Why you should pre-plan your practice exit

Ideally, create a plan that allows for at least five years to transfer the practice to other people

Ideally, create a plan that allows for at least five years to transfer the practice to other people. Setting up a 10-year plan is even better.
Ideally, create a plan that allows for at least five years to transfer the practice to other people. Setting up a 10-year plan is even better.

Let’s start by talking about exit planning. When you think about this term, what does it represent to you? Many will perceive it means they are ready to sell tomorrow, but it is not absolutely true. Whenever you consider starting a business, and no matter the phase of business you are in, an exit plan is vital to your future success.

Practice owners are waiting until they are tapped out, exhausted, and ready to get out as quickly as possible. This creates a tremendous amount of stress on what they receive for the sale of their practices and the likelihood of selling to another veterinarian is low.

The corporate route

The reason several practice owners elect to sell to a corporation or purchasing group is because they need every single dollar from that sale. Otherwise, their retirement income is going to drastically suffer. The practice has become an owner’s identity and personal pocketbook.

Expenses that would usually come out of people’s personal expenses are used as a tax deduction through the business, but those expenses are, in most times, not accounted for after the sale. The practice produces a significant amount or all their income and whenever extra cash is needed, it is simple to just transfer some money. When the practice is gone, the asset that produced an income regularly now turns into a lump sum of money responsible to recreate the owner’s income.

Whenever selling to another veterinarian or employees, the sale price could be a third or half of the amount someone outside the business would pay for the practice. The employee(s) might not have any money to fund the sale, or financing terms are restricted due to few lenders willing to provide enough money to purchase the practice out right.

The owner will likely finance the sale through a seller’s note, where the person who purchases the practice will then repay the seller through the expected future profits. All the risk is now placed on the practice continuing to operate at its current level and to potentially grow over time.

The problem is the selling owner is expecting to step out and not have to worry about a thing anymore. If the new owner does not know how to effectively run the business, there is a possibility the seller would not receive payments and might need to come back to work. In addition, when the practice is financed through a seller’s note, a double taxation event can occur.

The practice generates profits, and most practices are pass-through entities. This means all income produced in the practice are transferred to the owner’s personal tax return to determine how much in taxes are due.

When the buyer collects those profits, they are paying income tax on those dollars. When the payment is then made to the seller, the seller must then pay capital gains. This can cause taxes to be higher than needed and put higher pressure on the practice to perform better or delay how quickly the seller will receive the complete buy out.

Setting up a plan

Ideally, there needs to be at least five years to transfer the practice to other people. In a perfect world, 10 years is the best. The first reason for this time period is the buyer might not have any money. The second reason is they might not be able to get enough financing from a lender. The third reason is to reduce double taxation as much as possible.

Reason 1: Not having any money to purchase the practice

The buyer interested in acquiring the practice could be a financial position where they need years to accumulate enough funds to purchase a portion or all of the practice ownership. The easiest solution is to create a seller’s note, but this can create unnecessary taxes and risk on both the seller and buyer.

Reason 2: Financing options are limited

Different lenders can provide a specific amount of finances, but depending on the profitability of a practice it might not be enough. The financing could reduce some of the risk and taxes of the need for a seller’s note, but it does not eliminate the problem.

Reason 3: Double taxation on the sale from a seller’s note

A seller’s note is when the selling owner negotiates a price with a buyer, and then decides to finance the sale with the future profits from the practice. As the buyer receives the profits, they will pay income taxes determined on their personal circumstances.

When the buyer pays the seller, the seller would then pay long-term capital gains on that sale, and those rates are determined based on the seller’s income tax rate. This can increase the payout needed over time to account for taxes and potentially extend the sale longer than expected or wanted.

Three ways to reduce taxes and risk on the sale

Option 1: Find out the lowest defensible value

The IRS will allow for the sale of the business on paper to be less than the negotiated sale value. This does not mean you are giving away the practice, but the taxes due on the sale can be reduced significantly. When figuring out this number, it is important to have the right counsel, such as a CPA, to determine those numbers, as well as an exit planner to figure out the terms, and an attorney who can draft up the documents.

At the sale, this amount is then reported for tax purposes and could be funded by a financing from a lender. The sale could also be funded by a retention program established in the past for the buyer to have a down payment or purchase a sizeable portion of ownership.

Option 2: Direct payments to the selling owner

There are ways to set up compensation agreements to the seller where it can avoid double taxation. This is done through deferred compensation, retention stay bonuses, and consulting agreements. All the payments will go directly to the seller and avoid going to the buyer. The seller will receive the income, which could be paid each year or delayed, and then the income is reported on their tax return as taxable income. This could reduce taxes on the sale by stretching them over time and to eliminate income taxes and capital gains.

Option 3: Build up personal wealth with the practice

Since the practice sale is likely the largest transaction and the seller relies heavily on the sale price, the best way to reduce the pressure is to accumulate wealth on their personal balance sheet. Every month or few months the business is systematically transferring money to their personal life and saving for them. By accumulating assets out of the practice, the future sale price might not need to be as high because other assets can produce income in retirement.

The transition of ownership is not a simple task, and it is important to get the right counsel to help. There are strategic ways to handle the transition, especially for those who have a desire to sell to another veterinarian or employees. The sooner you prepare and understand what you want in the end, the pressure on the sale in the future could be reduced with proper planning. Do not wait until you are ready to leave to start thinking about how you are going to transition because the options available will be dramatically reduced.

Tom Seeko has worked with practice owners and veterinarians since 2014. He is the cofounder of Florida Veterinary Advisors that work with veterinarians throughout the United States, Certified Exit Planner (CExP), business and personal financial advisor, and cohost of the Smarter Vet Financial podcast.

This material is intended for general public use. By providing this content, Park Avenue Securities LLC is not undertaking to provide investment advice or a recommendation for any specific individual or situation, or to otherwise act in a fiduciary capacity. Please contact a financial representative for guidance and information that is specific to your individual situation. Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. This material contains the opinions of the author but not necessarily those of PAS or Guardian. registered representative and financial advisor of Park Avenue Securities LLC (PAS). Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial representative of The Guardian Life Insurance Company of America (Guardian), New York, N.Y. PAS is a wholly owned subsidiary of Guardian. Florida Veterinary Advisors is not an affiliate or subsidiary of PAS or Guardian. Florida Veterinary Advisors is not registered in any state or with the U.S. Securities and Exchange Commission as a Registered Investment Advisor. The individuals associated with Florida Veterinary Advisors do not maintain specialized licenses or qualifications for the financial services provided to veterinary professionals. CA Insurance License #0K80141. 2021-140075 (Exp. 6/24)

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