How To Handle The Expected Negotiation
There are a number of factors that are important when the goal is to minimize the taxes that you’ll have to pay on your practice sale price. As is commonly known, one of the most important factors is the amount of the sale price that is allocated to the sale and transfer of goodwill. Portions of the sale price allocated to goodwill will be taxed at long term capital gains tax rates. For most sellers, the long term gain tax rate will be less than the ordinary income tax rate that normally applies to the portion of the sale price allocated to the sale of tangible assets (equipment, instruments, etc.).
IT'S NOT AS EASY AS YOU’D EXPECT
When you reach negotiations on the allocation of your sale price, you may find that your buyer, upon advice from his / her accountant, wants less allocated to goodwill and more allocated to your tangible assets. Dollar amounts allocated to tangible assets can be tax deducted from your buyer’s income quickly, either in the first year via IRS Section 179 or within just a few years if via depreciation. Large allocations to tangible assets give buyers much greater tax deductions and tax savings in the year of the sale and in years shortly after the sale. In contrast, for buyers the dollars allocated to goodwill must be amortized (deducted) 1/15th per year over a 15-year period. To get faster tax deductions, buyers and their accountants may often negotiate strongly for less allocation to goodwill and more to tangible assets.
NEGOTIATION APPROACHES THAT OFTEN WORK
Although no approach is always successful with a given buyer or buyer’s accountant, there are three things to do that result in sellers getting favorable allocations in the majority of practice sales.
- First – Consult With Your Accountant. Make sure that, in your specific case, there is not some factor that would make it better for you to have a lower allocation to goodwill. If there is no such factor, proceed as discussed below.
- Second – Market Data. Explain to your buyer that on average, for general dental practices, plus or minus 76.8% of purchase prices are allocated to goodwill. Make sure that your buyer and his / her accountant know that is the market norm. Explain that, unless there are clearly identifiable reasons that the allocation should be different for a specific practice, the allocation should be consistent with norms in the dental practice market. If needed, we can provide a summary of market data that verifies the 76.8% average.
- Third – A Logical Explanation. After 25+ years in the practice brokerage business, we haven’t seen a lot of success by trying to resolve allocation negotiations by trying to debate the (low) value of dental equipment or the (high) value of the goodwill. There is no magic bullet for allocation negotiations. One approach might work one time and fail the next. That said, we’ve had the most success in achieving good levels of goodwill allocation by explaining the situation to buyers, as opposed to debating them. Here is an outline of the explanation that we often use.
(i) To be fair for both parties, the allocation should be consistent with market norms.
(ii) For the seller, each dollar taken away from the allocation to goodwill, and allocated to dental equipment, increases the tax rate on that dollar. That causes the seller to lose more of his / her sale price to taxes. For the seller, that money is lost forever.
(iii) For the buyer, it is not a matter of how much the buyer gets to deduct on his / her tax returns. It is only a matter of timing. No matter how the allocation is set, the buyer will sooner or later get the same amount of tax deduction. For the buyer it is not how much tax savings he / she realizes. It is only a matter of timing. Unlike the seller, the buyer does not permanently lose any dollars or any amount of tax deduction because of the amount allocated to goodwill.
(iv) Unless a buyer is willing to pay a price for the practice that is above the fair market value, to offset the seller’s financial loss from a low allocation to goodwill, a buyer should not expect an allocation to goodwill that is below the norms in the practice sale market.
Can sellers ever justify getting more than 76.8% allocated to goodwill? Yes, in some cases you can justify that. It would be justifiable for practices that have tangible asset (equipment, etc.) values that are lower than the average expected for practices with similar levels of collections, profit, and market values. The lower value of tangible assets is likely to make for a lower overall practice value and sale price -- in comparison to practices having equal collections and profit and greater tangible asset values. However, it could be justified to allocate a higher percentage of that lower sale price to goodwill. As an example: For a practice with a large patient base, and a strong profit margin, but having old equipment that has very little value at the time of the practice sale, a seller might be logically justified to try to achieve an 80% or 90% allocation to goodwill.
Most reasonable buyers will accept correct goodwill allocations once they understand the explanations provided in this article.