PHASING OUT – TRANSITIONING
The process of phasing out of full-time chiropractic practice, and gradually decreasing your patient load in steps, is a popular pre-retirement method. By doing this, an orderly transfer of your professional practice is made, bit by bit, over a pre-stated number of years (never less than two, and seldom more than eight, with five years the being the most common time period). By this process, you sell out over a structured time period, remaining in the practice until your last dollar is received.
The initial steps include:
- creating a strategic exit plan
- identifying your most important objectives
- deciding what percent of the practice should be sold initially, and over what time frame the remainder should be divested
- clarifying what you expect from a purchaser with whom you will be working for a few years, individual responsibilities, a phased-in transfer of the patient load and general business matters
- formulating a critical path and timetable, deciding what comes first, second, third, etc.
- establishing the market value of your chiropractic practice
- determining your retirement needs
- documenting the best way to accomplish your goals
- addressing the legal and tax problems
Always have your draft plan examined by legal and accounting experts. There is little point in going through this only to find that your nest egg is frittered away to Canada Revenue Agency, or you have unworkable or unenforceable covenants in your agreement. The same thing holds true for the idea of having the practice valued by a qualified appraiser. This is the best way to find out if it is worth less, or perhaps more, than what you had thought.
SELLING OUT, ALL CASH
A common failing among business owners (and a chiropractic practice must be considered as a service business) is that most think their business is the jewel to others that it is to them, and if offered for sale, it will be immediately snapped up. Unfortunately, it may not be. You must contend with buyer uncertainty and reluctance. Across the country, there are several chiropractic practices for sale, a shortage of qualified buyers, and problems associated with arranging financing, all making a cash sale difficult. Accordingly, the surest, and often the only, procedure is some form of seller financing, such as a buy-in or an earn-out.
The term “buy-in” refers to the purchaser whereas “buy-out” refers to the seller. However, both mean the same thing. This arrangement is most common when selling to a junior associate or partner. By this procedure you are paid out over the next few years, usually not less than two and seldom more than five. You remain active and in control until the debt owing to you is fully retired. The buyer becomes a working partner, increasing his/her ownership in stages. This is different from the earn-out (discussed below) where the selling price is adjustable – with the buy-in/buy-out, the selling price of the practice is agreed to and settled at the time the buy-sell contract is entered into.
One of the financing methods for the buy-in/buy-out arrangement, is to deduct from the buyer – now a partner – from his/her wages and a percent of the net profit based on this person’s increasing ownership an agreed to amount, which will be applied to the purchase price. This continues until your interest has been retired, the buyer owns it all and you leave the practice. However, you must ensure that a sufficient amount can be withheld, so that you can be paid out within the allotted time frame. It is important that the payments to you – and the debt service to any other(s) who may have loaned the buyer money for the down payment – can be made from his/her income and still leave enough for this person to make a decent living. Otherwise the buyer will default – guaranteed.
Alternatively, have the purchaser arrange financing elsewhere and pay you out now. Under this agreement, you remain under contract with the practice as his/her employee for a stated number of years, phasing out as you go.
Although not commonly used in the transfer of professional practices and small businesses, this arrangement could work well when selling over time to an outsider who is not presently involved in the practice. As an employee would already have a good idea of the value and potential of the practice, a buy-in with a fixed price would be the better route.
But, the intent of the earn-out is to accomplish two things. Although the seller can depart immediately, it can allow him/her to remain with the practice, maintaining control until paid out, and it bridges the gap between the price the seller wants and what a buyer is willing to pay. The earn-out is a payment for performance after the deal is closed. After it is sold, if the practice reaches or exceeds a certain agreed upon financial intake target, or other milestone, during a specified period, the purchaser pays the seller additional compensation pursuant to an agreed upon formula.
What does this mean?
Buyers traditionally buy based on historical performance, whereas sellers want to include, in their valuation and price, an increment for potential growth and profit increase. Whereas an increase in the seller’s price cannot be justified by future “maybes,” an earn-out is a logical way to cover the gap. It protects the purchaser who does not wish to overpay for “potential,” and the selling chiropractor who does not want to leave money on the table.
AN EXAMPLE OF EARN-OUT
For demonstration purposes, let us assume that during the past three years, your chiropractic practice has been growing at five per cent per year and, last year, it netted, after tax, $150,000. Using a 0.550 discount rate, the practice would have a value of $272,727. ($150,000 divided by 0.550) You are convinced that the net profit will increase by a minimum of 3.0 per cent per year for the next five years. Compounding the 3.0 per cent per annum, by the end of year five the net profit will be $167,390 and using the same 0.550 discount rate, the practice will have a value of $304,345. You think this is what the buyer should pay. With the earn-out method, the buyer agrees to the basic price of $272,727. If, in fact, the net profit increases at an average rate of 3.0 per cent per annum for the next five years, and in year five it does net $167,390, he/she will pay the additional $31,618 to the selling chiropractor, and the deal is done. Up to a predetermined cap, all increased net profit amounts above the base (here $150,000 per annum) would be prorated on the same basis.
Other calculation methods could include a certain amount per annum based on the businesses’ profit threshold, an agreement based on gross revenue rather that after tax profit, a higher discount rate if earnings are lower than anticipated, a cumulative earn-out based on annual profits during the entire contract period, and so forth.
Because they hold an increased potential for conflict, earn-out transactions require precise drafting and conductance. The rules must be clear and easy to carry out. It is ultra important that the method for calculating future earnings is spelled out. It is not good enough to say they will be computed according the GAAP Rules (Generally Accepted Accounting Principles). Be specific! Employ the best of lawyers and accountants to set it up – not the cheapest, the best.
THE LAST WORDS
It cannot be said too often: phasing out, or transitioning, from an active chiropractic practice must be a planned exercise. It can never be a case of saying that on an appointed day, with a wad of money in your jeans, you will depart. An exit whereby you have your health, your wealth, and, yes, your reputation, intact will take meticulous planning and methodical execution. Start now: not “someday”, when, for some unexpected reason, you must get out. Consider all your options, select the one that works best for you, get the best of legal and tax advice – and do it. •