Fundamentals of a Buy-Sell Agreement for Dentists
April 12, 2021
By Erick Cutler
Once you have established a stable dental practice with a partner or a few shareholders, your mind should turn to plans for what to do if one of you wants out of the business. It is natural to expect that either you will want to buy-out our partners or, depending on the circumstances, you will want to sell to one of your partners. While this may seem like
something you will consider in the future, life can take unexpected turns and you need to be prepared for unanticipated situations such as a sudden death or disability. The best way to prepare yourself and your business for this eventuality is through a buy-sell agreement.
What is a Buy-Sell Agreement?
Small businesses often have partners or a small number of shareholders who each control a piece of the company. In these cases, situations often arise when one partner wishes to leave and sell his/her share to the other partners or shareholders. Most people do not have the liquid assets readily available to buy someone out in an unexpected circumstance. That is what the dental buy-sell agreement is for, according to the American Institute of CPAs. A buy-sell agreement is a legal document that identifies the current value of the dental practice and takes note of the partners’ or shareholders’ plans to buy one or more of the others’ share of the business. Although participants in the buy-sell agreement may choose to use savings or a bank loan to make good on the agreement, most people prefer to use disability or life insurance to cover the payment.
Why Get a Buy-Sell Agreement?
Any business that has shareholders or partners should have a plan in place in the event that one of the parties is disabled or dies unexpectedly. To leave this task uncompleted puts the other partners at risk. If either you or your partner dies in an accident without a buy-sell agreement in place, the entire business may be cast into chaos. In most cases, your share of the business will be passed onto your spouse of other family member. Without a buy-sell agreement, your partners may not be able to buy out your family’s share of the business, which could create an unfortunate financial stalemate.
Types of Buy-Sell Agreements
There are three basic types of dental buy-sell agreements, commonly titled:
- Cross-Purchase Agreements
- Entity-Purchase Agreements
- Hybrid (also called “Wait-and-See”) Agreements
With cross-purchase agreements, each owner takes out an insurance policy on the other owners and pay the premiums for each policy individually. This may become complicated if there are several co-owners or shareholders. Entity-purchase agreements are similar, but they are purchased and maintained by the business for each partner. In this case, the company owners determine if they would rather have a term life policy in case of accidental death, or a universal life policy, which is more appropriately used to buy out a retiring owner. The policy is created to cover the value of that person’s share of the business. Hybrid agreements offer some combination of cross-purchase and entity-purchase agreements. If the co-owners cannot determine which approach is better, they may choose to do both in smaller quantities.
Determining the Price of the Buy-Sell Agreement
Before you can design and sign your buy-sell agreement, you must figure out the value of your dental practice as a whole. Since most dental practices are not publicly held, you will determine this value based on the assets of the business. These assets include the value of any owned property, equipment, accounts receivable, as well as an estimation of the earnings history and future earnings of the business with the new owner. The value is best assessed by a professional appraiser. You must also remain current with payments on any policies, and adjust the value of those policies to keep up with the value of each person’s share of the company.
When you consider what you need to do to protect your interests in your business, a buy-sell agreement seems like the best decision you could make. With a buy-sell agreement, you provide funds to keep your business going, even when a partner or shareholder leaves the business unexpectedly.