What Percentage of the Purchase Price should be Allocated to Goodwill?

I see this question frequently, and occasionally I get asked this question from potential buyers. I see claims made by sellers’ advisors that goodwill should be at least 80% of the total purchase price or worse, they suggest that anything lower than 80% will draw the attention of the IRS. This is just plain FALSE!

I hate to break the news to all the folks who believe that there are “standard” percentages that should be used, there aren’t! In fact, I often define goodwill for my buyers as “the difference”. That’s right; goodwill = the difference. Here’s what I mean by that.

Let’s assume you have two practices, each 4 Ops with nearly identical equipment and it’s valued at $150,000. Let’s also assume they’ll have the same allocation to the covenants of $5,000 and the only other remaining assets that need to be allocated are dental supplies and goodwill. Practice A has revenue of $1.5 mil and is selling for $1mil while practice B has revenue of $750k and is selling for $500k. Here’s the proper way to go about allocating the purchase price:

                                                            Practice A                      Practice B

Furniture and equipment                  $150,000 (15%)                  $150,000 (30%)

Dental Supplies                                     20,000                                  10,000

Covenants                                                5,000                                   5,000

Goodwill (the difference)                 825,000 (82.5%)                   335,000 (67%)

You’ll note that goodwill is listed last as it should be the last item that is assigned a value. That’s because every other asset above it should be relatively easy to value and after you’ve agreed upon the values of them, the difference goes to goodwill. Furniture and equipment can be appraised, and dental supplies can be estimated based on practice revenues. You might even see allocations for other items like net contract receivables, consulting agreements, leasehold improvements, patient charts, etc. in every case, a value should be assigned to those assets FIRST then the remainder of the purchase price is allocated to goodwill, LAST!

Technically you’ll see the definition of goodwill, an intangible asset, as the excess amount paid for a business over & above its tangible and other asset values. In my world that’s the same as saying “the difference,” it’s that simple. Statistically speaking I would agree that with the “typical” dental practice sale, 75-80% of the allocated purchase price is usually goodwill, but it’s just a statistic, that’s it.

So don’t get sucked into someone else’s world when they tell you “goodwill should be at least 80% of the purchase price of a dental practice” and any other allocation will draw the attention of the IRS. If you hear a seller’s advisor say that then you know they’re NOT being truthful with you and you have to begin to wonder what other statements they’ve made that aren’t truthful.

Written by Tim Lott, CPA, CVA. For more information on our services, please feel free to contact Tim or one of the members of the Dental CPA team by calling 844-DENT CPA or emailing info@dentalcpas.com.

Protect The Goodwill It’s Taken Years to Build — Before, During and After the Sale of Your Dental Practice

This is a guest post from Dr. Phil LoGrippo of ADS Florida.

The most valuable component of the price of a dental practice is the portion allocated to “goodwill.” Goodwill represents the intangible assets of a business—the difference between an established, successful business and one that has yet to achieve success. In an established dental practice, goodwill consists largely of the name, reputation and skill of the dentist and team, which have led to a strong, loyal patient base and consistent inflow of new patients. For the buyer, goodwill greatly increases the likelihood of continued cash flow from retention of that patient base and from new patients.

For you, the seller, preservation of the goodwill of your practice is paramount to a successful transition. A young dentist who purchased an established practice in Southwest Florida recently said, “The goodwill of the seller in my transition was priceless. His vote of confidence to our patients has increased retention and allowed me to succeed on a level I never would have been able to do otherwise.”

Keep on Building Goodwill

In order to assure that you retain goodwill not only prior to selling but also through the critical transition time during and after the sale, you should maintain your reputation and good name within the practice and community at all times. Through the transition process and even afterward, remain involved in study clubs, the local dental association, community organizations and volunteer groups such as Rotary. This not only will help ensure that you receive proper compensation for your years of practice building, but also that your buyer receives full value. Even after you retire, positive support and praise for the new dentist (such as in social settings) will go a long way toward continued retention of  patients in the new practice.

Choose the Right Broker

Working with an experienced and ethical transition broker is also invaluable in preserving goodwill and value. The right broker will perform a legitimate appraisal and value the practice in a manner that reflects the true anticipated cash flow following the sale, rather than telling you what you may want to hear and subsequently luring a buyer into a bad deal that destroys goodwill. The right broker will also work to find a buyer who is an appropriate fit for the practice, one whose abilities, ethics and practice style match your own, preserving your reputation and the reputation of the practice. Additionally, the right broker will guide the entire process, working with lenders, accountants, and counsel who are knowledgeable in dental transitions. The right broker will also work toward the ultimate goal of having a satisfied seller and buyer, preventing negative interactions that can sometimes occur when working with an inexperienced or self-serving advisor.

For more information, please contact info@dentalcpas.com

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Dental Practice Purchase Price Allocation: Is Goodwill the Devil?

Sometimes we come across uninformed buyers that want the majority of their purchase price allocated to equipment because they can get an immediate tax write-off under Internal Revenue Code Section 179 of up to $125k and $250k in very recent years. However, part of our job is to understand and educate ourselves about the state/locality that the transaction will occur in and educate our buyer/client on ALL the tax considerations of price allocation, not just income tax.

Many, many years ago goodwill was the devil in the eyes of every buyer. Why?

There was a time when goodwill was NOT deductible under the tax code, therefore from a buyer’s perspective, any allocation to goodwill was NOT providing them with any income tax savings. However, goodwill was always treated as a capital asset and subject to capital gains to sellers, therefore, sellers wanted most (and in some cases ALL) of the price allocated to goodwill. I remember when this one issue, the allocation between goodwill and tangible assets, was the most stressful part of most transitions. Not anymore though.

Now, buyers can write off goodwill over 15 years, so in my mind, that was a decent compromise from an income tax perspective between buyers/sellers when negotiating the allocation.

Enter the Sec. 179 write-off issue where the IRS increased the write-off election from $25,000 to over $100,000 and in recent years $250,000. All of a sudden, buyers were reverting back to the "old ways" of trying to minimize goodwill while trying to maximize equipment/furniture/computers and other areas that would generate a faster tax deduction, let alone ANY deduction. STILL, sellers wanted their capital gains so this issue of price allocation was once again a hurdle, though a low one that could usually be jumped fairly quickly.

Then the long term capital gains rates were lowered to 15%, down from 20% and at one time 28% so sellers once again began pushing firmly for more goodwill allocation while the buyers wanted more equipment due to the ability to write off $100,000 under Sec. 179 immediately. When the IRS recently increased the Sec. 179 write-off to $250,000, those that were purchasing large practices where the value of equipment could easily reach that level, began pushing for the higher equipment allocation and price allocation once again became a struggle.

These days, states & local governments are finding other ways to tax businesses aside from income tax, which usually means higher sales tax, personal property tax, transactional tax, etc. Therefore, buyers need to be educated on how the allocation of the purchase price can affect them from EVERY tax perspective, not just income tax.

Take Maryland for example. We have a 6% sales tax (was 5% a couple of years ago) on the allocation to equipment/furniture/computers and supplies, so on an allocation of $100,000 to those items you just cost yourself $6,000 DUE AT SETTLEMENT. Then our counties also assess a personal property tax on business assets, and on $100,000 over 10 years, that's easily another $10k-$15k. So the buyer’s allocation to tangible assets/supplies might cost them more than $20,000 in other taxes compared to $100,000 allocated to goodwill where there is no sales or personal property tax in most jurisdictions....YET.

Keep in mind the income tax savings on $100,000 will likely be nearly the same over 15 years whether it's goodwill OR equipment, with the only difference coming from the income tax brackets the deductions are taken in. The income tax benefit with equipment and supplies is the ability to get those tax savings sooner rather than later. However, if you run the numbers out over 15 years (the life of goodwill under the tax code), the allocation to equipment/supplies will almost always cost you more due to the other taxes you incur, at least here in Maryland and other jurisdictions we've seen.

This is just one reason why buyers should consider seeking advice from an advisor that has many years of experience with practice transactions & transitions, this one area can keep a buyer from making a mistake AND save them money.

This first appeared on NewDocs.

Send your questions to Tim Lott, CPA, CVA at tlott@dentalcpas.com

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