Should Dr. Thompson optimize his dental practice before selling it?
The impasse: A dentist must decide whether to delay retirement in order to make his practice more attractive or sell now and risk leaving money on the table.
BY TAMARA YOUNG
October 2024
State of mind Keen to retire and maximize the value of his practice
I've seen situations where business owners weren't able to purify before a sale because they waited too long. It's a very expensive oversight.
The information contained herein has been provided by TD Wealth and is for information purposes only. The information has been drawn from sources believed to be reliable. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual's objectives and risk tolerance. TD Wealth represents the products and services offered by TD Waterhouse Canada Inc., TD Waterhouse Private Investment Counsel Inc., TD Wealth Private Banking (offered by The Toronto-Dominion Bank) and TD Wealth Private Trust (offered by The Canada Trust Company). TD Wealth Private Wealth Management represents the products and services available through TD Wealth Private Investment Advice (a division of TD Waterhouse Canada Inc.), TD Wealth Private Investment Counsel (offered by TD Waterhouse Private Investment Counsel Inc.), TD Wealth Private Banking (offered by The Toronto-Dominion Bank) and TD Wealth Private Trust (offered by The Canada Trust Company). ®The TD logo and other TD trademarks are the property of The Toronto-Dominion Bank or its subsidiaries.
THE CHALLENGE
Dr. Thompson is nearly ready to sell the dental practice he has owned and operated for the last 35 years. Although it needs some modernizing, it's located in one of Ontario's fastest-growing regions and boasts a roster of loyal patients — many of whom Dr. Thompson has been seeing for decades. He's looking forward to spending more time with his six grandkids and travelling with his wife. But after conferring with peers about the sale process, he sees that there is more than one way forward and he has different options with different outcomes. However, Dr. Thompson believes that the Lifetime Capital Gains exemption will be his primary tool for making a successful sale of his practice. Still, he's faced with the dilemma of retiring later than he wished: Should he delay retirement for a few years and shell out funds to make the transaction as profitable as possible (Option A), or sell now as is and risk leaving money on the table (Option B)?
Disclaimer
PIERRE LÉTOURNEAU
Business Succession Advisor, TD Wealth
SOURCES
1 Succession Tsunami: Preparing for a decade of small business transitions in Canada, Canadian Federation of Independent Business, 2022, p.3, accessed Aug. 29, 2024, 20336445.fs1.hubspotusercontent-na1.net/hubfs/20336445/research/reports/2022/2022-10-EN-Succession-Tsunami-Preparing-for-a-decade-of-small-business-transitions-in-Canada.pdf
2 Ibid., p. 3.
CASE STUDY
Pierre Létourneau, Business Succession Advisor with TD Wealth, says that Dr. Thompson's predicament is not uncommon among dentists and the benefits and drawbacks of all business succession strategies need to be considered. The first thing to research is corporate “purification,” which will mitigate taxes when he does sell so that more funds go into his retirement plan. The next step is to decide whether or not to “optimize” the practice. Both strategies will potentially make the transaction more lucrative, but will take a significant amount of time and cost Dr. Thompson money upfront.
What the professionals say
Dr. Thompson's two options offer starkly different futures for his personal life. According to Létourneau's analysis, if he chooses to delay his retirement by three years — Option A — his savings will cover him well beyond his 95th birthday, at which point his total assets will be $7.8 million. He will also be able to comfortably gift his children at least $300,000 each without having to make sacrifices elsewhere or sell either of his homes.
But if Dr. Thompson chooses to sell now — Option B — his personal finances would be more strained. His retirement savings will be depleted by the time he turns 89, and he may face difficult choices around gifting money to his children or selling his home or cottage.
While the first option requires Dr. Thompson to work a little longer than he initially hoped to, his health is good and the advantages could outweigh the alternatives.
Dr. Thompson's decision highlights the importance of succession planning for dentists, and business owners in general, leading up to the sale of a small business. “It's a bit of a trade-off,” says Létourneau, “The question becomes, ‘Do I adjust my goals and get out sooner, or do I stick it out a bit longer and, in turn, worry less about my retirement?’” Ultimately, the decision will hinge on your individual circumstances and priorities.
The analysis
Although Dr. Thompson is fictional, he could be one of the 76% of Canada's business owners who plan to exit their business within the next decade.
RUN THE NUMBERS
SALE OPTION A
$2.25 million
TAX CONSIDERATION
RESULT
SALE PRICE
Lifetime Capital Gains Exemption of $1.25M, resulting in more than $400,000 of savings
At age 95, Dr. Thompson would still have $7.8M in assets ($2.9M in investments and $4.9M in real estate)
Goal Sell his practice successfully; enjoy a comfortable retirement that includes travel
Subject
Dr. Thompson1, 63, dentist. Health is excellent
Should Dr. Thompson prepare his practice for sale even if it means delaying his retirement and making additional investments?
IMAGE: INNA GERTSBERG
THE
CASE
1
($300,000 each)
RETIREMENT EXPENDITURES
ASSETS
$7.8 Million
How much Dr. Thompson is worth at 95 after a successful sales strategy.
RRSP
TFSA
NON-REGISTERED PORTFOLIO
COTTAGE
$900,000
$100,000
$2,500,000
$1,000,000
EXPENSES
$130,000/year
$900,000
GIFTS to three CHILDREN
MORTGAGE ON COTTAGE
$500,000
Fully repaid in the year practice is sold
after-tax and indexed to inflation
Held in private corporation
$1,500,000
PRIMARY RESIDENCE
Salary for 3 years and then retirement
TIMELINE
SOURCE: Canadian Federation of Independent Business
Only 9% of business owners have a succession plan in place.
Létourneau says it really comes down to priorities.
If Dr. Thompson delays retirement by three years — Option A — he'll have time to implement some important updates to his business before putting it on the market. The three-year delay also includes a one-year post-sale period where he would continue to work for the new owner to support a smooth transition.
Option B offers a shorter timeline. Dr. Thompson would sell his practice now without improvements and retire immediately following a shorter, one-year transition period. While this option would allow the dentist to retire sooner (something he's happy to do), it means accepting a lower sale price and an unintended tax consequence.
Jon Walton, Partner at MBC Brokerage, which specializes in the appraisal, optimization and sale of dental practices, says there is often a significant advantage for dentists who prepare their practices well in advance of a sale: Ultimately it can lead to a higher sale price.
Here is what Dr. Thompson should consider prior to making a decision.
According to Létourneau, the first item to tackle for Dr. Thompson is that of corporate purification — the process of removing passive assets from a corporation in order to secure the Lifetime Capital Gains Exemption (LCGE) prior to selling. To be eligible for the LCGE, at least 50% of the corporation's value must come from active business assets at any given time in the two years leading up to the sale.
Although Dr. Thompson wants to retire soon, if he delays the sale by at least two years, he would have sufficient time to complete this purification process and meet the eligibility requirements. This could potentially exempt $1.25M of the final sale price from capital gains tax and result in tax savings of more than $400,000. If he sells now, however, he won't have enough time to purify.
“I've seen situations where business owners weren't able to purify before a sale because they waited too long,” he says. “It's a very expensive oversight.”
The next strategy is optimization. This process may include a variety of updates including technological modernization — a digital x-ray machine can cost upwards of $100,000 — but could also include digitization of patient records, which is now standard for dental practices.
Both Walton and Létourneau emphasize another aspect of optimization: the importance of completing a thorough review of any legal agreements critical to the business. This could include anything from the dentist's employee contracts to his commercial lease.
Walton says reviewing these types of contracts prior to a sale is important “because [for the buyer] it's not just a risk today, but there's long-term risk as well.”
If Dr. Thompson hasn't had a lawyer evaluate his lease for a long time, he may be surprised to learn what it contains. Many leases include an item called a demolition clause, which could allow a landlord to terminate the lease early or relocate the tenancy in order to renovate the premises. This could potentially threaten the health of the business, and Walton adds that even its mere inclusion could deter prospective buyers.
Anyone interested in buying or selling a business may want to consider speaking with their financial, legal and tax advisors.
One last thought
PERSONAL FINANCES
LIABILITIES
2.5%
INFLATION CALCULATION
ASSUMPTIONS
5%
Rate of return on investments
2%
GROwth rate on real estate
BUSINESS OPTIONS
At age 89, Dr. Thompson's retirement funds would be completely depleted and he would need to sell his home or cottage to meet his lifestyle expenses
RESULT
Salary for 1 year and then retirement
TIMELINE
No Lifetime Capital Gains Exemption
TAX CONSIDERATION
$2.0 million
SALE PRICE
SALE OPTION B
Subject
Dr. Thompson1, 63, dentist. Health is excellent
Subject
GOAL
Subject
Létourneau says it really comes down to priorities.
If Dr. Thompson delays retirement by three years — Option A — he'll have time to implement some important updates to his business before putting it on the market. The three-year delay also includes a one-year post-sale period where he would continue to work for the new owner to support a smooth transition.
Option B offers a shorter timeline. Dr. Thompson would sell his practice now without improvements and retire immediately following a shorter, one-year transition period. While this option would allow the dentist to retire sooner (something he's happy to do), it means accepting a lower sale price and an unintended tax consequence.
Jon Walton, Partner at MBC Brokerage, which specializes in the appraisal, optimization and sale of dental practices, says there is often a significant advantage for dentists who prepare their practices well in advance of a sale: Ultimately it can lead to a higher sale price.
Here is what Dr. Thompson should consider prior to making a decision.
According to Létourneau, the first item to tackle for Dr. Thompson is that of corporate purification — the process of removing passive assets from a corporation in order to secure the Lifetime Capital Gains Exemption (LCGE) prior to selling. To be eligible for the LCGE, at least 50% of the corporation's value must come from active business assets at any given time in the two years leading up to the sale.
Although Dr. Thompson wants to retire soon, if he delays the sale by at least two years, he would have sufficient time to complete this purification process and meet the eligibility requirements. This could potentially exempt $1.25M of the final sale price from capital gains tax and result in tax savings of more than $400,000. If he sells now, however, he won't have enough time to purify.
"I've seen situations where business owners weren't able to purify before a sale because they waited too long," he says. "It's a very expensive oversight."
The next strategy is optimization. This process may include a variety of updates including technological modernization — a digital x-ray machine can cost upwards of $100,000 — but could also include digitization of patient records, which is now standard for dental practices.
Both Walton and Létourneau emphasize another aspect of optimization: the importance of completing a thorough review of any legal agreements critical to the business. This could include anything from the dentist's employee contracts to his commercial lease.
Walton says reviewing these types of contracts prior to a sale is important "because [for the buyer] it's not just a risk today, but there's long-term risk as well."
Dr. Thompson's two options offer starkly different futures for his personal life. According to Létourneau's analysis, if he chooses to delay his retirement by three years — Option A — his savings will cover him well beyond his 95th birthday, at which point his total assets will be $7.8 million. He will also be able to comfortably gift his children at least $300,000 each without having to make sacrifices elsewhere or sell either of his homes.
But if Dr. Thompson chooses to sell now — Option B — his personal finances would be more strained. His retirement savings will be depleted by the time he turns 89, and he may face difficult choices around gifting money to his children or selling his home or cottage.
While the first option requires Dr. Thompson to work a little longer than he initially hoped to, his health is good and the advantages could outweigh the alternatives.
Dr. Thompson's decision highlights the importance of succession planning for dentists, and business owners in general, leading up to the sale of a small business. "It's a bit of a trade-off," says Létourneau, "The question becomes, 'Do I adjust my goals and get out sooner, or do I stick it out a bit longer and, in turn, worry less about my retirement?'" Ultimately, the decision will hinge on your individual circumstances and priorities.
HIDE
Dr. Thompson1, 63, dentist. Health is excellent
Létourneau says it really comes down to priorities.
If Dr. Thompson delays retirement by three years — Option A — he'll have time to implement some important updates to his business before putting it on the market. The three-year delay also includes a one-year post-sale period where he would continue to work for the new owner to support a smooth transition.
Option B offers a shorter timeline. Dr. Thompson would sell his practice now without improvements and retire immediately following a shorter, one-year transition period. While this option would allow the dentist to retire sooner (something he's happy to do), it means accepting a lower sale price and an unintended tax consequence.
Jon Walton, Partner at MBC Brokerage, which specializes in the appraisal, optimization and sale of dental practices, says there is often a significant advantage for dentists who prepare their practices well in advance of a sale: Ultimately it can lead to a higher sale price.
Here is what Dr. Thompson should consider prior to making a decision.
According to Létourneau, the first item to tackle for Dr. Thompson is that of corporate purification — the process of removing passive assets from a corporation in order to secure the Lifetime Capital Gains Exemption (LCGE) prior to selling. To be eligible for the LCGE, at least 50% of the corporation's value must come from active business assets at any given time in the two years leading up to the sale.
SOURCE: Canadian Federation of Independent Business
Only 9% of business owners have a succession plan in place.
HIDE
Dr. Thompson is nearly ready to sell the dental practice he has owned and operated for the last 35 years. Although it needs some modernizing, it's located in one of Ontario's fastest-growing regions and boasts a roster of loyal patients — many of whom Dr. Thompson has been seeing for decades. He's looking forward to spending more time with his six grandkids and travelling with his wife. But after conferring with peers about the sale process, he sees that there is more than one way forward and he has different options with different outcomes. However, Dr. Thompson believes that the Lifetime Capital Gains exemption will be his primary tool for making a successful sale of his practice. Still, he's faced with the dilemma of retiring later than he wished: Should he delay retirement for a few years and shell out funds to make the transaction as profitable as possible (Option A), or sell now as is and risk leaving money on the table (Option B)?"
THE CHALLENGE
Although Dr. Thompson is fictional, he could be one of the 76% of Canada's business owners who plan to exit their business within the next decade.
1
Keen to retire and maximize the value of
his practice
STATE OF MIND
Sell his practice successfully; enjoy a comfortable retirement that includes travel
GOAL
Dr. Thompson1, 63, dentist. Health is excellent
Subject
THE
CASE
BUSINESS OPTIONS