20 Jun The Progressive Ownership Program
The PARAGON Progressive Ownership Program (“POP”) was designed to provide a logical means for a new dentist (typically a new graduate but POP is also a viable solution for more experienced dentists as well) to gradually enter into an equal co- ownership relationship with an experienced dentist. The acquisition of co-ownership interests (either stock acquisitions for practices operating as corporations or membership interest acquisitions for practices operating as an LLC) will typically occur over a few years by means of three (3) contractually defined acquisition points.
These acquisitions will occur based on the achievement of production goals and are measured based on the production level of the new doctor in relation to the production level of the existing practice owner(s). There is no acquisition within the first 12 months of the relationship. After the 12 month associateship period, the first minority interest acquisition occurs once the associate has reached a production level of at least 25% of the production of the host doctor (or the average production of the host doctors if there are more than one host doctor); the second minority acquisition occurs at the 50% production level; and, the third and final equal ownership acquisition at the 75% level. NOTE: These production levels must be sustained for 3 consecutive months to qualify for an acquisition. The associate is automatically vested to acquire equal ownership after 5 years of service regardless of individual production levels.
But, before we get into the finer details of how POP works and also how POP is custom designed for each individual practice, we must discuss an important prerequisite of POP. The practice MUST be structured as either a corporation or an LLC (limited liability company) before beginning the POP process. PARAGON will not structure a co- ownership relationship as a partnership. Either a corporation or LLC is necessary in order to achieve favorable personal income tax treatment on the sale of the acquisitions as well as protect the practice owners against personal liability issues (your PARAGON consultant will explain this in more detail in a personal consultation).
The income tax considerations will be covered in more detail in a personal consultation with your PARAGON consultant, but to briefly recap, the seller will enjoy favorable long- term capital gains tax treatment on each ownership interest sale. But, aside from income taxes, possibly one of the most significant considerations of any jointly owned practice is personal liability protection for the owners. It is well documented that in a non-incorporated or non-LLC, partnership situation (equal or unequal ownership interests), each doctor can easily be held personally responsible for the actions of the other doctors. Although there are numerous horror stories like the ones below, the true case histories presented below clearly illustrate the personal liability dangers of poorly planned practice co-ownership structures:
Dr. A and Dr. B were partners. One day, in an inexplicable moment, Dr. A slapped his dental assistant. Knowing that Dr. B had more personal assets, Dr. B was sued along with Dr. A. The assistant claimed that Dr. B was a partner and was therefore personally liable for the actions of Dr. A. It was determined in court that Dr. B was indeed personally liable for Dr. A’s actions since Dr. A and Dr. B were partners. Dr. A’s personal liability insurance did not name Dr. B as an additional insured. Dr. B’s insurance carrier denied the claim. Dr. B filed for bankruptcy after an extremely large judgment was awarded the assistant by the courts!
Dr. A and Dr. B were partners. Dr. B was covering the office on this particular day and was extremely busy with patient emergencies. Dr. B decided to send a staff member out to pick up some lunch for the office. Unfortunately, the staff member was involved in an automobile accident and a pedestrian died as a result of this accident. As often occurs, the victim’s family sued everyone imaginable, including Dr. A and Dr. B. After several years of very expensive litigation, the courts awarded a huge judgment against both doctors since they were the owners of the practice and the staff members employer. Dr. A was forced to file bankruptcy and he was not even in town the day the accident occurred!
Many co-ownership practice transition programs we have seen over the years are structured around some form of an office sharing situation. Partnerships can take many forms but, in very general terms, a partnership exists when two or more doctors are practicing under one roof and the practices are not joined in common ownership by incorporation (or as an LLC, PLLC, etc., structure). Office sharing arrangements are often considered to be partnerships by the courts. Office sharing arrangements are quite common among dentists (if they only knew the dangerous situation they have created). Please understand that POP is not an office sharing arrangement. In fact, PARAGON will not structure any of its practice transitions programs around an office sharing arrangement for two reasons. First, the personal liability issues can be extremely severe (as already illustrated). Second, the negative impact on future practice equity is quite damaging with hundreds of thousands of dollars at stake. We have several interesting articles to share on this topic. Ask your PARAGON consultant if you are interested in learning more about the dangers of office sharing and how these seemingly “good deals” can destroy your hard-earned practice equity value.
Now, back to POP…
POP is a logical 3-step, progressive practice transition process leading to EQUAL co- ownership of the Practice. The optional first step involves a short “get acquainted” period so the associate can get acquainted with the practice and the host doctor can “get acquainted” with the associate. This “Pre-Commitment Stage” is followed by the formal “Pre-Ownership Stage” that automatically evolves into the “Ownership Stage.”
STAGE 1: “PRE-COMMITMENT”
During this very short introductory period (30 to 60 days maximum), the doctors have the freedom to part ways without any financial penalties or geographical restrictions. The doctors can either mutually agree that they are simply not a good match and move on OR either doctor can unilaterally decide to end the relationship. It is important that Stage 1 be very short so that there will not be any chance of irreparable damage to the practice (your PARAGON consultant will explain the various reasons for this in your personal consultation). The associate is hired as an employee at a per diem salary (not based on production or collections so there are no lingering compensation issues with uncollected production if the relationship is terminated).
Stage 1 is optional. For example, if POP is being utilized as a transition program between a host and his or her associate of several months or years, Stage 1 is simply not necessary. In those transactions, POP would begin with Stage 2. It is also not at all unusual for two strangers to elect to enter into the formal stages of the POP relationship without this “get acquainted” period. Truthfully, not much is learned by doctors about each other since they are interacting with their patients much more so than with each other. PARAGON has discovered that doctors who desire the “get acquainted” period often don’t even know why they want this introductory period. It is probably because someone told them you must do it this way. It is our experience that most doctors can get acquainted well enough just by spending some quality time together prior to beginning their professional relationship. Most doctors feel quite comfortable jumping directly into the practice transition and virtually every time the relationship has proven successful and profitable for all.
If you do feel you will benefit from Stage 1, it is especially critical that you maintain a proper perspective. POP is a long-term transition plan (a process as opposed to an event) so don’t jump to conclusions based on a mere month or so. An associate not being as practice savvy as the host doctor is really not a valid reason to end a POP relationship. Most doctors graduate from dental school with little to no practice management expertise (I am sure you can still remember just how inexperienced in the business side of practice you were when you graduated). Most young doctors are also quite slow at first. If you measure a young, inexperienced doctor’s production speed against your speed you will likely never find a suitable match. Virtually all doctors eventually pick up speed once they leave the academic world and enter the “real world” of dentistry. Just because the associate is much slower than you now means very little in the overall scope of things. The true test of co-owner compatibility is much more about personalities and mutual respect than it is about clinical capabilities or clinical speed. Frankly, it must be assumed that a young doctor possesses adequate clinical capabilities simply because they graduated from dental school and passed the state dental boards. Dentists are like fine wines… most get even better with age (experience)!
Stage 1 Agreements Required: PARAGON will provide a draft of any agreements that are required to protect the doctors and to protect the value of the practice during Stage 1 of the POP process.
STAGE 2: “PRE-OWNERSHIP”
If not already incorporated or operating as an LLC, PLLC, etc. (or other suitable entity that prevents personal liability), it is critical that the practice formally begin operating as either a corporation or an LLC prior to progressing to Stage 2 (this should ideally be accomplished prior to, or at least during, Stage 1). It is also important that an LLC or PLLC has elected to be treated as a corporation (“C” or “S” corporation) for federal taxation purposes. This allows the practice owner to enjoy favorable long-term capital gains treatment as the co-ownership acquisitions are completed. An LLC or PLLC that reports taxes on the owner’s 1040, Schedule C will not qualify for favorable long-term capital gains treatment. However, the solution is relatively simple. Your accountant will assist you with this one-time IRS filing.
Stage 2 of POP marks the beginning of the formal practice transition relationship between the doctors. For the protection of each party, Stage 2 will not commence until all required contracts between the doctors have been fully executed. During Stage 2, the associate (not yet a new co-owner but the contracts are now in place for the steps required for a transition into co-ownership) is an employee of the practice, however, now the associate’s compensation will be based on collected production instead of the fixed per diem salary that was in effect during Stage 1. The associate’s Stage 2 compensation package will be structured exactly the same as the compensation package for all other practice owners (owners are compensated based on the compensation provisions of the practice’s Operating Agreement – more on the Operating Agreement later) since at some point along the Stage 2 process the associate will become a co-owner of the practice.
Provider Compensation: The provider compensation package can vary greatly from practice to practice due to a number of factors (including the practice overhead and the specific desires of the practice owners) but typically provider compensation is based on the collected production generated by each owner/provider. For example, a provider compensation package could possibly be that all owner/providers are compensated on their individual collected production as follows:
45.00% of the first $150,000 of collected production each calendar year; and
50.00% of the next $150,000 of collected production each calendar year; and
55.00% of all collected production each calendar year in excess of $300,000.
Provider compensation could be paid monthly, semi-monthly, weekly, etc. Provider compensation could also be paid monthly with provisions for weekly compensation advances (to be recovered at the end of each month). In other words, POP is completely flexible and we can easily work around your specific salary needs and goals.
NOTE: The compensation structure above is just an example of how POP could possibly be structured. PARAGON will help you set a specific compensation structure for your practice based on our in-depth financial analysis of your practice. The key is to set the provider compensation high enough so profit distributions are fair but not extremely large from month to month. You do not want a practice owner to start slacking off on his or her personal production because his or her monthly profit distributions are substantial enough to provide an acceptable personal income. This would cause an undue hardship on the remaining owner/producers and could quickly cause practice revenues to diminish if the producers were not able to pick up the production slack.
Earnest Money: Since Stage 2 involves multiple acquisitions of minority ownership (progressing to equal ownership), PARAGON strongly recommends that the associate be required to pay earnest money. The best way for this to happen is by means of deducting a certain percentage from each of the associate’s periodic compensation payments. The earnest money is accumulated and applied against future acquisitions. The specific handling of the earnest money, as well as penalties that are imposed on a party in the event that party fails to complete a scheduled acquisition, are covered in the transaction documents (your PARAGON consultant will explain). The inclusion of earnest money in the transition equation allows the inclusion of significant performance guarantees for the protection of both the buyer and the seller. On occasions, the parties may agree to embark on this journey without the earnest money commitment but it would certainly not be PARAGON’s recommendation to do so.
Ownership Interest Acquisitions: The timing of the 3 separate ownership interest acquisition points are specified in the contracts executed by the parties. The initial acquisition will not occur until the end of the initial 12 months of Stage 2 with subsequent acquisitions eligible to occur at any time thereafter (even simultaneous with the initial acquisition) once the contractual minimum production requirements have been satisfied.
Specifically, the acquisitions are timed as follows. After the initial 12 months of Stage 2, the associate will acquire a 1/3 share of equal ownership as soon as his or her production reaches 25% of the host doctor’s production and remains at the 25% or greater level for 3 consecutive calendar months (if there are more than one host doctors then the gauge would be the average production of all host doctors). The associate (now a minority interest owner) will acquire the second 1/3 share of equal ownership as soon as his or her production reaches 50% of the host doctor’s production and remains at the 50% or greater level for 3 consecutive calendar months. The associate will acquire the final 1/3 share of equal ownership as soon as his or her production reaches 75% of the host doctor’s production and remains at the 75% or greater level for 3 consecutive calendar months. Should the associate reach more than one level simultaneously then those acquisitions will occur simultaneously. For example, if the associate is able to close out year 1 of Stage 2 and his or her production equaled or exceeded 75% of the Host’s production for the final 3 months, then the associate would be eligible to acquire all three 1/3 ownership interests simultaneously on the first day of the second year of Stage 2.
The only exception to the associate’s minimum production requirement is that, regardless of the production levels achieved, the associate automatically becomes fully vested to acquire an equal ownership position in the practice at the end of 5 years service.
Ownership Interest Valuations: One of the most popular features of POP is that the acquisition price of each ownership interest is determined by the doctors based on a valuation formula that PARAGON pre-sets for the practice. This is very important to the success of the relationship. Knowing exactly what the valuation formula is for each acquisition before embarking on the relationship allows each party to know exactly what to expect at all times. Entering into a practice transition relationship without knowing the cost of ownership is like boarding a plane without knowing the destination. Frankly, it is foolish to enter into such an ambiguous relationship! Arguments over practice value and price is why dental associateships end in disaster about 90% of the time. Contrary to the historically poor results of dental associateships, PARAGON has a virtual 100% success rate with transitions that involve an associateship period. This is because PARAGON takes ambiguity out of the equation. Everyone knows exactly how the transaction flows from the very first day!
The exact same valuation process is repeated for each ownership interest acquisition and always begins with a Base Market Value factor (this factor is determined by PARAGON specifically for each individual practice). Valuation Adjustment Factors for minority interest and income tax considerations are then applied (also determined by PARAGON and assigned to each individual practice). Current accounts receivable balances, cash on hand, and any outstanding practice liabilities are also part of the valuation formula. NOTE: Your PARAGON consultant will explain this valuation process to you in your consultation and provide you with a sample worksheet that illustrates exactly how this very easy valuation process works.
PARAGON makes the mechanics of calculating the price of each ownership interest acquisition very easy. We provide you with a fill-in-the-blank worksheet that already has each of the practice-specific base valuation factors and practice-specific adjustment factors inserted. You just fill in the blanks with easily obtainable current practice data and then perform some extremely elementary math (we are talking about simple adding, subtracting, dividing and multiplying that your kids could help you with). There are no complicated valuation formulas or calculations for the doctors to worry about. PARAGON has already worked those practice-specific calculations into the valuation factors we provide on the worksheet.
In a POP transaction, the doctors are provided 100% of the tools necessary to complete each ownership interest acquisition without the need for any assistance from either PARAGON or from any other advisors. POP was specifically designed to be a completely self-contained, self-monitored transition process with all of the “guess-work” removed. The worksheets PARAGON provides are very easy to follow and easy to implement. The contracts you are provided are clear and precise. However, even though POP is designed for you to be able to handle everything without any third-party assistance, PARAGON is always there to assist you if you just feel better having someone look over your shoulder to make sure you have dotted all the “i’s” and crossed all the “t’s.” Our long list of satisfied clients will attest to the fact that both our pre-sale and post-sale service to our clients is unequalled.
Acquisition and Operating Agreements: PARAGON provides drafts and the necessary redrafts of each of the contracts and agreements that must be executed prior to beginning Stage 2. The primary agreements are:
- The Ownership Interest Acquisition Agreement (this is either a Stock Acquisition Agreement or a Membership Interest Acquisition Agreement depending if the practice is operating as a corporation or LLC) covers the entire Pre-Ownership stage of POP. In addition to the standard relationship issues and related protections for the parties, this agreement includes: all applicable worksheets; all practice specific forms; promissory notes, if applicable; and, any practice- specific supplemental contracts and agreements necessary to value each ownership interest acquisition and to fully complete each acquisition transaction without the doctor’s need for any third-party (including PARAGON) assistance.
- The Operating Agreement (this is either a Shareholder Agreement or a Member Agreement depending if the practice is operating as a corporation or LLC) governs how the co-owners function as a unit and how to handle virtually every conceivable practice ownership issue, including but not limited to: provider compensation; profit distributions; senior owner status and rights; minority owner status and rights; daily management of the practice operations; disposition of practice assets; practice dissolution; co-owner retirement options and rights; co- owner death and disability issues; the addition of future co-owners; ownership interest redemptions (mandatory and voluntary); and, ownership interest exchanges. In short, if it can happen, you will know exactly how to deal with it!
STAGE 3: “OWNERSHIP”
Stage 3 of the POP process is automatically triggered when the initial acquisition is completed since once any acquisition occurs the doctors are then co-owners of the practice (although they may not yet be equal owners). Since all three acquisitions typically have not yet been completed, Stage 3 and Stage 2 progress simultaneously for a while with the operations of the practice being totally governed by the Operating Agreement and the remaining acquisitions being governed by the Ownership Interest Acquisition Agreement.
It is not at all likely that a problem would ever develop of this nature, but should any issue develop due to these two agreements being in force simultaneously, the Operating Agreement will always prevail (this is clearly stated in the Operating Agreement).
The Ownership Interest Acquisition Agreement will automatically terminate as soon as the final acquisition has been completed (this is clearly stated in the Ownership Interest Acquisition Agreement).
There are no additional agreements required for Stage 3 to begin. All necessary agreements for Stage 3 are executed when Stage 2 begins. In fact, the only other agreement that should ever be needed for a POP relationship will not occur until an owner wishes to sell his or her ownership in the practice in anticipation of retirement (it is possible to sell and not retire immediately) or upon an owner’s retirement. PARAGON can’t provide a draft of that Ownership Interest Redemption Agreement now simply because tax laws are constantly changing and what is applicable today may or may not be applicable years from now when the need for the agreement actually occurs. We also have no way of knowing now if an owner would be selling to immediately retire or selling to cash in on his or her practice equity but will remain an associate for the practice until he or she is ready to retire. When retirement does become a reality, PARAGON will be happy to assist you with that transition as well.
That’s POP… a very creative, well-organized, turn-key transition program designed by one of the industry leaders in dental practice transitions.
POP allows the transition process to evolve naturally and at a pace that is productive and stress free for the doctors and staff. POP makes it effortless for the young, inexperienced dentist to gain entry into a wonderful practice opportunity straight out of dental school. POP makes it easy for the seasoned veteran to cultivate his or her heir apparent while enjoying excellent passive income. POP completely eliminates the “guess-work” normally associated with the practice value (present and future) and the practice sales process. POP eliminates all the “guess-work” from the professional working relationship that is shared between two or more doctors. POP allows committed doctors to easily evolve into a healthy and productive non-solo practice ownership relationship that is mutually beneficial and extremely profitable for all parties.
Contact PARAGON today to schedule your complimentary consultation to learn more about POP… no obligation, just a very worthwhile education!