Buying or Selling a Veterinary Practice? The Issue is Affordability
Cynthia R. Wutchiett, CPA
Paul, age 50, owns a companion animal practice in a suburban community. While retirement is at least another ten to fifteen years away, he knows the value of advanced planning. Four years ago, he began his plan for attaining financial security. Today, he is well on his way to reaching his goal by age 56. The value of his practice plays an important part in attaining this security and with his business plan in operation, the practice is on track for reaching his target value of $900,000. Dr. Paul knows that the practice value he is building is only assured if he has a buyer willing and able to buy when he is ready to sell. As his financial security depends on getting full value for his practice, he knows his plans for ownership succession must be carefully thought out.
Dr. Paul has been told that how the sale is structured significantly affects the dollars he ultimately receives. Dr. Paul wants to structure the sale in a way that will be fair to all parties and wants to understand the issues and alternatives. His practice is structured as a C Corporation.
What is being sold, corporate stock or assets and liabilities?
Dr. Paul learns that buyers usually prefer to buy assets and liabilities rather than stock. This enables them to select which assets they will purchase and which liabilities they will assume. Buying assets also allows the buyer to claim depreciation (a tax-deductible expense) on all depreciable assets such as medical equipment, office equipment, and goodwill. If the buyer purchases stock, the buyer acquires all assets and liabilities owned by the corporation, but without the benefit of claiming a depreciation expense on the tangible assets or the goodwill.
Sellers usually prefer to sell stock. All gain on the sale is taxed as a capital gain. If instead, individual assets and liabilities are sold, part of the gain (for example, the recapture of depreciation previously claimed on tangible assets, the value of accounts receivable, the value of inventory, etc.) will likely be taxed as ordinary income.
Dr. Paul decides that the corporation will not be dissolved and therefore stock, rather than assets and liabilities, will be sold.
Who is the seller, Dr. Paul or the corporation?
If Dr. Paul is the seller, he will pay capital gains tax on his gain - the difference between his selling price and his tax basis. The buyer's tax basis for future sales will equal the amount paid.
If the corporation is the seller, there is no taxable gain or loss on the sale. The buyer's tax basis will again equal the amount paid. If Dr. Paul wants to take the cash out of the corporation, however, a tax liability will be incurred. If the cash is paid to him as a dividend, it will be taxed to him as ordinary income and will not be tax deductible by the corporation. Also, dividends are paid pro rata, which means that the new owners will share in the distribution according to their percent of ownership. If Dr. Paul receives the cash as compensation, it will be taxed to him just like any other compensation he receives from the practice-as ordinary income. This expense will be tax deductible by the corporation only if there are profits to offset it.
Although Dr. Paul's tax basis is quite low, he decides to sell his shares, pay the tax, and invest his proceeds outside of the practice.
Can the sale be structured to make the purchase more "affordable" for the buyer?
The buyers will likely use all or a portion of their owners' return on investment, after taxes, to make their payments. Can this tax be avoided? His advisors tell him that the buyer's tax cost can be reduced if he sells the practice for less. This would occur if operating expenses were increased. For example, can Dr. Paul as the practice's landlord increase the rent and still stay within the range of fair market rent? Increasing practice expenses reduces Dr. Paul's selling price. In exchange, he receives additional rental income. Is this acceptable to the buyer and the seller? If Dr. Paul agrees, he will be agreeing to an increase in his tax liability. He will be replacing capital gains with ordinary income - a significant increase in his tax liability.
Dr. Paul decides that the selling price will not be changed and tax liability will be paid as incurred. Will his buyers understand that they will be in the same "after tax" position in buying his stock as they would if buying any other investment? They will be receiving a substantial return on their investment to help cover their payments.
This manuscript is intended to provide the reader with general guidance in practice succession matters. The materials do no constitute, and should not be treated as, appraisal, tax, or legal guidance or technique for use in any particular succession situation. Although every effort has been made to assure the accuracy of these materials, Wutchiett & Associates, Inc. does not assume any responsibility for any individual's reliance on the information presented. Each reader should independently verify all statements made in the material before applying them to a particular fact situation and should independently determine whether the succession technique is appropriate before recommending that technique to a client or implementing such a technique on behalf of a client or for the reader's own behalf.
Benefits of being a Well-Managed Practice�
There are many advantages to being a Well-Managed Practice�. The most noticeable and first achieved are:
1. More resources. Well-Managed Practices� have the resources to practice better medicine. This includes the cash flow available to invest in the practice. For example, Well-Managed Practices� invest 2 percent to 5 percent of their practice revenue in new medical or office equipment and technology every year. Practices that are not so well-managed are often relieved if they can just meet payroll or cover their drug bills.
Their staff people are usually better educated, better trained, and better paid and there is a higher ratio of staff to doctors. The reverse is true for practices that are not so well managed. Such practices usually have less qualified people earning lower wages and turning over every one to two years.
2. Higher compensation. Owners of Well-Managed Practices� have incomes that are significantly higher than owners of average practices. From our 2000 Well-Managed Practice� Study, owners averaged $197,000 versus the national average of $65,000.
3. Balance of personal and professional time. In addition, these owners aren't spending all of their waking lives in the practice. They are working an average of 40 to 45 hours per week.
4. Higher practice value. Owners of Well-Managed Practices� eventually receive a higher value for their practice when it is time to sell. Given two practices with the same number of doctors and the same revenue production, the Well-Managed Practice� will typically be valued at almost twice that of the average practice.
Perhaps the most important thing to remember about Well-Managed Practices� is that any practice can be one. It won't happen overnight, but the goal is attainable for any practice that decides to achieve it. The choice is yours.
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