December 1, 2002
by Barry McNulty
A question I am asked frequently these days is, “When should I start thinking about transition?” My response is often a surprise; “It’s earlier than you might think.” In my view, it is prudent to start thinking about your transition even before you actually buy or start your own practice. Yes that’s early, but there are some decisions about getting out of practice that could influence how you get into practice. For example, it could influence the location you choose, the dcor of your office, how it’s equipped, staffed and so on. Thinking about the possibility of selling your practice some day and ideally getting a return of your capital, can also influence day-to-day practice decisions. For example, a new client came to me years ago to help him plan his transition. This client owned a fabulous building that housed his practice. It had cost him a fortune. Unfortunately the location wasn’t great, and while he thought his building was wonderful nobody was willing to buy it for a price that even remotely repaid him for the money he had sunk into it. Had he been thinking about the impact of this building on his future transition he probably would never have gone ahead with it. That would have saved him a lot of money and aggravation.
When it comes to a more detailed transition plan, I recommend starting the process at least 10 years from your intended date. Of course, this depends a lot on the individual. Ten years may seem like a long time to plan for something, but there are a myriad of details and contingencies to consider and decide upon. Incidentally, if you’re currently less than 10 years from your transition date, don’t despair. While in my experience, the best time to start a detailed transition plan may be at least 10 years prior to the date, the next best time is now!
Your transition choice must work within a larger context.
There are three areas of your life that must be organized to complement your transition selection. The first is your finances. The second is your practice. And the third is your personal life (after all, what are you going to do with the 2000 or so hours a year that used to be taken up with the office?). Can you see why planning for your transition can take 10 years?
You don’t have to decide right away on a specific transition model. Generally you have two broad choices. You can sell outright or do a staged transition. In either case, there are many variations open to you. The ultimate choice will be heavily influenced by your personal preferences.
Many practitioners plan on doing a staged transition, with a backup plan in mind that if it doesn’t work out they can always simply sell outright. It takes longer to arrange a staged transition because you fundamentally sell part of your practice now and the balance of it at a later date. This can take the form of a chart sale only, a sale of part of your goodwill and tangible assets (equipment, leaseholds, etc.), or the creation of a partnership. Naturally, there are a couple of prerequisites for making such an association work. Your patient base must be sufficiently large. Your office also has to be able to support multiple dentists. Incidentally, don’t automatically plan on spending money to renovate. The answer to fitting another practitioner in may be calendar management.
Associate arrangements are not always successful, as many practice owners know from personal experience or from observing colleagues’ practices. In my experience, if you wish to pursue a staged transition alternative, then reaching an agreement on terms and expectations in advance is a must! I can’t express this strongly enough. It is critical that you have a well-drafted document that clearly defines your relationship and deals with your expectations. It should even include such details as the buy-in price and buy-in timing. It must also protect, to the greatest extent possible, your goodwill. While there is no guarantee of success, proper structuring and documentation will substantially improve your odds.
With respect to your finances, you can’t have what is considered to be a successful transition if you don’t have the resources to maintain a satisfactory lifestyle thereafter. Depending on your circumstances, you may need even more than 10 years to get this aspect of your transition plan properly orchestrated. Let’s look further at defining what I mean by finances. How much will you need on an after-tax basis to maintain a satisfactory lifestyle? Given some reasonable assumptions that relate to tax, investment returns, longevity, inflation, and so on, your financial advisor should be able to come up with a specific sum that you’ll need to accumulate. Next, you’ll have to assess your current financial position to determine if you have the resources to meet your objective. Going through this exercise can often be an “eye opener”. If an analysis of your present financial resources indicates that you won’t have enough to support your retirement lifestyle, you’ll have to develop strategies to make up the deficit. In this case, the more advance planning you do the better, since one of the primary ingredients of a successful wealth creation strategy is time. Again, this is why looking ahead 10 years is so important.
Another justification for advance planning is the opportunity it provides to organize your affairs in the most tax-efficient manner. This can easily take 10 years. There are the pros and cons of various incorporation strategies. Special RRSP contribution rules and retirement compensation arrangements are other examples of tools that can be useful in reducing or deferring your tax liability on transition. To get maximum benefit from these tax strategies, the groundwork must be established years in advance.
Time is also a key factor when it comes to getting your practice ready for your transition. It’s a good idea to get a professional evaluation so that you understand what the value is today and what, if anything, can be done to enhance that value. Many factors can influence the future value of your practice. Some experts feel very bearish about the outlook for practice values. This is largely fueled by demographic statistics that seem to indicate there will be a substantial increase in the supply of practices for sale as baby boomers age. At the same time, the concern is that the changing demographics of dental school graduates will decrease demand. Who knows? It’s interesting how many times factors such as changes in the economy, culture, or accessibility of credit affect the accuracy of such predictions. From a planning perspective it’s fair to say that well-run, profitable practices should continue to attract a premium over poorly-run offices, no matter what changes take place. Your practice is an investment. Regardless of future market conditions, enhancing the return you can expect from that investment between now and transition will usually improve its market value. Even if the sale value doesn’t increase, the resulting additional income will make the exercise worthwhile. This may involve investing in new equipment that would need to be replaced prior to transition anyway. If you are 8 to 10 years away from transition, such investments can make sense. It can take a number of years to get a return on the money you spend to purchase new equipment. For example, intraoral cameras and/or a panoramic x-ray are worth considering if you don’t already have them. So waiting until a year or two before your transition date to make necessary replacements could mean that you don’t get your money back on such an expenditure. At the very least, purchasing in advance will give you the opportunity to enjoy the asset in your practice. Take a look around the practice. How does it look? What impression will a prospective purchaser likely have? Is your new patient flow allowing for growth in the practice? Is your recall system operating effectively? If you are in general practice, is there a specialty aspect about your service mix that should be adjusted? For example, do you do a lot of ortho? If so, you will either have to plan to change your service mix or you can expect that the market size for your practice will likely be restricted.
Finally, if you’re going to fill those 2000 or so extra hours that come with retirement, you may need some time to develop other interests, hobbies, or volunteer work. If you already have a burning passion or activity that will fill your leisure time, you’re very fortunate. If you don’t, there are consultants who can help to guide you in this area. Or, you can start experimenting on your own with alternative activities for this exciting phase of your life.
Regardless of the transition type you choose, a successful process happens by design, not default. You may be retired for quite a number of years, so it’s worth taking the time now to plan for a quality transition experience. Good Luck!
Barry McNulty CFP, RFP, CIM, FMA, FCSI is a financial advisor with Assante Capital Management Ltd., who specializes in working with dentists. The opinions expressed in this article are not necessarily those of Assante.