When Partners Retire, The Practice Should Come First
When dentists retire from a group practice, it presents interesting for the retiring dentist, and for the remaining dentists.
The retiring dentist desires to obtain a fair price for his interest in the practice. The remaining dentists fear the additional financial responsibility from the retiring dentist’s buy out, a lost in income, and a different practice.
During this dynamic period the interests of the practice should come first. At the same time all partners need to be flexible in planning for an orderly transition. For example, the remaining partners may be confronted with adverse conditions impacting the practice’s future earnings. A recession, the intrusion of managed care into the practice, or the disability of a remaining partner are all possible eventualities.
Given these facts of business life, the partnership should provide for some flexibility in the payment terms to ensure that the retiring partner receives his buy out payments. Here are several specific suggestions for planning an orderly transition.
First, the partners should prepare a set of cash flow projections before establishing the buy out payments. The cash flow projections will not only be helpful in forecasting future earnings, but will also aid in determining the pay out to the retiring partner. These projections will also help set the term of the pay out and the net income to the remaining partners.
The partnership should create safeguards to insure that the remaining partners do not suffer economic hardship in the event of a downturn in practice income. One safeguard involves setting a cap on the amount of the payment to the retiring partner in any one year. The cap can be tied to gross income. For example, an amount can be set not to exceed a percentage of gross income, (i.e. seven to ten percent of gross income in any one year).
Since gross income does not take into consideration overhead, it is preferable to limit the pay out to a percentage of adjusted net income. Before applying this standard partners should define what they mean by adjusted net income. Generally, adjusted net income should mean gross income less all overhead except partner’s salaries, bonuses, pension plan contributions, and fringe benefits (like continuing education, travel and entertainment, and automobile reimbursement).
The partnership can also guarantee the remaining dentists that their salaries will not fall below the amount earned in the year before the retiring partner’s departure. As a result, if the pay out to the retiring partner cannot be made in full in any one year, the amount not paid can be deferred, and paid during the next succeeding year.
The pay out to the retiring partner should be for a fixed term. Generally the payment terms should be five or seven years. If the total payments cannot be made during the fixed term, the partners should give consideration to extending the term by a year or two. If the extension term expires, when a balance is still owed the retiring partner, then the partners might consider extinguishing the balance owed. Clearly, the partnership should establish a cut off date. If there is still a balance after the cut off date, the pay out amount was probably too large from the outset.
When you have several dentists retiring at the same time or within several years of each other, the partnership can reduce the pay out amounts to the several retiring partners proportionately, or automatically doubling the payment term of each retiring partner. For example, partner “A” retires in 1996, and Partner “B” retires in 1998. Each partner will be paid over five years. When Partner “B” retires in 1998, Partner “A” has three years remaining on his original term. At that point the term of Partner “A” is extended over six years, and the term of Partner “B” is extended over ten years. When Partner “A” is paid in full, Partner “B” will revert to his original term.
Another matter that should not be overlooked by the partners is the admission of an associate, or new dentist, to the partnership. If the retiring partners buy out arrangement is a financial burden on the partnership, and the payment terms are not flexible, the remaining partners will have a difficult time in attracting or convincing an associate, or a new dentist, to buy into the partnership. As a result, the remaining partners’ later retirement from the practice will be jeopardized.
By extending the payment term when the partnership faces economic hardship, or when it is paying out more than one retiring dentist, the partnership is putting the practice first. Flexibility in the payment arrangements to the retiring partners will minimize the risk of the remaining partners suffering a lost in income, and maximize the potential for the retiring partners to receive their total buy out payments.
Under the adjusted net income limitation, the retiring partners may receive their payments over a longer period of time.
Certainly, the retiring partners bear greater risk with a net income cap. The risk to the retiring partners, however, is a reasonable one. This provision provides greater flexibility for the remaining partners. It enables them to devote their efforts, production, and commitment to the practice while satisfying their financial obligation to each retiring partner.