Exit Planning, Retirement Funding and the Passive Income Practice

Dr Phillip Palmer, January 2011 

Exit planning has traditionally been a fairly simple task for dentists. The choices a dentist faced included either winding down the amount of days worked gradually easing into retirement or working until 3-6 months before wanting to stop, and then advertise the practice for sale. After negotiations with the buyer, dentists would sell and walk away. It would be much like a house sale; they walk in as you walk out. Sometimes there would be a good handover of patients and staff, and sometimes this process would be less than ideal.

More recently, other options for exit planning started becoming available for practice owners:

• You could sell and stay working as an employee dentist for the buyer (Over the last 3-4 years this model has increased in popularity with corporate entities often being the ‘buyer’).
• A deferred sale/employee with view; whereby a new dentist (Dr Junior) works for a year as an employee for Dr Senior. If all goes well, a contract is signed for the purchase of half (or even all) the practice in some years hence. The employed dentist continues to work as an associate, and the transaction is settled after the agreed time. This technique gave Dr Senior certainty of a buyer, and extra income from Dr Junior during the years as an employee.
• The incremental percentage technique; whereby after a similar trial period, the practice contracts are exchanged and incrementally each year, a further percentage of the practice changes hands from Dr Senior to Dr Junior.

In each case, after the practice is sold, the ex-owner commonly takes the money he made from the sale, goes on a holiday and then invests whatever is left in real estate or the stock market to fund his retirement.

For a practice grossing say $800,000 per year- if it was sold on the open market, it could bring up to $500,000. If that entire sum were used to purchase a residential investment property, one would be lucky to net more than $30,000 per year, and probably less, to fund retirement.

Another way to exit plan and fund a dentist’s retirement is to create the passive income practice, also known as the Never Sell concept.

Using this method, the practice is setup in such a way as to be self managed, with little effort (1 day/month) needed from the owner when the practice is mature. The profit that is able to be taken out of the practice can be as high as 25%, (one of our clients has the passive profit at 30 %!) after payment of all normal expenses and clinicians’ wages.

If maintained as a going concern, and run properly, there is no reason to expect a return from the $800,000 grossing practice of less than $200,000 pa. (and still maintain an asset worth at least the $500,000).

For this option to work:

1. Obviously, the practice and the staff need to be trained to provide a certain level of service and communication. They would also require a deep knowledge and understanding of the systems to run a practice.
2. The team need to be trained to be self-managed.
3. Some degree (the more the better) of management, leadership and business skills is required by the owner. They will need:
a) The ability to look at and analyse the right numbers. b) The ability to motivate key staff members to manage the practice and outperform through the judicious use of incentives including well designed bonus systems.
4. As the owner dentist is no longer present full time in the passive income practice, there also needs to be regular training in communications and the provision of service (ie: clinical training).
5. There needs to be more than 1 clinician. Rarely is there sufficient profit over and above the employee dentist’s wage (40% after lab) to warrant running the practice as a business with only 1 clinician.

There are plenty of horror stories out there (especially post GFC) of retired dentists needing to return to practice because the practice sale didn’t fund their retirement the way they expected it to. The never sell represents a new way of looking at the asset that is your practice and how it can bring you returns long after your clinical career comes to an end.