When should we freeze the practice price

Sometimes you, the associate, are offered an opportunity to buy into the practice in which you have been associating. You may be offered a fifty percent interest in a two-doctor partnership or a thirty-three percent interest in a three-way doctor partnership, etc. We all know that the price the associate is paying today will likely be based upon the practice’s value today; however, how do we determine the price of the practice in the future when you have the opportunity to purchase additional interests in the practice? Well, in my opinion, it will depend on several factors and how your initial purchase transaction was structured.

For example, let’s look at a situation where you buy into a practice today at a fifty percent interest, and you and your partner are expected to be partners for at least five years. Most likely, in this situation, you will determine the value of your partner’s buyout based upon the fair market value of the practice at that time. In some cases, your partner or shareholder agreement may provide a formula based on the practice’s financials at that time. In either case, you will likely pay what the fair market value is at that time.

Now, let’s consider the same facts above, someone is offered a fifty percent interest in a two-doctor partnership, and you are expecting to be partners for at least five years. However, the seller is suggesting that you buy into the practice at ten percent per year over five years so that at the end of five years, you will be a TRUE fifty percent owner. In this situation, I believe the buyer/associate has every right to suggest that the price they pay for each additional ten percent interest be based on the value agreed upon TODAY, and NOT the current market value after year one, two, three, four, and five. The reason is simple. The seller most likely wants a fifty percent partner at some point; however, they either have trouble letting go of their control of the practice, and therefore they want to retain the majority ownership percentage, or they want to retain more of the profits over the five year period or a combination of both reasons. If this is the case, I believe the seller OWES the buyer/associate the opportunity to retain the current price of their additional interests over this five-year period since they are retaining control and potentially a higher portion of the profits. Once you are equal owners and then there is a buyout out later on of the senior partner, say in another five years, then I would expect the buyer/associate to pay the fair market value of the practice at that time for their buyout.

However, using the fact pattern in the example in the preceding paragraph, except the deal is that after five years when the buyer/associate hits their fifty percent interest, the original owner is expecting to be bought out of their fifty percent interest. What value do you place on the original owners’ fifty percent interest at that time? Well, that is likely going to be negotiated. On one hand, if the buyer were afforded the opportunity to “freeze” the value for each of their ten percent interest purchases, you may naturally want that final buyout to remain at the price it would have been five years earlier. On the other hand, the seller would have a valid argument that they allowed the price to be frozen for five years; they should receive fair market value after five years when they are ready to sell their fifty percent interest. 

Finally, when we talk about “freezing” the price, what we really mean is freezing the goodwill portion of the purchase price ONLY! Think about it, the dental practice will likely continue to make purchases of tangible assets like equipment, computers, technology, maybe expanding the space, etc. AND any existing equipment will continue to depreciate and be worth less five years later. Therefore, even if the associate is afforded the opportunity to “freeze” the price of the additional interests in the practice over a short period of time, they should absolutely expect to pay the fair market value of the tangible assets at any time, in my opinion.

At the end of the day, this one piece of a practice acquisition puzzle will be negotiated along with all the other pieces. If you do not get your way on one piece of the puzzle, then you should look to the other pieces and attempt to negotiate them so that once the puzzle is complete, you feel as though you have received a “fair deal” on the entire puzzle.