cost must be deducted in the year of sale.
Thus, for the buyer, there is a tax incentive to allocate value for items that can be depreciated over the shorter periods (5 years for computers and electronic equipment, and 7 years for equipment and instruments). Any difference between the allocated value of assets and the actual sales price is considered "goodwill (and thus requires 15 years to write off). The practice purchase must be reported in the year of sale on Form 8594.
This form must be submitted by both the purchaser and the seller, and requires that the assets and the value attributed to each asset be listed.
The tax ramifications of a sale can best be demonstrated by reviewing an example purchase.
Determination of practice value The practice being sold is a non-incorporated sole proprietorship grossing $410,000. The value of the tangible assets of the practice (equipment, instruments, furnishings, inventories of frames and lenses) is determined to be $140,000 ($70,000 for the equipment, instruments and furnishings; $45,000 for patient records; and $25,000 for the supplies and inventory). The accounts receivable of the practice amount to $15,000. The average net income for the 3 years preceding the sale is $125,000.
Determination of terms of sale It is agreed that Dr. Buyer will purchase the practice for $265,000 ($140,000 + $125,000). The accounts receivable will be paid to Dr. Seller as payment is received by Dr. Buyer during the 6 months following the sale. (Dr. Seller will remain in the practice during this 6 month period to assist Dr. Buyer.) The agreement specifies that Dr. Buyer will pay $25,000 down with the balance of $240,000 to be paid in 120 equal monthly installments (i.e., over 10 years).
Determination of terms of sale If no interest were charged, the payments to Dr. Seller would be $24,000 a year or $2,000 per month. However, it is agreed that Dr. Buyer will pay 7.5% simple interest on the unpaid balance during this period, or about $850 monthly. Thus Dr. Seller will receive $2,850 per month, or $34,200 per year. Over 10 years, the total payment will be $342,000. The interest paid by Dr. Buyer will total $102,000, which is tax deductible. The same amount is ordinary income for Dr. Seller.
Allocation of assets for tax purposes The equipment, instruments, and furnishings are sold at their fair market value. The same is true for the supplies and inventory. The sales price for patient records is determined by assigning a value to each record sold, based upon its age and the period of time since the last examination. Since the sales price and the value allocated to the assets is the same ($265,000), there is no goodwill to be considered.
Allocation of assets for tax purposes The $265,000 sales price paid to Dr. Seller will be taxed at Dr. Sellers individual bracket, as will the $101,000 in interest payments.
Allocation of assets for tax purposes Dr. Buyer will be able to depreciate $70,000 of the sales price (equipment, instruments, furnishings) over 7 years. The patient records ($45,000) will be subjected to straight line depreciation over a 15 year period. The $101,000 in interest payments will have to be deducted in accordance with customary accounting procedures (and thus the deduction will be much bigger at the beginning of the 10 year payment period than at the end). The $25,000 for supplies and inventory must be deducted by Dr. Buyer in the year of purchase.
Summary of tax considerations for the seller Dr. Seller will receive $59,200 in the year of sale and an annual income of $34,200 for nine years thereafter. Dr. Seller must pay taxes on this income, based upon Dr. Sellers individual tax bracket
Summary of tax considerations for the purchaser In the first year Dr. Buyer may claim a total tax deduction of $55,470 ($13,070 for depreciation, $17,400 for interest, and $25,000 for supplies and inventory). Dr. Buyer may also be able to claim an additional interest deduction if the $20,000 down payment had to be borrowed. In the second year, Dr. Buyer's deduction is $36,250 ($20,150 for depreciation and $16,100 for interest). By the fifth year the deduction has dropped to $20,850 ($9,250 for depreciation and $11,600 for interest). By the tenth year the deduction is a mere $4,400 ($3,000 for depreciation and $1,400 for interest). Thus Dr. Buyer's tax benefits have greatly diminished, at a time when Buyers income has probably reached its highest level.
To ensure that a purchase is affordable, a break even analysis can be performed: If a practice grossing $450,000 is sold for $290,000, with $250,000 borrowed at 9% interest, to be repaid in 10 years, can the transaction break even? Monthly income after the sale should be $37,500 (450,000 ÷ 12)is it enough to pay the debt, overhead, and income? The buyers salary will be $90,000 or $7,500 per month The loan requires payment of $3,167 per month The overhead costs are 40% of gross or $15,000 per month Total fixed costs ÷ 1-variable costs (lab and materials costs) $7,500+$3,167+$15,000 ÷ = $25,667 ÷.72 = $35,649 Since $37,500 is earned, and the break even point is $35,649, there will be a $1,851 cushion each month