How to transition your practice to family members

May 22, 2017

Treating children the same as hypothetical buyers can help to ensure a smooth process.

Consider the solo dental practice doing quite well and needing one or more associates as its growth proceeds. What could be better than having the family involved to assist in the fine reputation and upward financial trend of the practice? Allowing brothers, sisters, father or mother to be in contact as they age and enjoying that relationship and tutelage is something that many families wish to attain.

Suppose a father who has been practicing as a proprietorship with an almost fully saturated schedule decides to add his two adult children to his practice. What is the consideration to be paid to him? How is that compensation determined for the shares transferred to the offspring? Does he have to receive payment from the son and daughter?

Who cares if the dentist gives away his most valuable possession to his children?

According to almost all experts and in reviewing IRS court cases, there must be consideration, and that amount paid must be determined in an “arms length” manner. For some precautionary protection, a dental practice valuation could be performed and the amount designated as the value of it should be considered. There can be adjustments for properly determined areas such as the lack of marketability and minority ownership discounting, but when involved with remuneration among related parties, it is important to be as straightforward as if the buyer were unrelated. Exacting a less than market value amount without extremely supported documentation could render the transaction as improperly reported and result in penalties and interest to both parties from government taxing agencies.

The determination of the value of the dental practice

If the dentist who is the parent were to list the practice for sale, he or she would probably retain an expert dental practice evaluator to perform a valuation of the practice. That appraisal would then be reviewed so that the methodologies employed would be understood by the dentist. He or she would then meet with one or more brokers to determine a marketing strategy and probably sign a listing agreement to get the best possible price and terms from those interested in an acquisition. This approach should be similar when selling to the adult children, except for the listing agreement and brokerage fee to be paid. Of course no marketing strategy would be needed either.

What about the preparation of the closing documents?

It is important to have a review of the valuation by the dental CPA who would explain the sale and need for the proper protocol to the children. The attorney for the dentist would prepare the agreement, if versed in representing dentists. If not, an attorney should be hired who has worked with dentists for the preparation of the agreements. This protects all of the parties. This process would replicate the best price and terms for a potential sale to a third party. Following these steps would assist in ensuring a smooth transition in the event of an IRS audit regarding the price and terms since the transfer would be to an adult child.

Making the financing easier on the children by assisting with the debt paperwork

Various tax allocations may be inserted into any transaction that are formulated by the advisers to the parties involved with the agreement. Each side of the transition of the dental practice typically has their own thoughts as to best advocate for their client. If the seller were to finance the acquisition by a buyer, the terms would probably be similar to a bank loan regarding the interest rate, term and monthly payments as well as the collateral. The seller/father would do the same with his adult children. He can arrange the financing and “hold” the note from the children. A bank would want to file a lien against the assets of the practice besides getting personal guarantees of the buyers. The selling dentist should do the same with his family. It is common practice to be secured when selling unless 100 percent of the agreed upon price is paid in full at closing on the sale’s date. The settlement with the children should be no different.

Final thoughts on transitioning from parent to child

If the approach and paperwork between family members are similar to a hypothetical dentist who was not known to the seller, there should be no government intervention with it. Acting as if the children are the same as the hypothetical buyer regarding the terms and conditions of the transition will almost always guarantee protection during an IRS audit.