Do you know what will happen to your dental practice if a partner wants to leave? How about if they suddenly become incapacitated, cannot work, or pass away? Do you have a plan if any of these situations occur? If you don’t then this is a great time to create a plan. In fact, you should create this type of plan as part of the several documents you need when you join or create a dental practice partnership.

A buy-out agreement is a legal document that answers these very important questions. It addresses one or more partners leaving your practice long before anyone starts thinking about retirement or selling their portion of the practice. It should also be in place long before a partner becomes ill or incapacitated. Having this document now will address many vital questions before they need to be answered, giving everyone a system to use when changes in the partnership must occur.

What is a Buy-Out Agreement?

A buy-out agreement or buy-sell agreement is a document that addresses what will happen when someone has to or wants to leave your dental practice. There is often a "triggering event' that sets certain actions in motion. Common triggering events include things like:

• Death
• Incapacitation
• Voluntary retirement
• Leaving the practice for any reason before retirement

In this type of agreement, the other partners agree to purchase the exiting partner's practice shares. This document is very helpful because it addresses problems with families having to deal with assets in a dental practice that they may not want or know how to handle. It also addresses how voluntary retirements occur so that the process is fair for everyone involved.

Generally, there are three types of buy-out or buy-sell agreements commonly used in a dental practice transition.

Cross-Purchase Agreement

A cross-purchase agreement relies on the involvement of a life or disability insurance policy for each partner. Each partner takes out an insurance policy on the other owners, and they each pay the policy individually. By doing this, if a partner dies, all of the other partners are automatically paid through the life insurance policy.

This type of agreement is used in combination with a process that sets out that shares will go back to the practice, and that they will be divided among the remaining partners using a particular method.

Entity-Purchase Agreement

An entity-purchase agreement functions very much like a cross-purchase agreement. However, instead of each individual partner maintaining the life insurance, the business purchases the insurance. The benefit amount is equal to the partner's share in the business. The practice then gets the life insurance payout upon the partner's death, and the practice uses that money to buy the deceased partner's shares from his or her estate.

Hybrid-Agreements (Wait-and-See Agreements)

Hybrid agreements often use some combination of both a cross-purchase or entity-purchase agreement. Practice owners will often do a smaller amount of both types of purchase agreement if they cannot decide which option will work best for them.

What Goes Into a Buy-Out Agreement?

Buy-out or buy-sell agreements have the advantage of being very flexible. The partners can decide what kind of plan they want to use and which processes makes sense for their buy-out. However, you should ensure that you address some very basic terms and conditions in the agreement.

Defining "Permanent Disability"

Because buy-out agreements are often triggered by disability, it is very important to define what "permanent disability" means in the context of the agreement. For example, most people would agree that you are not permanently disabled if you will be able to work in three months. But what about six months? Twelve months? Does a doctor have to determine that you are permanently disabled for the triggering event to take place?

Most agreements will use a minimum of 12 months as a permanent disability timeframe, but that is something that you and your partners should consider as you draft your agreement.

How Are Accounts Receivable, Debts, and Vehicles Handled?

Accounts receivable and debts are assets and liabilities of the practice that the disabled or deceased partner likely contributed to create. As a result, they can be difficult to "divide out" in a way that is fair for everyone involved. You should spend some time thinking about how these will be addressed as part of the buy-out process.

If you have company vehicles that an individual partner used, make sure that you address how those will be transferred back to the practice or how the partner's family can purchase or otherwise acquire those assets.

What Notices Will be Required?

If the partner is leaving the practice voluntarily or due to retirement, he or she will likely know in advance when they plan to make this type of move. How much notice does the dental practice need to adjust for their departure? In some cases, finding a replacement partner can be extremely difficult and time-consuming. It can take years, depending on the location of your practice.

You should also consider whether you will require notice if the partner becomes disabled. Notice provisions related to disability are much more flexible in most cases, but you still may want some notice, if possible.

What Restrictive Covenants Would You Want in Place?

Suppose you are allowing the partner to sell his or her interest in the practice. In that case, you may also want to specifically restrict them from competing with your practice or soliciting clients away from your dental practice. While these covenants are required to be reasonable, this is something you want to think about in the context of voluntarily or forced retirements or if a partner leaves the firm before retirement.

Keep in mind that you may not want to make your restrictive covenant so restrictive that it does not allow the partner to continue to work in the dental practice as an employee or associate.

Can Any Party Sell a Partial Interest of their Share in the Practice?

Partial sales may be a good idea for partners who want to phase out their practice until they retire or who want to move to work part-time for any reason. Having this potential flexibility may be a good option for partners in the future.

Why Should You Create a Buy-Out Agreement?

In situations where a partner leaves, whether it is a sudden death or a forced retirement, emotions and tensions may be high. Instead of acting on impulse or in a way that would not be fair to the remaining partners or the deceased or disabled partner's family, your buy-out or buy-sell agreement creates a process that everyone can reference and rely upon in a difficult situation.

If you do not create a buy-out agreement, you also put the remaining partners at risk. If there is no plan for death or sudden disability, the entire partnership could be in jeopardy. Your dental practice may not have the liquid assets to buy-out a partner, which can create a whole slew of problems with the deceased or disabled partner's family or other loved ones.

The Importance of Valuation in a Buy-Out Agreement

The buy-out or buy-sell agreement price is a vital, need-to-know factor to create an effective agreement. Valuation will determine the value (and therefore the price) of each share at a given time.

Determining the practice's value can be challenging, but it is a critical first step in the buy-out agreement process. You can set the buy-out price ahead of time, with the option to make periodic adjustments. Alternatively, you can create a process by which the practice will be valued at the time of the triggering event.

It is a good idea to get a professional appraiser who is familiar with dental practices to help you with this process. When you have insurance policies in place, you should make adjustments to those benefits to reflect periodic fluctuations in your dental practice’s value.

Conclusion

Determining the buy-out terms and how to pay for the buy-out can feel complicated and overwhelming, but it is very important for the long-term health of your dental practice. The above guidelines will help you engage in the critical-thinking process to develop this document.

If you are considering entering a business partnership, you should first consult a dental lawyer. They will walk you through the documents you'll absolutely need to protect yourself if your partnership goes south in the future, including a buy-out agreement. If you have any questions, please contact Ali Oromchian at Dental & Medical Counsel at 925-999-8200 or contact us below for a complimentary consultation.