ASK ALISON: Should vendors take a larger lump sum and lower remuneration, or vice versa?
Ask Alison: Should vendors take a larger lump sum and lower remuneration, or vice versa?
Following a sale, it is common for a principal to remain working at the practice, providing the clinical treatments they love, but without any of the management responsibilities. Quite often buyers prefer principals to stay on post-sale to provide continuity and ensure that the goodwill tied to that dentist can be retained post-sale; this is particularly important for private and specialist practices if a corporate is involved. In this case, it is more likely than not that the ex-principal will be required to stay working at the practice for some time. Therefore, an agreement as to remuneration will need to be made prior to the sale.
Most principals expect to be paid a fairly high remuneration post-sale to reflect their experience and seniority, and they will probably want at least the amount that other associates in the practice are paid, if not more. However, vendors should be careful as this route can prove to be a costly mistake in the long run.
Taking a lower lump sum makes financial sense
At MediEstates, we often advise principals to take a lower rate of remuneration and part of my job is to explain why this route is best for them.
When we value a practice, we are not just looking at the current trading performance of the business but considering how that will be affected under new ownership, including how income will be generated post-sale and the associated cost of this.
The profit a business makes currently and how that profit will change under new ownership are calculated using an adjusted EBITDA method - Earnings Before Interest, Tax, Depreciation and Amortisation - a metric used to evaluate a company’s ongoing operating performance. This profit figure is then multiplied to produce the valuation.
Due to the use of a multiplier, the final valuation figure can be significantly impacted if the principal is paid more after the sale. A lower profit is going to equal a lower valuation because that lower profit is multiplied a number of times over. On the other hand, if they take a lower rate of remuneration the practice becomes more profitable and the extra profit is multiplied again.
So, the vital message for all principals selling their practice is although you might be tempted to earn more for a number of years after the sale, it actually makes more financial sense to have that money up front. The reality is that many principals are looking to work short-to mid-term, for three-five years post-sale which makes it far more beneficial to have a lump sum than to continue earning at a higher level but over a longer working period.
A higher lump sum saves on tax overall
Another important point is that not only do you get more up front, but there is also an implication on the tax that you pay. When you sell a business, you can qualify for Entrepreneurs’ Relief on your capital gains tax, and consequently will pay only 10 per cent tax on the sale of the business.
By comparison, if you earn more post-sale, then obviously the money that you’re earning is going to be at your normal rate of income tax, which is a much higher rate. So, not only are you getting more money up front by taking a lower post-sale rate, you will have a lower overall tax bill, providing a double benefit.
MediEstates guides the sales process
When it comes to post-sale remuneration, a lot of dentists feel that because they have been the principal they should be paid more than the associates because of their experience. In this situation, it can be difficult sometimes to see the bigger picture and that’s why it’s important for vendors to liaise with experts like MediEstates throughout the sales process.
We put all the complex financial issues into commonsense language, so that our clients can understand that they are going to get more, by taking less post-sale. We are not only here to advise how to maximise value but to also do so in the most tax efficient way.
Posted by: Alison Bates on 14 Sep 2018