Legal Due Diligence

Welcome back, associates. I'm excited for today's topic, Legal Due Diligence, and while I'm not an attorney or a substitute for one, I would like to share with you some of the important features of the legal process that you will encounter during your practice purchase. My goal for you in this module is to introduce you to core topics and give you a jump start on what to expect when you hire an attorney to to your practice acquisition team. Let's first talk about the Purchase and Sales Agreement, or PSA for short. Typically, the first iteration of the Purchase and Sales Agreement is drafted by the seller's attorney and then it's sent to the buyer's attorney for review and comment. And this is the start of what the legal world would colloquially call the Redlining Process. The redlining process denotes the back and forth negotiations that occur between legal teams on important sections of the Purchase and Sales agreement. Each attorney has their client's best interests at heart and will be vying to construct the agreement in a way that reflects those interests. Ultimately, their goal is to have a final agreement that is fair and mutually agreed upon by both parties. Now, let's chat about a few important topics within the Purchase and Sales Agreement that you'll need to be familiar. First is the price you're paying to acquire the practice. Now, the price isn't something typically argued over by the attorneys, and I highly recommend that you all watch our videos relating to the financial side of the acquisition process and the importance of establishing a fair price before you actually submit your letter of intent. Once you're in the legal due diligence stage, the only thing that should impact price is adverse findings during financial or legal due diligence. But absent any of those, your lawyer is just recording the agreed upon price from the letter of intent in their purchase and sales agreement. Next is understanding how to handle accounts receivable and any patient credits. Accounts receivable is any money owed to the practice for work performed but not paid at the time of service. Accounts receivable can be amounts owed by patients, insurance companies, or both. Now, whether or not the seller is willing to include the accounts receivable and in the purchase of the practice depends almost entirely on the seller. But more often than not, I find that they actually do not want to include the accounts receivable. But if you find yourself in a situation where the seller is willing to include the accounts receivable, it's going to be important for you to understand the quality of the accounts receivable and establish a fair price accordingly. Accounts receivable are split into aging buckets and the first aging bucket is the current bucket which is any accounts receivable that are 0 to 30 days old. The next bucket is 31 to 60 days, 61 to 90 days is the third bucket and then the last one is anything that is over 90 days old. @ practice CFO we have established a sliding scale when determining how much each dollar in each accounts receivable bucket is actually worth. Generally, we are willing to pay 85% of every dollar in the current bucket, which is zero to 30 days. We're willing to pay 60% of everything in the 31 to 60 day bucket and 50% of everything in the 61 to 90 day bucket. And lastly zero dollars for anything over 90 days. In short, the longer an amount is in accounts receivable, the higher the likelihood it will not be collectible, which is why we want to account for that risk by reducing the rate we pay based on the age of the accounts receivable. Now on the Patient Credits Patient credits are the opposite of accounts receivable in a lot of respects. It's money that is owed from the practice to the patient in the form of either a cash payment or a reduction in the payment that is due from the patient for future services provided. Now you'll want to understand how much inpatient credits you will be inheriting and either reduce the accounts receivable price that you're going to pay or the purchase price by the amount of outstanding patient credits now. Alternatively, you can have the seller remit payment to anyone with patient credits on their account before the close of the practice sale and that would be an adequate solution as well. Best practices for you is to get an updated list of any outstanding accounts receivable and patient credits or on the day prior to close so that your purchase and sales agreement has the most up to date information regarding accounts receivable inpatient credits before you actually sign. Next we have the purchase price allocation. The allocation is typically only recorded by the lawyers based on the buyer and the seller CPA's advice. The reason for that is that the allocation has varying tax implications based on the structure and your CPA is the most equipped to answer those questions depending on your personal situation and my colleague Greg Maravilla has an entire Associates on Fire module dedicated to purchase price allocation and how best to navigate that. Be sure to check that out. As a new buyer, you may be less concerned about the allocation than the seller because it's likely that you're walking into a practice that you plan to own for the next 15 years or more. And you're planning hopefully to grow that practice pretty substantially over the next over the first five years. So having tax deductions in years six through 15 will provide more of a benefit than it will in years one through five because you will be in new higher marginal tax brackets. Again, consult with your dental cpa because every practice and every person is a little bit different and your situation needs to be tailored accordingly. The purchase and sales agreement should detail specifically what's included in the price and what's not. It's highly likely that most of you will purchase your practice as an as an asset purchase and not as a stock purchase. And what's included in an asset purchase at a high level are all of the assets in the dental practice itself, including dental equipment, any furniture, any leasehold improvements that the seller did to the space, any dental supplies that are currently on hand. And what it won't include is any outstanding debt that the seller currently has or or any of the seller's personal assets like their automobiles or any other personal asset that they have on their corporate books. Additionally, there may be certain contracts that the seller has in place with practice management software companies, any telephone providers, payroll service providers, et cetera. And of those, you may wish to continue those as the new owner and take them over Any existing service agreement contracts that are going to continue post close, you're going to want to have those outlined in the purchase and sales agreement before signing. Your lawyer should also go through any redos or rework, so to speak, which happen that may happen in the first six to 12 months of ownership. Rework is used to describe a patient that is seeking to fix work that was previously done by the seller but that broke or otherwise became inadequate for the patient. Your lawyer should have something in the PSA to account for the possibility of this happening. It could be as simple as the seller being required to come in and fix any previous work on their own dime. Or it could be that you do the work and the seller owes you for payment of that work.

How to handle accrued benefits to the staff is also very important and it's similar to rework in that your lawyer is going to want to add language to the PSA for how to account for those accrued benefits and how the seller is going to compensate you, the buyer, for any accrued benefits that you will end up paying as the new owner. And again, you can have the seller pay all those accrued benefits out prior to closing, or you can have it compensated through a reduction in a price of accounts receivable or the practice purchase, all of which are suitable remedies just need to be discussed with your lawyer and included in writing. Next we have the non compete section. A non compete agreement is very common in the dental space and it usually starts or usually states, I should say that the seller can't work or start a new practice within a 10 to 20 mile radius. There will also be a small amount of the purchase price allocated to this non compete agreement in the purchase price allocation. The reason being is that if we allocate money to this non compete agreement in the allocation, it's more likely that it will hold up in court if it ever comes to that. Now also would depend on the state that you're in and any case law that is takes precedent in that state in terms of whether or not your non compete agreement will hold hold up in court. Now there are plenty of other topics that your lawyer will guide you through in the purchase of sales agreement and the legal due diligence process, but the ones mentioned above are the most common and they tend to have the biggest impact to you as the buyer. Now lastly, you're going to want to sign the purchase of sales agreement on the closing day because the banks are going to want a signed copy of that purchase agreement showing that it was signed and dated on the closing date before they're willing to disburse funds to the seller.

For the purchase of the practice. In addition to your psa, your lawyer will guide you through your new lease agreement. Now it may not be an entirely new lease agreement, it may be an assignment of the previous seller's lease agreement, but regardless they're going to walk you through that process. A few topics that your lawyer will discuss with you is lease assignment, which details whether or not the seller is going to be able to assign their lease agreement to you, their existing lease agreement, or if you're going to have to create a new lease agreement altogether. Remember from financial due diligence section when we went over that the banks are going to require that at a minimum you have at least 10 years incorporated into your lease agreement. Now that can be 10 years of, you know, a 10 year lease agreement or it could be a five year lease agreement with, you know, five to 10 year, 10 years more in options. As long as you have 10 years at a minimum, that should satisfy the bank's requirements. All they want to see there is that they have enough years, you have enough years on your lease agreement to get you through the duration of their loan. Now the lawyer. Your lawyer is also going to go over any personal guarantees and personal guarantees in relation to the lease agreement. Now maybe somewhat self explanatory here, but essentially what a personal guarantee in relation to a lease agreement is stating is whether or not the seller is going to remain liable for the lease in the future in the event that you default on the lease agreement in any way. Also important for you in that respect whether or not you will be liable in the future if you decide to sell your practice and assign that lease to to someone else. So on both sides of the coin there, it's equally important to have a good understanding of what you're walking into now. Be sure to reference our Lease Guide in the Associates on Fire Resources folder under Fuel Cell number three. It's going to give you some in depth.

Illustrations and analysis on the lease agreement process and it should follow along closely with our module so that you can have an interactive copy and and experience with these Associates on Fire with the Associates on Fire program. Now lastly, your lawyer is going to help you with your corporation documents. The initial corporation documents. They're going to help you file your articles of incorporation or organization. Depending on whether or not you've elected your legal entities legal entity status to be a C corporation, you're going to file articles of incorporation or if you're going to be a limited liability corporation in which you will file articles of organization. Most of that depends on what state you're in in and whether or not they make require you to be as a professional service provider, a corporation that is taxed as a small business corporation or S corporation. So need to get an understanding of what your state requirements are. If you work with a dental specific attorney in your state, they most likely have that answer readily available for you.

The next thing they're going to help you with from a corporation document standpoint are your corporate bylaws and your stock certificates. Usually your stock certificates are going to have roughly 1,000 shares outstanding to begin with and you will likely be 100% owner of those thousand shares of stock initially. They will also help you with your initial corporate meeting minutes and they will package all of these items together into your corporate binder and be sure that you get a hard and a soft copy of this corporate binder and that your signature is in all of the correct places so that your corporation is legitimized. It's what's important here is that you find a dental specific lawyer that to bring on your acquisition team because they're going to have the most experience for important sections of the Purchase of Sale agreement that apply to your space specifically. And they're also going to have such a well oiled process that their fees will likely be a lot less in relation to a general lawyer who will need to dive in and spend more time understanding some of the nuances of the purchase and sales agreement in the dental space.

And that rounds out our section on legal due diligence. I hope you enjoyed it as much as I did. I look forward to our conversations in future modules. See you very soon.