Asset purchase versus stock purchase in dental practice purchases
Got a desire to acquire? Matthew Odgers, JD, and Greg Maravilla, CPA, present the fundamentals for asset- versus stock-structured purchases of dental practices.
An agreement to purchase a dental practice may be structured in different ways, most commonly as either an asset purchase or a stock purchase. An asset sale transfers some or all of the assets of the business in a series of transactions. A stock sale is the transfer of a partnership interest from the seller to the buyer with all of its incumbent benefits—and liabilities.
Since each structure has unique tax and liability implications for both seller and buyer, parties to the sale should clearly understand the differences between the two. The financial and legal interests of each might be best served by one over the other, and they may be in conflict.
Asset sale: Overview
In an asset sale, the buyer purchases some or all of the assets of the dental practice. That includes tangible assets like equipment, inventory, and possibly accounts receivable. Asset purchases can also be intangibles, such as goodwill, non-compete agreements, or client records. Goodwill is the positive reputation of the dental practice. Goodwill is quantifiable, both in the purchase price of the practice and in tax considerations. After the asset sale, the seller and buyer may choose to create a new legal entity to continue the practice together.
Asset sale: Tax implications
Because of tax considerations, buyers may prefer an asset sale, while sellers would opt for a stock sale. In an asset sale, buyers can take depreciation deductions on the assets to lower taxable income. While assets like equipment and goodwill are both depreciating, equipment depreciates faster. This permits buyers to take a bigger tax deduction in the few years after purchase, freeing up the cash flow of the business.
Sellers, meanwhile, are taxed on the asset sale in the year it occurs. However, installment sales may reduce this burden by spreading payments over multiple years, like a loan. Under the installment method, the seller includes in income each year only part of the gain received, or is considered to have received. Sellers pay the ordinary tax rate on the sale of tangible assets, instead of the lower capital gains rate. Goodwill and intangibles, on the other hand, get long-term capital gains tax treatment, a significantly lower rate. Because of faster depreciation, the buyer prefers more of the purchase price to be allocated to tangible assets, and because of the lower taxes for intangibles, the seller is incentivized to allocate more of the purchase price to intangibles. The difference in tax payable can be significant depending on the seller's tax bracket and state of residence. Note that the amount of purchase price allocated to tangible and intangible assets can be flexible, but it should be agreed upon in writing by seller and buyer and reported to the IRS on Form 8594.
Asset sale: Liability implications
Buyers are typically protected from current and future liabilities of the dental practice, such as lawsuits and health and safety violations if the sale is structured as an asset purchase. Sellers typically retain the cash and short- and long-term debt obligations of the practice. In a dental practice, potential liabilities may include lawsuits from former patients, contract disputes, and Occupational Health and Safety Act (OSHA) violations, among many others.
Stock sale: Overview
A stock sale is simpler than an asset sale. The seller transfers his or her interest in the practice to the buyer. Unlike an asset sale, there are no separate conveyances for items such as equipment, leases, and goodwill. The buyer simply takes the place of the seller in the ownership of the dental practice. With that transfer of ownership, the buyer assumes all responsibilities, risks, rewards and benefits of the stake in the business, unless specifically excluded in the purchase agreement or other legal document.
Stock sale: Tax implications
Sellers pay a capital gains tax rate on the proceeds of the sale. This can result in significant tax savings compared to an asset sale, in particular if the assets sold were depreciated. In an asset sale, sellers may be hit with depreciation recapture, which does not occur in a stock sale.
Buyers do not have the benefit of depreciation tax deductions in the event of a stock sale. As the business assets do not leave the practice, the new owner simply steps into the shoes of the seller, and assets continue to depreciate on the same schedule. Because of the possible tax savings for buyers by choosing an asset sale, they may prefer it over a stock sale, especially if the dental practice has significant depreciating inventory.
Stock sale: Liability implications
By taking over the seller's interest in the dental practice, the buyer automatically assumes all of the business's current and future liabilities, known and unknown. This can pose a legal risk to the buyer. However, a dental practice purchase agreement may be structured to protect the buyer from some liability. For example, the seller may be required, through the contract, to assume full liability for lawsuits that would otherwise affect the incoming partner.
Choosing between a stock and asset sale
Whether the sale of all or part of a dental practice should be structured as an asset or stock sale depends on several factors. Both parties would choose a structure that offers the lowest tax rate and ensures legal protections against liability. Because of the nature of an asset sale versus stock sale, buyers and sellers may have a different preference. That tension means buyers and sellers should obtain separate legal counsel even if they are currently colleagues in the practice.
Those who want to sell or buy a stake in a dental practice, or its assets, should take time to evaluate both their short- and long-term interests. Today, the vast majority of dental practice sales are asset sales in order to avoid liability and avoid confusion about who is responsible for settling liabilities. With the counsel of a dental lawyer, dental CPA and appropriate financial advisors, buyers and sellers can make the sound business choice.
ALSO BY MR. ODGERS: The first step toward buying a dental practice: The letter of intent
Greg Maravilla, CPA, is a CFO Advisor for PracticeCFO. PracticeCFO is an integrated business and personal financial planning, wealth management, and accounting and tax firm primarily serving dentists and doctors. He coordinates the firm's assets to help deliver actionable financial advice and information to clients. Greg spent more than 20 years in corporate accounting and finance for both publicly traded and privately held companies. Most recently, he served as CFO of a national lending company for 5 years. During his career, he has raised more than $475MM in debt and equity capital, reported to boards of directors, ran full-cycle accounting departments, managed audits, led software conversions and upgrades, and constructed multi-year capital and operating budgets. He graduated cum laude from Harvard University with a bachelor’s degree in Psychology and attained an MBA from the UCLA Anderson School of Management.
Editor's note:
This article first appeared in the Apex360 e-newsletter. Apex360is a DentistryIQ partner publication for dental practitioners and members of the dental industry. Its goal is to provide timely dental information and present it in meaningful context, empowering those in the dental space to make better business decisions. Visit the Apex360 home page here, and subscribe to the Apex360 e-newsletter here.
