59: Practice Sales: The Role of the Attorney

Foreign.

Welcome, everybody, to another edition of the Dental Boardroom podcast. I have my beloved guest Matt Odgers on the show again. Welcome, Matt.

Yeah, thank you so much for having me back, Wes.

If you've been listening to some of our recent podcasts, you're seeing Matt is a regular. We recently did one on the purpose of escrow in a dental practice sale. And right now we're in the middle of a series on dental practice transitions. And so we're covering a lot of the topics to help potential sellers and buyers become really versed in that process. So they go into it like a pro. And this series is being double broadcasted on this, the Dental Boardroom podcast, but also on our other podcast called the Dental Practice Sale podcast, which is attached to our company called PracticeOrbit.com, which is centralizing practice sales into one location and helping provide technology and tools for buyers and sellers to navigate what is a relatively complicated transaction known as a dental practice sale. All right, Matt, so we got a cool subject today that's going to be near and dear to your heart and one that I'm also grateful for, which is what do attorneys do in a dental practice sale? So if I'm a buyer or a seller, I'm going to have you educate me on your role so I know how to leverage you to the max to protect myself and to navigate that transaction in an intelligent way. All right, let's kick this off. Matt, I'm going to just ask you a couple questions here that would be great if you just bullet point for me and the listeners. Bullet point for me. What are the main documents or the main features in the dental practice sale that you address as an active dental transaction attorney?

Yeah, absolutely. So I'm going to kind of go in the order of timeline of events from when a sale kicks off all the way through till the closing. So at the beginning, there's going to be a letter of intent which is submitted and an attorney or a broker is going to draft and help on that front. Once the letter of intent is submitted, the next Dr. Document is going to be an asset purchase agreement, which is also referred to as a practice purchase agreement or a purchase and sale agreement. But it's the document that has all the terms for what's being bought and what's being sold and then the promises that both parties are making in relation to that. The other document is going to be the lease and either reviewing or negotiating a lease or a real estate purchase agreement. So it's whatever the document is that the deal has to get the dentist into the office space so that they have security and they can hit the ground running. Those are kind of the main documents that are in just about every single practice sale. Now some of the ancillary documents that come up from time to time that are deal specific is if the seller, if the buyer and the seller agree that the seller is going to work back in the practice, there's an associate work back agreement. And whether that be an independent contractor or a W2, if the parties agree that the seller is going to be providing some financing, either financing the entire deal or just a portion of it and a bank's going to do the rest, then there should be a promissory note and security agreement. And I believe that kind of sums up all of the big ones, the big documents that are in majority of transactions.

Great. And if you're representing a buyer, something unique there is helping the buyer establish their legal entity.

Yeah, that's right.

Which buyers don't do this as a sole prop. Sole proprietor. Do it as a corporation, what's called an S corporation. Do it right from the beginning is our strong recommendation there. Well, let's go through some of these. Matt, can we.

Yeah, absolutely.

On, let's talk about the first, the main three, I'll call them the big three. The letter of intent, the asset sale agreement. Sometimes we call it the psa. The purchase and sale agreement is a common language I hear tossed around. And then of course the lease document or the real estate purchase agreement. And then if we have some time, we'll just quickly address the work back agreement and the seller carryback note if they contribute to some of the financing. The letter of intent. We just did a, we did a couple podcasts a few months back. Listeners can check it out on the Dental Boardroom podcast where we talked about why the letter of intent and what are the terms or the language that should be in a good letter of intent. And we also just mentioned it in our recent podcast on why to use escrow and how escrow instructions should be included in the letter of intent. Let's go ahead and kick this off. Why is the letter of intent, which sometimes is just this template document that a broker sort of throws out and has the buyer sign it just to kind of lock it in. And then what's supposed to happen is the buyer and seller go off market and now they enter into private negotiations. Do you think that the letter of intent should get more value treated to it and more care in the creation of it? And if so, why?

Yeah, so the attorney. As an attorney, obviously, I always recommend that you have your attorneys involved in the letter of intent and at least do a cursory review for two reasons. The first one is that for the most part, letters of intent are not binding, but that's not always the case. And so you want to make sure that there's no provisions in there that could create a binding contract. And so an attorney can help you kind of navigate that side of it. So when it comes to the business terms in the letter of intent, the attorney can help advise on, you know, what they've seen in the past and kind of point you in the right direction. But a lot of times you're going to lean on a practice consultant or a CPA or evaluations expert to help you know what you're going to offer. The attorney's rule is more geared towards making sure that those terms are properly documented in the letter of intent and then determining which terms you want to leave out to be negotiated in the purchase agreement. Once a term is in the letter of intent, it can be changed, but it can be a bit of an uphill battle. So you do want to make sure that you've kind of thought through all of the different terms and that you're good to go on that front.

Yeah, I'm going to use the word anchor. The LOI tends to anchor everybody to specific terms, particularly the price. And so let's say you're now after loi, you're into due diligence and something comes up and you as a buyer feel like the price justifiably should be reduced. That is much harder said than done. Sellers start to plan their whole life on that amount that's on the loi. So this is where an ounce of prevention is worth a pound of cure, in my opinion. On this and having some analysis done on the profitability and post purchase cash flow to the buyer, I think should be done wherever possible prior to signing the letter of intent because it's so much easier to negotiate a price before then because as I said, anchoring always occurs when the LOI is signed. Now, one thing I'll mention about this, Matt. You, you and I know that there's as in your career space and my career space is equally in a broker's career space. There are some brokers who I think are more ethical than others, but one of the things that brokers do that I'm not a fan of is they will just tell a buyer, hey, Dr. So and so Dr. Buyer, I've got nine other people ready to sign this letter of intent. But the doctor's chosen you because the doctor believes you are the chosen one. And but you got sign by tomorrow at 2 o', clock, otherwise you're going to lose this because I'm going to go to the next person. And you know what, sometimes that may be true. If it's a really nice practice in a really nice area. It is true. The demand usually is pretty strong for that one practice. And so the seller has options and therefore the broker has options and can use that language. But in a lot of times that's just negotiation. That's like Donald Trump the art of the deal, just trying to get the highest bid and get somebody to sign in really quickly. And so the buyer oftentimes is like, oh, I don't want to miss this deal. So they just sign it without really looking at what the cash flow and the profitability is. So be aware of that. It's sometimes hard to tell whether there are other buyers lined up for it. But last thing you want to do is move into a practice where you're going to make less money than you are as an associate with three times the responsibility.

Yeah, absolutely. And going back a little bit, it's commonly accepted that most letters of intent are non binding. But with that said, there's usually some provisions in the letter of intent that are going to be binding. And that's where an attorney can help you navigate and kind of help you summarize what you're agreeing to when you sign that. The provisions, such as if you're a seller, whether you're allowed to continue marketing the practice, you may be waiving your right to do that and that might be enforceable. Or if you're a buyer regarding confidential information that's going to be given to you during due diligence, that's another one that's binding. And then also which we talked about in our last podcast, is how the earnest money deposit is going to be handled and in which events it's going to be returned to you or forfeited to the seller. So those are the big things that if you're going through a letter of intent, regardless of who drafts it, the buyer, the seller, or a broker, you want to be on the lookout for those terms and make sure that you're crystal clear on what the letter of intent says and what you're going to be bound to.

Yep. And a little preface into our next podcast on what the heck do CPAs do in a dental sale? When I say you should do some analysis before signing the letter of intent, because the letter of intent really anchors the seller, especially to a given price. A good dental CPA will, and I'm obviously very biased for practice cfo, who I think does a great job in this area, do a free initial analysis for practices at least practice CFO will do it for practices that have more than a million in collections. A free analysis. We call it the initial analysis and asking price assessment where we get the P and LS and we do what's called normalizing the P and L, where you basically right size the P and L to be able to compare it against industry standards. Because P&LS profit and loss statements come in so many formats. And you got to reorganize the list of expenses in such a way that you can isolate what is labor, what is lab, what is supply, facility, marketing and admin, and what is doctor's personal travel to Hawaii and the doctor's Amazon cost for their own house and the doctor's kids on payroll and sifting all that stuff out so we know what's the true profitability of the practice. And then you can use common benchmarks, industry benchmarks, to determine whether the asking price is reasonable. And then if you really go the distance, you say, if you buy it at that price, what are you going to take home after overhead, debt and taxes. And does it make sense? And if it doesn't make sense, then walk away or ask for a lower price or put in an LOI at a lower price so that your debt payment is lower and your cash flow is better. So that's really, really important. And the last thing I'll say is, so just to summarize that if you can get that done before the LOI signing, do it. That's preferred. If you don't and you already sign it and this happens a lot, we'll do that initial analysis even after the LOI is in just to confirm that we still want to move forward with this thing. The last thing I'll say about the LOI is that it does have the number of days. Correct me if I'm wrong on this, Matt. The number of days for the due diligence to be completed.

Yeah, there's a million different ways Lois are written, but a good LOI should have a time period. Sometimes it goes right up until the practice actually closes. But when there's an earnest money deposit, a lot of times it'll be set to 30 or 45 days to give the buyer more than enough time to make any requests and do their due diligence.

Yep. How do you handle this? Very practical question. When a buyer comes to you and the buyer is. Has no money, but they got $600,000 in student loans, maybe they have a little bit money in the bank and they don't know if their LOI is going to be accepted, but they want to engage you to look at it, to review it, but they don't know if they're going to move forward. How do attorneys, you don't have to say exactly how you do it, but how do attorneys in general handle that situation with a buyer?

Yeah. So actually I'm not positive how other attorneys do it, but I'd be happy to talk about how I do it.

Great. Great.

A lot of times it really depends. We have a flat rate that we charge for the letter of intent to be reviewed, which is $350, and then we apply that to the transaction once it's accepted. And that includes as many letters of intent as the buyer is going to be submitting. So the goal is that they're retaining us. And if the first one doesn't work out or it's not accepted, then we roll that over to the second or the third. So as long as the buyer is motivated to purchase a practice, even if it takes them two, three years to find the right practice, we're comfortable working with them on that front. And then once the LOI is accepted, we apply that to the rate that we charge for the other services.

That's a great model, buyers. It's a no brainer to do that. $350. No brainer. I would absolutely do that every time. All right, let's move into the next document, which is kind of the main document of the transition, which is the asset sale agreement. And I'll just start off from the CPA side explaining that an asset sale is when the seller is selling all the stuff that they own inside of his or her corporation or inside of his or her business. Dental, chairs, equipment, furniture, fixtures, patient records. Everything that you can't touch is called an intangible asset or goodwill. That's different than selling the stock of your corporation, where your corporation essentially is just changing ownership, but the corporation and related tax ID all stay the same. This almost never happens in dental. It's an asset sale. So the buyer, you help the buyer set up their own corporation with its own tax id and it buys all that stuff and puts it inside of its corporation. And the employees are terminated with the seller and they're hired with the buyer. And the buyer has to get contracted with all the insurance companies that they want to be in. So this is called an asset sale agreement, not a stock sale agreement. And so go ahead and tell us about this. Now, Matt, you and I know that we're going to be doing a number of episodes on the deal terms within a purchase and sale agreement. Things like what happens when a patient comes in and you have to redo work at no cost that was done by the seller. There's a lot of things like that that are very important to be addressed and that the buyer and the seller should understand. What are common practices around those? For example, also buying the ar. What do you do with the AR for treatment that's been done but not paid on yet at the time of close? A lot of things. So we're going to talk about all those. Give us maybe a general approach to what are you doing with you and the other attorney, both on the buyer and the seller side with the purchase and sale agreement?

Yeah, absolutely. So from a practical standpoint, for the most part, the seller's attorney is going to do the initial draft of the asset purchase agreement. Once the draft is completed, then he emails it over to the buyer's attorney, and the buyer's attorney is going to review it, mark it up with their comments, talk with their client about it, make any revisions, and then send it back to the seller's attorney. And that back and forth happens until the agreement is fully negotiated. So that's how the process works as far as negotiations go. The negotiations can be done over the phone in person, or a lot of times it's just done back and forth via email. Now, discussing what the actual purpose of the asset purchase agreement is, is that it's ultimately designed to cover all of the terms of what assets are going to be sold and what conditions are going to be tied to the sale. And so it's going to include things like each of the party's representations and warranties. The seller is going to be making a handful of promises which are called representations, saying that these are things that have happened in the past that are going to apply to the assets. So for a piece of equipment, an example of a representation would be that the seller has properly maintained the equipment, or when it comes to billing, that the seller hasn't overbilled. Or another promise may be that the seller represents that all of the financials are accurate. On the buyer side, with the promises that the buyer's making, there are usually a lot less promises that the buyer has to make. They have to promise that they're going to pay the purchase price, and then they have to promise that they don't have any outstanding litigation or things like that, but it's quite a bit less. And then the purchase agreement also should define exactly what assets are going to be included, what assets are going to be excluded, and then how to handle matters that arise after the sale that are a consequence of something that happened before the sale. So all of those things, and that's a very high level there. You know, we'll have another podcast where we go into the weeds on all of the specific provisions. But the walkaway point here is that this is kind of the main agreement that discusses how the transaction is going to happen and that you come back to if there's ever a problem post transaction. So it should be very detailed. It's important that you work with somebody who's familiar with dental terms instead of a general business attorney because you don't want them to overlook something like how to handle patient retreatment after the sale. A general business attorney might not understand that something that does come up from time to time. So all of those things are going to be included. And the other big one is going to be the allocation of the purchase price, which as an attorney we work closely with the client CPA to negotiate the allocation.

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In working a on a few occasions over the years with a seller or a buyer whose attorney is not dental specific and I find that they end up coming to me to ask all sorts of questions around these deal points because they don't know what the industry standards are. Which is why I highly advocate, even if it costs a little bit more for the specialty knowledge that you have somebody who's done this a lot that is a dental specific attorney.

Yeah, absolutely. And so either they're going to miss something and ultimately regardless of whose side you're on, whether you're a buyer or a seller, it benefits both sides to have every single condition discussed and agreed upon so that there's clarity. Without that clarity that leads to disputes and issues in the future. So a lot of times when there's a non dental attorney on the deal, there's a lot of explaining as to why all these provisions are needed. But also a lot of times there'll be pushback on something that really doesn't impact either the buyer or the seller just due to lack of understanding. So working with dental specific attorneys on both the buyer and the seller side is going to lead to a lot smoother transaction. And that smooth this maintains the goodwill between the parties so there's not this animosity that can come up when there's a bunch of bickering back and forth between attorneys during the negotiation.

One feature in the purchase and sale agreement I'll mention here, even though we'll probably have an episode dedicated to this, and this is in MySpace a little bit more, but this is one of the most important aspects in the purchase and sale agreement is how are you allocating out the purchase price across the various assets. They have significant tax implications to both the buyer and the seller. And so that's a feature to always look out for that. The attorneys are usually recruiting the CPAs in order to determine what that is. Is it safe to say, Matt, that here in California there's a set of dental attorneys that you and I know, virtually all of them, and that when working with them, you sort of know what's a material point and an immaterial point, and that you all sort of can speak a common language to get through the deal points relatively quickly, or do you find that a lot of times it does get a bit aggressive or hostile and one attorney's just not being terribly reasonable on behalf of their seller? Because it is kind of a small community, I would say.

Oh, it's a very small community. And there's attorneys that can be more difficult to work with, but there's also clients that are difficult to work with. So it's a very hard generalization to make because, you know, every now and then your job as the dental attorney is to advocate for what your client wants and what's in your client's best interest. And so it's a very tough question. So sometimes a client will have a strong position on something, and that might not be what the other attorney is necessarily advising them on, but they're still bringing it into the negotiation, as is their duty. And so when looking for a dental attorney, you want somebody who can think outside of the box, and if there's a position that the other side takes that's very set in stone or that's incredibly important to them and they're not going to be moving on it. It's not always something that requires that the deal be called. You need to have an open mind to be able to kind of move the terms around a little bit, to make sure that you make up for it somewhere else, if it's a business term, or find a way to communicate with the other side, if it's a liability term, in order to kind of convince them?

Yeah, I think a good attorney, and a good CPA for that matter, too, knows how to communicate an issue to their client in a way where they can make an assessment of the level of importance of that issue and whether it should be a make or break issue, or maybe it's an issue that we could concede on, because in the long run, it just doesn't matter. It's a blip. It shouldn't break the deal. I have seen some cases where things are negotiated And a deal is lost over something where I am like, that is so almost. It's not irrelevant, but it's just so small compared to the things that do matter. For example, how you allocate the purchase price across the assets. Rarely should ever break a deal, even though there are important tax implications for a buyer if it's a good practice and they have to end up paying, you know, an extra $20,000 in taxes because the price allocation wasn't in their favor. I'm going to explain that to the buyer now. I'm going to advocate to try to save them 20 grand, but also not going to let it break the deal because in the long run, it just doesn't matter. Okay, let's move on to the final document, Matt, which is the lease or the real estate purchase agreement. I'll just start off here by saying this is something that should be addressed pretty much as soon as the letter of intent is signed, in my opinion. Because the lease often is the primary culprit for delayed sales. Because landlords can be so difficult to recruit into the conversation. Sometimes they're unreasonable, sometimes they don't want to allow the seller to assign the lease to the buy higher or negotiate new terms to extend the existing lease term such that the banks are willing to lend. Because banks want generally 10 years, some will do five years to be on the remainder of the lease, which includes options. And so it's very common. And you and I are in a deal right now where that's the case. The landlord is going to slow this thing up because we have to get an extension on the lease terms for the bank to lend. Go ahead and kick us off on what you do as an attorney when it comes to the lease agreement.

Yeah, absolutely. So I'm going to mainly focus on the buyer side here for what the attorney does on the buyer side. So on the lease, if the seller is currently in the middle of their term, say that they have five years left on their lease, the attorney's role is generally to review the lease that the seller has signed and is locked into and make sure that there's no red flags or major deal breakers. It's never going to be perfect or exactly how you want it, but you ultimately just want to make sure that there's nothing that's going to create unnecessary liability or unnecessary expense that's above and beyond what the market is doing in the area where you're purchasing the practice. So the first thing is to review the lease and get a summary of it. And then secondly is to Negotiate with the landlord an assignment of that lease so that you can, as a buyer, that you can take that over. And that's really the big picture. Some of the issues that we run into, and to your point, Wes, why it's so important to start talking with the landlord right after the loi, even before you start on the purchase agreement, is that the landlord generally doesn't have any benefit or any motivation to work with and help out on this lease assignment. You know, there might be language in the lease that says that the landlord may not unreasonably withhold consent to assign the lease, but from the landlord's position, they're not making any additional money. It's extra work, it's extra legal expense. So their response time, a lot of times is pretty, pretty slow. So that's something that going into it, you should anticipate and get after right away so that even with their slow response, you could still close on time. Now, depending on how the original lease is drafted, you may be able to ask for some modifications to the lease that you can have modified with the assignment. So there might be something like a lease assignment and amendment to the lease if you want to ask for additional things. The landlord, again, doesn't have very much motivation at that point to change what they already have locked in on their lease. So that's usually an uphill battle. But sometimes, if it's towards the end of the lease and the landlord wants the new tenant to come in and extend the term, they may be willing to play ball and help out the new tenant and make those changes. Now, from the seller's perspective, the seller, again, has signed this lease and is already locked into the space. Most California leases require a personal guarantee, meaning that if you sign the lease as a seller in the name of your corporation, that you also have to sign personally, where you guarantee that the payments will be made on that lease. Now, once you sell your practice and you assign the lease to the tenant, a lot of landlords are going to try and require that the seller stay on as a personal guarantor of that lease. So stay on and continue to be liable in case that lease isn't paid by the buyer who's called the assignee.

So when we say personally liable, that means that the seller's house, the seller's bank account, the seller's personal assets are subject to make the landlord whole if the buyer doesn't make their rent payments.

Yeah, exactly. And so from this on, when you're working with a seller on the legal side, you want to try and talk with the landlord to limit the length of that additional guarantee where you're going to have to stay on. And what we commonly see is that the seller has to stay on as a guarantor through the remainder of the term, but should be released in the event that the buyer extends the lease further than the current term. And this is another important part, if you're a practice owner and starting to think about selling is if you're going to be renewing your lease or extending or entering into a new lease, even if you're far off, it's incredibly important to negotiate hard to have the right to assign the lease and make sure all of that stuff is crystal clear and try and negotiate a release of yourself as a guarantor. Because majority of the time, when that's not negotiated ahead of time, the landlord's not going to help you out and give you any breaks on that front.

Yep. They generally don't want to concede because they know that they have the upper hand because they're already locked into a lease. They got the seller locked into a lease and they could force the seller to have to stay in that lease. Hopefully the assignment language is strong enough that the seller can claim a reasonableness upon the request to transfer that lease over to a potential buyer. Safe to say that the time to negotiate the lease terms for the buyer of the practice, the future tenant, is not when they're buying the practice. At that point, they're just trying to get the existing lease to be assigned to them. That's a win right there. Then when the terms expire and it's time to renew the lease or add more options, that's the time to negotiate with the landlord.

Yeah, that's exactly right. And as you mentioned earlier, Wes, buyers generally, when they get lending, the bank is going to require that you take over the assignment of the lease and the term of that be at least or close to the same length of time in which the bank is going to give you a loan. And so that is the one thing that we do have success and negotiating with landlords is if there's only a year or two left on the lease having an amendment to extend or transfer options to extend lease. And when you go to exercise those options, you may be able to renegotiate at that time.

Yeah, I think where the buyer needs to be careful of is in the case, and this isn't often, but in the case where a landlord is wanting to repurpose that unit being leased out by the selling dentist to a different purpose. Maybe a retail property rather than a dental office. Then once that lease is up, the dentist essentially is going to have to move most of the time. Landlords love dental tenants, they're stable, they pay the bills. So usually it's a pretty safe bet that you're going to be able to extend that lease as a buyer once it comes. Once it comes due.

Yeah. And real quick, we've been talking because majority of the time there is an assignment, sellers generally don't wait until the end of their lease to sell their practice. But that does come up from time to time. So once in a while, if the seller is on a month to month lease, or if the seller owns the real estate or if it's coming to the end of their current term, you may be in a position where you get to negotiate a brand new lease. And if you're negotiating a brand new lease, then it's all game. We can negotiate aggressively on your behalf to get, to get a good deal. And then with the assignment rights and all of that stuff, the other path is if the seller owns the real estate and you're also going to be purchasing the real estate. And when that happens, you don't have to. You're not worried about the lease. You're going to negotiate what's called a real estate purchase agreement. And it's a different path altogether. And those are a little bit more cut and dry. There are a little bit more boilerplate documents and it's a, can be a cleaner process, but there's additional inspections and things like that that should be taken into account.

Yeah. And a lot of times when the seller owns the building, which isn't infrequent, it's fairly common for sellers to own their building. I advise it to my clients if they have the chance to buy it at a, at a reasonable price. But when it comes to selling the practice, for me it feels like around 60 to 70% of the time the seller wants to retain ownership of the building to have this secure income stream in retirement. And that's the case where absolutely you can negotiate all the terms of a lease because it's essentially the first time that a true lease is being drafted up in that case. And also it's very good idea at that point. I've seen if you're the buyer to build into that lease, a first right of refusal such that if the seller decides to sell the building that you have the ability to be the first one in line at a given price. So if somebody else comes in and offers a higher price than you, you just, if you're willing to bring up the price to that same level, the seller or the owner has to sell it to you at that price. Matt, any final comments on the lease?

No, I think we, I mean, we'll do another one of these podcasts where we get into the weeds on it and look for specific provisions to avoid. But I just wanted to kind of highlight how the process works and kind of what to expect for both buyers and sellers.

Great. And in terms of the other two more incidental, the workback agreement and the seller financing note, suffice it to say that the work back agreement, oftentimes the seller decides to stay on it as an associate, they scale back. That's just a normal associate agreement and we'll punt that for another podcast episode. And then the final one is sometimes the bank won't lend the full amount of the purchase price because the cash flows don't support that price. But the buyer and the seller agree to pay the higher price and the difference between what the bank will lend and the purchase price. The seller essentially acts as a second bank and carries the loan. And so you'll have essentially two loans, the buyer one to the bank on the main portion of the lending proceeds and the second one to the seller for the difference. So you're making two monthly payments and there should be a security note to outline the terms of that seller carryback note. And we can also do a separate podcast episode addressing when why as a buyer, should you be willing to pay a higher price when the bank isn't willing to lend at the higher price? There's more depth of discussion we could jump into there, but I think this has been very educational. Hopefully for our listeners. Our next episode is going to be on what CPAs do in a dental practice. So stay tuned for that one.

Yeah, thanks, Wesley.

Sam.