Buying A Dental Practice Part III – The Asset Purchase Agreement
The first two posts in this series looked at evaluating potential practices and due diligence. This final post looks at the asset purchase agreement. This post is not intended to be exhaustive, but we have included some of the fundamental provisions we consider in our practice.
What Is The Purchase Price Allocation?
The purchase price allocation is the division of the total purchase price into several categories. These categories include the amount attributable to equipment, goodwill and the covenant not to compete. The allocation of purchase price can have significant tax consequences for both the buyer and the seller.
A buyer will likely want to allocate as much of the purchase price as possible to equipment. Lenders may require that a certain percentage of the purchase price be attributable to tangible physical assets like equipment. Additionally, purchased equipment can often be deducted under Section 179 of the Internal Revenue Code. This can result in an immediate tax savings, whereas goodwill must be depreciated over 15 years.
Sellers, on the other hand, may want to minimize the allocation of the proceeds to equipment and other tangible assets. Sellers have likely already depreciated these assets under Section 179 and these amounts will be taxed as ordinary income. However, goodwill is taxed at the capital gains rates, which are significantly lower.
How Do I Address Accounts Receivable?
The asset purchase agreement should address accounts receivable. The first consideration is who will own the accounts receivable following the sale. Are they going to transfer to the buyer or remain the property of the seller?
If the buyer gets the accounts receivable, the next step is to value the receivables. This requires evaluating the age and collectability of the receivables to determine a price. For example, a buyer could pay 100% of the face value of all current receivables. However, the buyer would pay less for older receivables, based on their age. This option allows the buyer to maintain control of all patient communications.
If the seller keeps the accounts receivable, the buyer will pay less at closing. The buyer also will not have to worry about collecting the receivables. However, the seller, in collecting the receivables, may use methods to collect the debt that anger your patient base. For example, a seller could refer a patient to a collection agency or sue a patient to collect the debt. This also leads to potential confusion, as the buyer may receive payments that are intended for the seller.
Alternatively, the parties could take a hybrid approach where the seller retains the accounts receivable, but the buyer collects them on the seller’s behalf. Under this approach, the buyer is in control of the collection efforts, but any payment is then sent to the seller. Since the buyer must use staff members to collect, the seller also pays an administrative fee to the buyer, typically a percentage of the collections.
How Does The Buyer Protect The Investment In The Practice?
Every asset purchase agreement should contain restrictive covenants to prevent a seller from competing. In fact, lenders typically require that an asset purchase agreement contain restrictive covenants. The two most common common restrictive covenants are non-compete agreements and non-solicitation agreements.
A non-compete agreement simply states that the seller will not practice dentistry within a certain radius of the existing practice for a certain period of time. A non-solicitation agreement prohibits marketing to former patients. Non-solicitation agreements also often prohibit the seller from attempting to recruit former staff.
However, you have to be careful in drafting restrictive covenants. Arizona courts disfavor them, especially in the healthcare setting, due to concerns over patient choice. Additionally, Arizona has specific requirements for restrictive covenants that, if not followed, can lead to a court invalidating them. You should consider retaining experienced legal counsel to ensure the agreement is enforceable.
The above are just a few of the many issues that can arise when buying a practice. If you are considering buying a dental practice and have questions about an asset purchase agreement, please feel free to contact one of our attorneys directly.