8 THE ADA PRACTICAL GUIDE TO VALUING A PRACTICE the prospective associate with an understanding of the fair purchase price. Without this knowledge, a good faith relationship by both parties may end without the intended transaction. It is not unrealistic for an associate to anticipate a buy-in or buy-out and then be financially unable to execute when the opportunity becomes available. For example, an associate may believe the buy-in value to be approximately $300,000. When the opportunity becomes available a year or two later, the associate learns the practice price would actually require an investment of $500,000. He or she may not be able or willing to exercise the option at this price. In such an instance, the original owner may have to increase his or her time commitment to the practice and begin a search for another associate or buyer. In turn, the associate is forced to locate another practice and start anew. This result is particularly unfortunate when the associateship has existed for several years. Prior to Entering into a Purchase and Sale, Option or Buy-sell Agreement Agreements for the purchase of an interest in a practice can be designed for a variety of purposes. A purchase and sale agreement can assure that an associate or a member of a solo group can buy the practice in the event that the owner dies or becomes disabled. An option agreement may accommodate an associate buying into the practice at a future date. A buy-sell agreement may provide for acquiring the interest of a withdrawing shareholder or partner by the business entity or remaining owner(s) in the event of death, disability or other events. It is wise to perform a thorough practice valuation prior to establishing the price for any such agreement, especially those that require one party to buy the practice at some future point in time, or if a specified event takes place. If the practice valuation results in an excessive purchase price, and the purchase price is not funded with insurance proceeds, the dentist obligated to purchase the practice under the buy-sell agreement may not be able to obtain the necessary financing. In this instance the dentist would be required by contract to purchase the practice, even if he were not able to obtain proper financing. Moreover, even if the agreement is funded by insurance proceeds, premiums based on an inflated sales price, especially if the dentist being insured is older or has had health problems, may be prohibitive. For these reasons, it is prudent to base the sales price on a professional valuation. One final caution concerning buy-sell agreements: sometimes the parties insert a simple rule of thumb into an agreement that will be used to determine the price in the event that the actual buy-sell transaction occurs. This is done rather than stipulating that a comprehensive appraisal be performed at the time of the transaction. Although this may be the least expensive approach, both parties should thoroughly understand the potential consequences of this type of arrangement. For example, upon the death of a partner, the surviving partner could be required to pay the estate of the deceased partner substantially more than the current fair market value of the deceased partner’s interest in the practice. This unfortunate situation has occurred when the dentists agree to the inclusion of an inappropriate rule of thumb (such as a percentage of gross revenue) in a buy-sell agreement. Financial Planning Needs The proceeds from the sale of a dental practice may be an important part of a dentist’s financial plan for retirement. Financial and retirement planning must be based on a realistic projection of the practice’s value. Performing or obtaining a thorough practice valuation every few years is, therefore, critical to a dentist’s financial planning. This is especially important for dentists nearing retirement and those who assume that the sale of the practice will provide a significant portion of their retirement funding. The proceeds from the sale of a dental practice may be an important part of a dentist’s financial plan for retirement.