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"It was a great experience for both of us. I got paid in full at closing and my associate who bought the practice got 100% financing."

William B. Shropshire, DDS

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The Importance of Associate Contracts

by Earl M. Douglas, DDS, MBA, BVAL | Earl Douglas on Google Plus

The best business dealings are when you deal with someone whose word and handshake are all you need ... and then you put it in writing! Written contracts between owners and associates are critical. Too often, dentists tell associates to come and work for them to see how things work out. Later, if things mesh, they get together and work out a contract. Too many times, however, later never comes and contracts don't materialize. This lack of a contract is the source of several critical problems.

First, both parties tend to create their own set of understandings and expectations ... and these understandings rarely coincide. As time goes on, friction mounts when these contradictory goals collide, and they then tend to occur more frequently. This results in a very unpleasant practice for everyone involved - i.e., dentists, staff, and patients.

One critical element of a contract is a "covenant-not-to-compete/nonsolicitation agreement." For example, let's say an associate has worked in a practice for five years without such an agreement. During these five years of "seeing how things work out," the associate has, in effect, freely acquired the goodwill of the patients he or she has treated.

Now, suppose the owner wants to sell his "$900,000" practice. The owner's production is $500,000 and the associate's production is $400,000. When the owner has a practice valuation, the value is placed at his or her production level of $500,000. Despite the owner's strongest assertions otherwise, the buyer, the buyer's accountant and attorney, and the lender will not support paying the seller for goodwill that actually belongs to the associate. In fact, the associate can leave with his or her patients and establish a new practice or associateship nearby. The bottom line is that buyers will not pay a seller for goodwill that the associate owns and the buyer does not expect to receive.

At this point, the seller will want to negotiate a covenant-not-to-compete and a nonsolicitation agreement with the associate. That owner will quickly discover that unless enhancements are offered - i.e., money - the associate will not be willing to make such concessions. The owner can terminate the associate, but the associate still can take the patients he or she has treated.

The owner has no leverage after the fact. In our example, the loss of $400,000 of goodwill translates into a loss of $250,000 in the sale price. This is the price the owner paid for not having a written agreement.

Many problems can arise between owners and associates, and when they have not been anticipated and be much more difficult. One party will invariably have a stronger bargaining position, and one will be more vulnerable after time has passed and individual investments in time, energy, and money have been made.

Another important issue is the status of the associate, whether that associate is an employee or independent contractor. Frequently, owners will designate the associate as a contractor to avoid paying employer withholding taxes. The caution here is to ensure that the associate actually meets the criteria for a contractor. Does the associate provide his or her own dental equipment, instruments, supplies, auxiliary staff, and does the associate set his or her own schedule and work without any supervision? In such a case, the associate might possibly, but not necessarily, pass the contractor tests.

If these conditions are not met, the Internal Revenue Service may judge the contractor to be an employee. In this case, the owner may expect to pay the IRS for all past withholding and payroll taxes, with possible additional penalties and interest. If an associate has been working for a year or more, this can become very expensive.

If the associate is incorporated, an owner may more safely consider contracting with the associate?s corporation, and the associate?s corporation will pay his or her salary and withholding taxes. If the associate is not incorporated, it is safer to regard that individual as an employee and withhold taxes and pay the payroll taxes due. These taxes amount to about 3 percent of the associate?s gross production, so reducing the associate?s commission by 3 percent would have the same financial effect as if the associate were a contractor who paid his or her own taxes. This avoids the huge financial risk the owner would face if the IRS disallowed a contractor status.

When is the best time to plant an acorn? Now! The same applies to a contract with your associate. The benefits are enormous and the cost is negligible. Talk to your consultant or attorney today!