eyecare by the numbers

The Economics of Practice Succession

by Alan H. Cleinman

The TV you just bought was not as good a deal at $400 as you thought. It really cost you $600. And the car you brag was a steal at $40,000…its price was closer to $60,000. When you think of the economics of living in this way, it can get depressing. But it is our reality.

There's a huge difference between pre-tax and post-tax dollars, and it behooves everyone to understand this difference and also to keep it top of mind. This is especially true when considering a practice transaction, whether you're on the selling or buying side. Failing to understand the true economics of any deal can be a very costly mistake to all parties— except Uncle Sam.

LONG-TERM APPROACH

There are a variety of ways to reduce the tax impact (see chart below) on all parties to a transaction. These designs generally require a long-term approach to succession.

■ Make sure time is on your side. The time to create a succession plan is long before you begin discussions with your potential successor.
■ Make sure the individual you hire is “successor material.” This requires open and honest dialogue during the interview process. Set clear expectations for both sides.
■ Don't waste your money on a practice valuation. The value of the transaction will be the end result of the process, not the starting point.
Many factors go into the final deal,and each can have a significant impact on the ultimate value of the transaction, including taxation issues, post-sale benefits, non-economic considerations, and employment. The design of the deal has a great impact on its value.
■ Get the deal designed up front. All of the details of succession should be worked out years in advance of any transaction. Negotiating often can get emotional, and doing so with an “insider” can be debilitating for the practice.
■ Make sure you have good numbers. An accurate and effective financial control system will save you a great deal of work and also will help improve overall practice value.
■ The succession process will likely be the most complex business decision of your life, so surround yourself with the right experience to navigate this unfamiliar territory.
■ There are all kinds of tools one can employ to improve the economic, professional, and organizational impact of the succession planning process. Some can be complex, and even a small misstep can create unforeseen challenges.

This is one of the most important activities you will ever undertake, so invest the necessary time to clearly understand the opportunities, processes, and pitfalls. EB

TAX IMPACT: UNCLE SAM GETS MOST OF EVERY DOLLAR!

In the above example, the employer/seller pays a dollar in salary to the employee/buyer as well as about 10 cents in taxes to Uncle Sam. And, the employee pays about 35 cents in taxes. Then, the employee/buyer pays the seller a dollar (which really costs about $1.35) toward the purchase price. Principal payments, in this instance, are NOT a deductible expense (only the interest on the debt would be currently deductible), so those payments are made with after-tax monies. And, the dollar paid to the employer/seller by the employee/buyer is, of course, taxable. As a result, the seller would pay 15 percent of the dollar received to Uncle Sam. Add it all up and, in a classic buy-sell transaction, taxes can take 60 percent (or more) of every dollar! Add on other closing costs, and it becomes clear that there must be a better way. And there often is.

Though Uncle Sam will be at the table under most every instance, he doesn't have to eat the entire meal.

Alan Cleinman is founder and CEO of Cleinman Performance Partners (www.cleinman.com). The information in this column is derived from the database of Cleinman Performance Network, the members of which are generally very large optometry practices. The information is not intended to represent national averages. ©2012 Cleinman Performance Partners, Inc .