- The Delayed Internal Sale: Exit Plan...or ticking time bomb?
A popular exit plan for many dentist practice owners is known as the Delayed Internal Sale.
The plan involves finding a younger dentist (either internally or through recruitment) and offering them the chance to buy the practice once they have worked together for a few years.
The buyer gets to take the business for a test drive…the vendor gets to know their successor before they sell. It seems like an ideal way to transfer ownership for all parties involved…and yet… all is not as it seems.
The success rate of the delayed internal sale is low and, when it doesn’t proceed, the fallout of the failure is often much higher than anyone anticipated.
What are the advantages of a delayed internal sale?
There are lots of perceived advantages of a delayed internal sale.
For the dentist owner:
- They feel they can lock in a young dentist for a few years, without worrying about them leaving for another job or starting or buying somewhere else.
- They can get a sense of the clinical skills and personality of their successor and how they get along with staff and patients, and feel more assured that their legacy will be intact after they are gone.
For the young dentist working in the practice:
- They feel that they can lock in a practice sale without competitive tension.
- They feel that they can effectively take the practice for a test drive. They will know it inside and out, before they risk capital loss by purchasing. They will have a familiarity of the practice that few buyers will under other circumstances. In particular, they will know:
- the condition of the equipment and fit-out
- Who are important referrers
- Staff dynamics
What are the disadvantages? Why does it fall apart?
With all of the above going for it, the delayed internal sale seems to be a “win-win” scenario. It should be an ideal way to transact for all parties. However, all is not as it seems on the surface. The delayed internal sale exit plan is one fraught with problems that lead to a high rate of failure.
Much of the high rate of failure can be attributed to the vague set-up of the relationship. Often, the initial discussions on a transaction like this are very non-specific. The owner tells the young dentist that in a few years, if he/she stays working there, and things work out, there will be a buy-in/buy-out opportunity. The young dentist works there for a year or so and, from time to time, the owner and the young dentist bring up the proposed future transaction in quiet conversation in more and more solid and definite terms, until they are talking as if it is happening someday. In reality, extremely little has actually been agreed upon; little, if any of it, has ever been written down and, if it was, none of it is detailed or binding. They often haven’t discussed or documented:
- A timeline of exactly when the transaction might happen. Practice purchases and sales are major milestones in a dentist’s life. Both parties need to be ready financially, emotionally and professionally for the transaction to occur. This takes planning and it is unlikely that both parties will coincidentally be ready at the same time.
- How the practice will be valued when the transaction happens and by whom. There are multiple valid methodologies for valuing a dental practice. Internal purchasers are somehow regularly surprised and upset to learn that the purchase price will also include the purchase of goodwill that they themselves created.
- Post-sale terms for the vendor (will they work post sale, how many hours per week, weeks per year, at what remuneration, as a contractor or employee).
Even if they have discussed and documented all of this…Time kills all deals. Over the few years that this understanding has been in place:
- The financial fortunes of the buyer or seller may change, such that they can no longer afford to proceed at the agreed price and terms.
- The health of the buyer or seller may change, such that the timetable and price agreed can’t be upheld.
- A practice may come on the market that is a better fit for the purchaser (closer to the purchaser’s home, a better opportunity for other reasons, etc.).
- An unsolicited buyer could approach the vendor and offer more money than the buyer can afford.
- Practice fortunes change over time. The practice may become unaffordable for the purchaser if it becomes very successful, or unattractive if the practice becomes unsuccessful.
Why is the fallout so bad?
When anyone is excited about plans that don’t go ahead, there is always upset and frustration. In this case the plans:
- Have been in place over several years.
- Involve a high stakes financial transaction.
- Have an opportunity cost for both parties, of other opportunities that have been ignored and turned down.
- Involved invested time, effort and money spent talking with accountants, lawyers, financiers.
- Have knock on effects into post-sale plans for all parties.
If, after several years, one party wants to transact as previously agreed and feels that the other party intentionally mislead or backed out of a clear commitment for “no good reason”, the frustration and upset can reach fever pitch. There is likely to be considerable anger at the wasted time, expense and lost opportunities that the transaction has cost them, and it isn’t uncommon that commercial or professional ‘revenge’ is sought (and sometimes achieved) by the aggrieved party.
All in all, what looked like a good idea and an ideal transaction for both parties, can unfortunately sometimes lead to a very poor result at the end of the day, for all concerned.
To read more articles on the Subject of "Seller: Types of Sale" please click the following articles:
- And The Seller Stayed On
- Partnership Exit-Planning: Selling a House that comes with a Marriage
- Internal sale – Who owns the goodwill?