71: The Cons of Dental Partnerships

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Welcome back everybody to another episode of the Dental Boardroom podcast. It's Wes, I'm your host and I'm carrying on the subject of dental partnerships. I'm doing a multi episode series on dental partnerships. The pros, the cons, how they're valued, timelines to formation, talking about profit allocation, methodologies, a lot of great relevant subjects for those dentists who are in or considering a dental partnership. Hopefully you can listen to these before you join that dental partnership. And in our last episode we talked about the advantages of dental partnerships and a lot of dentists sort of, they feel that they have good chemistry and that's enough to let's do this. They get the legal documents in place and they form the partnership. I believe that those dentists and any dentist considering a partnership need to be fully educated on these pros and cons and different attributes of what makes successful dental partnerships. Because there are so many landmines that dentists go into blinded. Not knowing what those risks are are only to discover them after you've already set up the full structure and it's on. It's difficult to untether it all and roll it back. So going into it with wise, with eyes wide open, full understanding is always the best approach. And this isn't just dentists, this is any small business where partners are being formed. So the last episode we talked about the pros which were financial efficiencies, collaboration, division of ownership, responsibilities, specialization, scheduling, flexibility and succession planning. In this episode I'm going to talk about the disadvantages of dental partnerships. And let me dive right in. The first one is decision making. Now it's like a marriage, you'll hear me say that over and over. Now you've got another person who really you need to get buy off on important decisions. And in the practice, what are some of these decisions that could lead to conflict? Hiring, who you hire, when you hire, spending. I mean, think about a marriage. What is the one of the top reasons why marriages end in divorce? Because they have a different way of approaching money. And as a partnership, you are sharing a bank account, you are sharing profits, you are making these decisions taking mutually because they affect you mutually. So how you spend your money and what you spend your money on, what supplies and labs are you using? Now there's some discretion that each can use, but some supplies and labs can be a lot more costly than others. How much you pay a person, you may have a different opinion on what is a an appropriate cost or some for a person to support your team relative to the value that they provide. Also, when should you buy certain equipment? What about doing a build out now? What if the one of the partners owns the building? What should the rent be? The building owner partner wants the rent to be high, the other wants it to be low. Ideally you own the building together so that it doesn't matter, you're both benefited the same way. But building rent can be an issue. Whether or not to set up a 401k or other retirement plan like a defined benefit plan. One partner may love real estate and not want to use a 401k.

Because they can't go invest in a local rental property while the other partner doesn't want to have anything to do with those more sort of time intensive investments. They just want a plug and play asset allocation, 401k and to move on with other things in their life. So difference on setting those up and when you set those up and you fund it as an owner, there are employee costs, what are called required non elective owner contributions. Who pays for those owner contributions to the staff? If only one doctor is funding their 401k or their defined benefit plan and the other one is, is not because of differences or because one doctor spends a lot more in their personal life and is always sort of struggling with cash flows and therefore not willing or able to invest in different things in the practice or to invest through a 401k. These decision making create a lot of potential areas or landmines for conflict. How about tax planning decisions? What can you run through the business? Should you buy new equipment and should you take accelerated depreciation on that at the end of the year? There's a lot of decisions around your money that has a tax effect to it. And also just how aggressive do you want to be with your taxes? And I have met some dentists extremely aggressive and I'm fairly assertive myself. I always say we here at practice, cfo, we go to bat for you. We toe the line as much as we can with what we can run through and deduct. We don't cross the line because our dual mandate, beyond saving you in taxes, is also avoiding a disastrous IRS audit. You want to avoid those at all costs. And so as a, as a, as a, as a set of partners, you may have a difference of opinion on how aggressive you are in these areas, how you spend your money, who you hire, all of that. So decision making is one of the cons. One of the challenges of a dental partnership is arriving at consensus on so many decisions that affect both partners. Second A disadvantage, a difference in mission statement and values. And think big picture, think strategy. What are we doing with this business? Do we want to grow it into a very large 15 op single location practice? Do we want to try to recruit associates and create an associate model? Do we want to bring in specialists and have a multi specialty model? Do we want to open up a second office? Do we want to try to recruit a bunch of doctors and build a group practice, maybe even go DSO at some point? A lot of dentists these days are what I call empire builders trying to build that empire. These are strategic decisions. What I recommend at the beginning of the partnership, perhaps even before, is sit down and define what do you want? Where do you see the practice in 10 years, in 15 years, even 20 years, where do you see it? What do you want with your career? That's one of the questions I always ask when I interview somebody. It's one of the most important questions to me is where do you see yourself if you want to be satisfied in your development as a professional? Where do you want to see yourself in five years and where do you want to see yourself in 10 years? If one of them says, I want to be a partner and I want to be managing people and I want to take involvement in leadership decisions at the firm, that's very different than somebody who says, I want to be playing my role as a cpa, as advisor, as best as I can. Those are two very different career paths. Ambitions. Sit down. Define that. Here at Practice CFO we have, and I recommend every dentist do. This is literally write out what is your mission statement and what are your core values. And we use a management program. It's called Entrepreneurial Operating System, or eos. I brought it up on multiple podcasts and it has been a great addition to the way that, that I and my partners run practice CFO to make sure that we're all rowing in a common direction. So really define that you don't want to have a difference. Because if you want to accomplish something maybe more productive in your career and go beyond the chair and the clinical while your partner doesn't, you're going to have an anchor on you. It's going to really slow you down. There's going to be resentment that's being created. The other partner may feel like you're getting distracted, you're going after shiny objects. You're not focusing on what's making money right here and right now. Those are two different mindsets. So it's a disadvantage in partnerships when you can't align Those.

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All right, let's go on to number three. I can't tell you how critical and prolific this one is. And this relates to how you allocate out the money that is sitting in the bank account. I call this your profit allocation or colloquially here at practice cfo and we do this for partnerships. Every month we prepare a report, it's called the splits, and it shows how much of the cash in the bank can be distributed to each part, to each partner. And there are so many reasons why this is a very, very sticky subject and the primary reason why partnerships have contention and ultimately dissolve. Now, what most there's various ways to distribute profits from the partnership ultimately to the dentist. Now, it might be the owners, one of the owners own personal corporations. That's for another podcast where we talk about formation structures. For now, just know that out of the partnership entity, out of the partnership checking account, either monthly or quarterly, usually monthly, you got money that's going to go out, it's going to go to you to fund your life and, and all of that and how, how you calculate that money that goes out to each of you is very important. It's very important that it's modeled and designed and run before forming the partnership. Actually run in A spreadsheet scenarios. Dr. A. At your collection level. This is about what you're going to take home based on the overhead, the existing overhead in the practice Dr. B. This is what you're projected to take home based on your production and the existing overhead. Does this make sense? And too many partnerships form without going through that exercise. It's a modeling exercise. And you'll want a good CPA who understands dental and who also will do dental partnerships. This is a bit tricky because if it's a general cpa, I'm telling you, they're not going to know up from down. They may be great tax preparers, that's awesome. But they're not going to know up from down when it comes to dental profit allocation models. This is very sort of niche. And then there's even a lot of dental CPA firms who don't do partnerships because of the complexity of partnerships. And there's some very good dental CPA firms who are very solid with your single doctor practice. But a lot of those dental CPA firms, they just want to, they want to stick with vanilla. They do it really well. They want, they don't want complexities. And it is very true that partnerships create complexities. While at practice cfo, we have, we, we made that decision early on. We were going to lean into partnerships rather than lean out of partnerships. And so we do have a lot of part partnerships. They are more costly because there's a lot more time. 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Time and there's more reporting and delicacy in the way partnerships are run. But ideally partnerships are going to have a lot higher collections to justify some of the added costs that go into servicing a good partnership. Now, with profit allocation models, there's different models. I'm just going to name three of them. One is 50, 50. Everything is 50, 50. No matter how much you produce. No matter how much I produce, everything's 50, 50. The only scenario, the only time I've seen this is with two brothers essentially producing the same amount. And they were just all about, just a communal approach. And I sort of almost tried to talk them out of it, but that's what they wanted to do. And by and large here we are many years later, it's for the most part been fine. The second model is a full allocation, or what sometimes is called eat what you kill model. And in this model you essentially create two separate profit and loss statements for each doctor. Now, you don't have two corporations or two tax IDs or two sets of profit and loss statements. You really take the existing profit and loss statement, you export it to Excel and you create, you create some columns and ultimately at the bottom you come out with what is each doctor's take home. When you look at their production, they get their share of any hygiene or associate comp. You allocate out the costs commensurate with their production and you specifically allocate a cost that are 100% to them. And it gets a bit, it gets a bit complicated from a calculation standpoint because you have to go through Every GL code in the accounting software, every type of spend, every type of expense, you have to say, is this cost split 50:50? Is this COT split based on the two owner ratio? So if their ownership is 50:50, is it split that way? Is it split based on their production and is it just the production of the two owners in this scenario, I'm saying two owners. And so if one doctor does 60% of the doctor production, not the global production, just the two doctors, do you split it 60, 40, or do you split it based on global production? So if you have a couple associates, maybe you have some specialists, your hygiene department, do you allocate that cost pro rata across the production for all of them? And the reason why you may, you may do this full allocation model is because the nuances are too. There's too many. There's too many. The way I do my dentistry, the supplies I use, the equipment I use, the treatment that I use, the team that I use, the number of ops that I use, everything, it's too unique to just have more of a blended approach. This is by far the most complicated model to design. We have a spreadsheet that we sit down, we model this out, and then every month we have a chart of accounts for in our accounting software to make sure that all of the spend and you have to, you have to come up with credit cards to be allocated to certain types of expenditures. When the transactions feed into the accounting software, we know exactly how to categorize everything. I know this is probably getting a little bit complicated. We do this for a few partnerships, not a lot. But this is one method of allocating out the profits. Another one is called the associate owner model. This is the most common and I'm going to go into more depth on this in a future podcast. But in the associate owner model, each of you is paid a percent of your production and then you add to that the profits based on your ownership. So if your ownership's 50 50, you will take the profits after paying everyone, including yourselves as sort of theoretical associates and then all of your overhead, what's Left? You split 50 50. Now few a number of these of the issues here is that as you do this sort of associate owner model, you get into it, you start to realize there are some costs that really should be allocated out differently. If one doctor is doing all the invisalign, well, that doctor should assume all of that cost. If one doctor has an extra employee specifically dedicated to them, maybe that employee cost should be allocated just to that doctor. What about debt what if you buy a piece of equipment that only one doctor is using, like a cone beam and the other one is not? Who pays for the debt on that? What about personal expenses? What if you have kids on payroll? What about funding that, that 401k? What about tax planning? These are. These all affect how the profits should be allocated. And to the extent that you share in those costs equally or close to equal, then this model can work. Otherwise, you got to start to get into a more complicated model to Talking about the 401k a little bit more. What if one doctor is really living on a budget and the other doctor is not living on a budget and the doctor that's living on a budget therefore doesn't need to take as much out of the practice and can reroute that into a 401k or defined benefit plan and the other one doesn't? Well, if you set up the 401k, you're going to have these non elective contributions. I think I talked about this a little bit earlier. Who's going to pay for those non elective contributions? Is it going to be both doctors equally or is it going to be just the one doctor who's funding his or her 401k? There's an argument for both sides. An argument to fund it equally is to say, hey, both doctors have equal opportunity to fund their retirement plan. It shouldn't be the skin off of one partner's back if the other one elects not to do that because. Because it is good for tax and retirement planning purposes. But then the other doctor might say, I'm getting zero benefit out of it. Allocate the costs according to who's getting the benefits of those costs, allocate the costs according to who's getting the benefits of those costs. And so when you're doing the profit allocation, there's all these nuances that you have to address to avoid them emerging later and becoming these mountains of conflict that just make you constantly disgruntled with each other? All right, I will discuss more profit allocations in a future podcast. Let's go on to number four. Allocating allocation of new patients. When one partner buys in to the new into a partnership, let's say it's a standalone single doctor office, brings on a partner, that partner buys, let's say 50% of the practice. That buyer coming in is assuming that they are going to get half of all new patients and maybe even some of the existing patients being handed over. Because what you're paying for is you're paying for this thing called goodwill, which is the doctor's brand, the practices brand, the doctor's relationships with their patients. And you're paying a lot of money out of pocket. You may be paying a million dollars, so you have to not only pay yourself to live, but you got to pay back your debt on that million dollars. So it is a recipe for disaster. If incoming partner takes out a million dollar debt, has to pay it. But all new patients go to the old doctor because they want to, because the old doctor tells the staff, hey, send, send the patients my way, send the good patients my way, send the crappy patients to the, maybe send the younger patients to the new doctor. That has to be avoided at all costs. I have seen a very, very long drawn out legal dispute with hundreds of thousands of dollars being laid out to resolve that very issue. And the buying doctor won the lawsuit in that case. It's really, really important, therefore, that the seller and the buyer agree, or if two doctors are forming a partnership at the onset, agree, that new patients need to be split to in a way that's commensurate with the ownership. So allocation of new patients has been a source of a lot of conflict in a lot of partnerships. Let's go on to the next one. Personal challenges affect the business. This is a marriage. And if one doctor gets, loses their health, becomes disabled, maybe a doctor goes into depression, maybe a doctor's going through a divorce, one doctor just mentally checks out, too much anxiety, whatever that is, maybe the loss of a child, some of these things can cause a partner to really, really get out of pocket, really check out. And it does place a burden on the remaining partner and will generally cause a reduction of pay to that remaining partner because the production will suffer a lot and the practice will suffer because of that. And so there's ways to address this in the partnership agreement by having triggers that force an automatic buyout so that the remaining partner can kind of move to a solution to that if the other partner is not able to resume their clinical work or being, you know, working in the practice quick enough. So personal challenges very much affect a partnership. All right, let's go on to the next one, which is shared liability. As a partnership, you are building both equally liable. Now, the partnership agreement, if it's owned through a professional corporation, you can protect your personal assets, like your house and your personal investments, things like that. But your exposure inside of the practice to losing the practice, to having creditors foreclose on the practice, or having liabilities against patients or staff that foreclose, force you to have to pay out large lawsuits. Maybe it's an HR lawsuit because a staff member claims sexual harassment from one partner. Well, guess what? The partnership has to pay that. Now you can try to allocate that to the partner who created the offense, whether it was legitimate or not. But at the end of the day, it has to be paid. And if that partner doesn't pay it, well, guess what? The non offending partner is going to pay it. And so having a very strong belief in, in each other's clinical skill sets, in each other's ability to manage employees, a lot of these areas that have exposure to lawsuits and risk that is shared equally. All right, let's go on to the next one. Difficult to exit. Partnerships can be very difficult to exit because you are married and tied to a tax ID and tied to a bank account and you're tied to a contract that binds you together. And so one doctor may not want to sell and you may want to exit. So now you have to go find a buyer of your interest. Let's say you want 50%. Maybe the other partner doesn't want to buy your 50%. Maybe they don't feel ready to take on ownership of the full thing. Well, now you got to go find an associate. And what happens if this, if the remaining doctor doesn't like the associate that you find or the buyer that you find, and if the buyer knows that the remaining partner finds, doesn't like them or doesn't want them on board, hopefully they get some good advice and don't partner. Because who wants to step into partnership with somebody that doesn't want you in the house? That's a recipe for disaster right there. So you really have to have buy in of both partners in a very aligned way in order to exit the practice and exit in a way where you can leave with dignity and leave with the proper payout for the value of your share of the partnership. So partnerships can be very typical. Difficult to exit. And lastly, this one is a very simple one. But you simply dislike each other. Now, I'm sure when you went into it, you liked each other at least enough. But as in many marriages and many relationships, when you get in the trenches and you're having to make all these decisions and it gets rough and the economics get challenging at times, or the employees are difficult or you have a shared, you have a difference in the way you want to raise the kids, so to speak, all of that, suddenly you don't like each other. And I do know a number of partnerships, unfortunately, who essentially are metaphorically sleeping in the other room. And they don't want to divorce. They don't want to dissolve the partnership. Because of all these complications I've talked about with the difficulty to exit. Maybe there's non compete agreements and so the exiting partner will have to move 20 miles away. What does that mean for them now they maybe have to move their house. What about if there's existing debt on the practice that you're both liable for disliking the partners just makes business ownership so much less enjoyable. You got to wake up every day, you got to go into the office and you got to share space with someone who really doesn't want you there or maybe someone that you don't want there. So this is a big con or disadvantage of dental partnerships. With that, we will move on to other subjects of dental partnerships in the near future. Future Hope this has been productive. Stay tuned.