Almost invariably, when the parties to a practice pur-chase and sale endeavour to negotiate, finalize and agree upon the terms of the sale without the benefit of legal and account-ing advice, they are often much farther away from a final agreement than they hoped or realized. As well, unrepresented parties run the risk of suffering a loss of confidence in one another when they later realize that there was not in fact a meeting of minds as to the terms of the purchase and sale and they cannot reconcile their respective “reasonable” positions.
In approaching a practice purchase and sale, there are many factors to consider, monetary and otherwise, that will influence the direction of negotiations and the final terms and conditions. Having accounting and legal advice early in the process is critical for both parties so they may make fully informed decisions in the negotiation process.
This article is for the benefit of both purchaser and seller, as a truly suc-cessful negotiation and transaction is dependent upon both parties being well informed and fully advised. Discussed will be some (but certainly not all) points often missed by unrepresented parties.
The Valuation
The valuation of a dental practice is usually a voluminous, comprehensive and sometimes complex document containing information on the practice being sold. It is strongly advised that a valuation be obtained from a qualified practice valuator.
Next Stop -Your Accountants
Once the purchaser and seller have resolved to enter into negotiations, the first stop should be their respective accountants.
Value Analysis
If you are planning to sell your practice, make sure that your accountant is involved during the valuation process.
From the purchaser’s perspective, your accountant should be walking through the valuation with you so that you can make the appropriate decisions, with the first threshold decision being whether or not the practice is worth pursuing based on the informa-tion provided. As well, your accoun-tant may suggest that you request further particulars in the course of this initial analysis. This would also be a good time to contact your lender to confirm that financing can be approved to the extent required.
Asset vs. Share Sale
From the seller’s perspective, you must consult with an accountant to determine whether it will be a sale of shares (of the professional corporation that owns the practice) or assets (by either the seller personally or his or her professional corporation), as there are significant tax implications to both parties that stem from this. The seller’s intentions in this regard should be communicated to the purchaser (and their advisors) before review by the purchaser’s accountant and certainly well before any drafting begins by the purchaser’s solicitor.
As a purchaser, it is important to understand the implications of an asset sale versus a share sale, as the direc-tion of negotiations will be significantly affected by this determination. The seller generally wants to sell shares of their Professional Corporation so they can minimize taxes on the sale by taking advantage of the $750,000 capital gains exemption. The seller needs to work with their accountant and lawyer to ensure that the rules are complied with to implement the tax-free sale. On the other hand, the purchaser generally wants to buy assets to avoid hidden liabilities and increase the asset base for tax write-offs. When the purchaser buys shares, there is an actual tax cost to them, which can often be negotiated to justify a reduction of the sale price.
Purchase Price Allocation -Asset Sale
Should the buyer and seller decide on buying/selling assets of the practice, the allocation of purchase price will also need to be negotiated. The allocation can have a significant impact on the amount of income tax and HST the seller and purchaser have to pay. There are also instances where the allocation may not affect the seller at all, but will benefit the buyer.
Next Stop -Your Solicitors
While your solicitor should be notified as soon as possible of your contemplated transaction, their involvement in terms of drafting becomes more significant once the accountant has completed his or her analysis and has made recommendations. Otherwise, you may needlessly incur legal fees for documents drafted in a context that may not ultimately apply.
Before any drafting begins, the solicitors for the purchaser and the seller will wish to review certain key aspects of the business -aspects that can have a significant effect on the value of the practice and perhaps the parties’ approach in negotiations.
Identifying the Vendors -Share Sale
It might be surprising to hear that your family members may need to be named as sellers in the Agreement. It is not uncommon for family members to hold equity shares for the purpose of duplicating capital gains exemptions on the sale of shares. It is critically impor tant for the solicitors to be aware of this, as the form of agreement will be vastly different as it must make allow-ances for the additional parties and their respective rights (and obligations) under the Agreement.
Preliminary Due Diligence
While a properly drafted agreement contains due diligence conditions to be satisfied within a prescribed period after acceptance, it might be prudent for your solicitor to research the background of the other party. This would involve various searches available in the public record. As a selling dentist, you may wish to have the comfort of knowing that the dentist taking over the care of your patients is a dentist of good character and credit-worthiness and without past or pending complaints or claims. As a purchaser, you may wish to know that the seller is a person of good character and without any past or pending claims, or liabili-ties which may be an impediment to the completion of the transaction.
Employee Liabilities
On the sale of a business, a significant potential liability can arise from the subsequent termination of employees. As a result, a properly framed agreement will expressly address the allocation (and time limits) of such liabilities between the purchaser and the seller. Both parties should consult with their respective solicitors to fully understand the potential liabilities to employees at or beyond the completion of the transaction.
Premises Lease
There is almost invariably provision under the premises lease in relation to the assignment of the Tenant’s rights and obligations. In the event of a practice sale, the Lease often requires the Landlord’s consent. This may also apply in a share sale if the Lease has a provision that deems a change in control to be an assignment of the Lease. At times, the Lease will provide that such consent shall not be unreasonably withheld and other times it may say that the Landlord may “arbitrarily withhold consent” or worse, “terminate the Lease without compensation to the Tenant”. The solicitors for both parties should review the premises lease and consult with their respective clients as to the requirements and possible obstacles to an assignment of lease (or new lease). It is also important for the purchaser to understand any onerous provisions in the lease (with the view of eliminating them wherever possible). The purchaser should also be aware that if they are financing the purchase, lenders invariably require a lease with aggregate terms (including available renewals) equal to or greater in duration than the term of the loan.
Preparation of Agreements
While it can be helpful to maintain nonbinding reference memoranda during the initial stages, attempting to reduce the parties’ understanding to writing in some form of binding agreement or something purporting to be a “standard form” agreement without the benefit of legal and accounting advice can lead to disastrous results for one or both parties.
Too often the writers receive initial calls from purchasers and sellers who indicate either “we have a deal and just need you to quickly write something up” or worse “we have drafted and signed an agreement and just need you to help us close the deal”.
For the reasons cited above (and others), it is important to leave the preparation of binding agreements to the solicitors, with proper and timely input from your accountants from the beginning and throughout the process.
Representation Throughout and Beyond the Transaction
After the offer is signed and accepted, regardless of whether you are the buyer or seller, you will still need an accountant to help you through the process.
For the purchaser, a properly drafted agreement provides for a period of time to conduct detailed financial due diligence by your accountant. Financial due diligence includes a review of financial statements and tax returns, accounts receivables listing, and production reports. You want to ensure that the valuation gave an up-to-date picture of the practice. Particularly if you are buying shares of a professional corporation, you take over all the liabilities of the corporation, including tax liabilities.
For the seller, there are tax returns and financial statements that need to be filed. If you are incorporating right before a sale, your accountant will need to prepare appropriate documents for filing with the Canada Revenue Agency to ensure the available capital gains exemption. In addition, these documents need to be provided to the buyer’s accountant for their due diligence.
The solicitor for the purchaser will also conduct further due diligence after execution of the agreement and before completion of the sale to ascertain and requisition action by the seller in rela-tion to any liabilities, claims, judgments or any other impediment to the completion of the purchase of the practice (clear of all encumbrances).
It is also important to retain your accounting and legal advisors not only to the completion of the transaction, but beyond as well, as there are a several routine (and sometimes unexpected) tasks that will require your accounting and legal advisors.
John McMillan is a Toronto business lawyer serving dental professionals. He can be reached at (416) 364-4771 or johnmcmillan@bellnet.ca
Andrea Wong, CA is a Toronto chartered accountant at Meyers Norris Penny LLP specializing in providing strategic and tax advice to health professionals. She can be reached at( 416) 515-3831 or Andrea.Chan@mnp.ca
