I’m not trying to convince you of anything. I’m just an observer. And my observations are telling me this:
“If You Were Thinking About Selling, You Better Do It Now.“
Why? Here are my Top 10 Reasons:
1. Interest Rates Are Likely Going Up in 2022
A few weeks ago, the Bank of Canada did four (4) things: it noted that (1) inflation is ticking up, (2) that’s it’s leaving the historically low overnight interest rate alone (0.25%) and (3) that it was scaling back on buying government bonds (which was helping to keep inflation in check). What’s the fourth (4th) thing? It signalled that it could start to raise interest rates in the second half of 2022.
What does that have to do with you and your practice’s worth? Well, when interest rates are up, that means buyers are paying more to the bank to borrow money. Banks are giving 100% financing to buyers, amortized over 12 years nowadays. Higher interest rates mean less money for the buyer to take home. That means that the practice they’re buying isn’t going to be worth as much because of the increased costs of borrowing. When interest rates are high, the value of money goes up (there’s less money circulating in the market) and the cost of things goes down. You get the idea.
2. The Inclusion Rate of the Lifetime Capital Gains Exemption May Go Up in 2022 or after
Right now, if you’re selling shares of your dentistry professional corporation, you may trigger capital gains (you may not trigger capital gains if you qualify for the lifetime capital gains exemption, but that’s an article for another time). Right now, the way that the capital gains are calculated is that you pay your personal marginal tax rate on 50% of the gain on your shares. So if you originally bought your shares for $1 each from your company when you first created it and now you’re selling those same shares for exactly $1,000,001 to a buyer, you’ve now got a $1-million capital gain, 50% of which (i.e. $500k) is taxable at your full marginal tax rate (which could be as high as 53%, mind you). This would result in a particular tax bill of $265k in taxable capital gains if you were at the top marginal tax rate for the year (again, this assumes you’re not using your lifetime capital gains exemption).
Now, importantly, if the inclusion rate goes from 50% to 75%, that means you’re paying your full marginal tax rate on $750k, not $500k, in our example above. Thus, in our example above, your new tax bill could be $132k MORE (0.75% of $750k gain, taxed at 53%, results in taxable capital gains of $397,500, which is $132k MORE than $265k). You get the idea…
Now, it’s only a RUMOUR at this point that’s the inclusion rate could go up from 50% to 75%. But there are a few things to consider here.
First, this rumour has been happening for years. Second, the NDP has made it their position that they want this to happen (and the Liberals may need to cave and agree to it in order to do things like pass the budget next year with their help). Third, there’s a view that the Liberal government can unilaterally change the rate and make it apply starting Jan 1, 2022. Fourth, when the Liberal government changed the Tax on Split Income Rules in 2018 (which effectively put an end to income splitting with family members through dividends), they targeted professionals like dentists and doctors to raise more taxes and didn’t seem to care about the political fallout (those professionals make too much money anyway, right?); so if the Liberals have already gone after professionals before, they’ll have no problem going after them again to fill their coffers, right?
Fifth, right now there’s a clear disconnect between taxes someone pays on salary (which can go as high as 53%), dividends (which can be taxed between 39% and 47%), and capital gains (which are effectively taxed at around 26%); so to be fair and try to level the playing field (a common theme of the Income Tax Act and tax policy), it would make absolute sense for the federal government to target capital gains to get them taxed at around the same as salary or dividends.
Finally, let’s not forget the elephant in the room: because of COVID-19 and all the government spending (CERB, CEWS, CEBA, CECRA, etc.), the government needs to raise money. And targeting those who are cashing out on their business makes sense, right?
Even if the federal government leaves the inclusion rate alone for 2022, who’s to say that it will leave it alone in 2023 or 2024? Do you really want to wait to find out and possibly pay more tax if they DO change it?
3. Practice Values Are Back Up
This is a good thing, to counter all the bad news. During COVID-19 (March to September 2020), practice values went down to new lows before bouncing back. Fast forward to now (nearing the end of 2021): practice values are back up to pre-covid-19 levels. So if you do decide to sell now (and keep in mind that it typically takes 3-6 months to sell from the time you say ‘go’), you’re looking at a positive selling environment for now.
4. Higher Rents
Buyers need at least 10 or 12 years of non-use of a demo clause in order to get bank financing. Otherwise, there are risks. And with risks comes either a renegotiation of the purchase price (lower) or better terms for the buyer. Landlords today – especially with the beating that they took during COVID-19 – are now looking for new revenue streams. We’ve noticed that, when it comes to negotiating with big landlords that own attractive spaces, they are stubbornly asking for higher than normal rental rates. This translates into less cash for the tenant and a future buyer (hence, lower appraisal and purchase price).
5. Demo Clauses
The worst part is that landlords everywhere are putting in demolition clauses on renewals or new leases so that they have the freedom to tear down the building and put up condo units (or sell to a property developer who will do exactly that). A demo clause interferes with the buyer’s 10 or 12-year financing amortization schedule with the bank (it creates risk). And that risk translates into buyers either being unwilling to buy or asking for large concessions, like a big price reduction.
This year, we’ve seen a lot of transactions stall (and some fall apart entirely) due to demo clauses. Some options to get around this include: (1) selling charts/moving team members to a neighbouring dentist, (2) inducing the landlord to push back the application of the demo clause (e.g. 12-15 years at a minimum!), (3) moving out and starting over and hopefully BEING the landlord or (4) tying a relocation clause into a demo clause so that IF the landlord does demo, they need to pay to give the tenant equivalent space elsewhere with similar dimensions, etc. and the landlord would pay for moving costs and not move the tenant into the new space until it’s perfectly ready to go.
6. Corporation Wasn’t Set Up Correctly
Often times dentists bring us their corporation’s minute book (a giant booklet of documents that tell us, among other things, who owns the corporation). The idea is that, if the corporation was set up properly, when the shareholder dentist who owns it goes to sell it, they can include family members in the sale. Why? To pay less taxes overall. Because each human gets access to the almost $900k of lifetime capital gains exemption. So if the corporation meets all the tests of being a small business corporation and the shareholders have held their common shares for the required 24 months before a sale, then they can hopefully qualify. There’s a lot of moving parts and considerations (tax and accounting) to factor in here, but that’s the whole idea: that you sell shares and you minimize the capital gains tax on the sale.
Now, what we’ve been finding is that the corporation was set up years ago by a non-dental lawyer and it only gave common shares to the dentist and that’s it. Well, we can’t just add adult family members to the corporation now and sell; they need to hold their shares for 24 months! A lot can happen in that time, especially to practice values. And it might be all the other things I mentioned above that drives a practice’s value down during that 24 month waiting period (i.e. interest rates go up, capital gains inclusion rate goes up, landlord raises rental rates, landlord inserts a demo clause, etc.).
7. Corporation Owns Bad Assets
If you’re thinking about selling shares of your dentistry professional corporation, you need to make sure that it’s clean. What do I mean by that? Just open up the last few financial statements for the corporation and look at the balance sheet. You CANNOT sell a corporation with bad assets in it. What are bad assets? Too much cash, investments, life insurance, loans to related parties, real estate investments, etc. If you sell your company with those bad assets in there, then the buyer gets them. But they didn’t pay for them, right? They only paid for your practice. But your shares of your corporation (which you’re selling) give them the right to own the corporation that owns your practice AND whatever other assets you left in there at the time of closing.
So it’s super important that, for the 2-5 years leading up to a sale, you remove these bad assets out. You need to “purify” them into a separate company. Don’t loan cash to the other company. That’s not going to help. You need to “purify”. And here’s the thing: if you try to purify and sell too soon (like before 2-3 years), then there are tax repercussions (you’ll be penalized). So you’d better purify these assets out long before you’re thinking of selling. The only other way to purify out without being punished before a sale is to do it out of the corporation’s Safe Income on Hand (this is adjusted after-tax corporate profits which only skilled accountants can calculate based on a complex formula). If your corporation HAS ENOUGH safe income on hand, then you CAN purify out at the last minute and sell and avoid tax consequences; but if your corporation doesn’t have enough, then you’ll be faced with paying more taxes.
And if it’s too much taxes, then you could be better off just keeping the bad assets in your corporation and selling assets. If you’re able to allocate most of the purchase price to the goodwill (a class of asset called eligible capital property), you can dividend yourself up to half of that amount tax-free as a capital dividend, which is good. And your corporation (after paying capital gains tax on selling that asset class) can also get a refundable dividend tax when it declares taxable dividends. So that’s good. What’s bad about an asset sale? There may be HST on the sale when you sell leaseholds. And you don’t get to use your lifetime capital gains exemption. But if your corporation wasn’t set up properly to multiply the capital gains exemption OR if you have too many bad assets in it, then you’ll have no choice but to clean it up and wait a few years to sell OR sell assets now.
8. Labour Shortages and Higher Staffing Costs
Let’s face it: there’s a labour shortage in the dental industry. Why is that? Well, it’s combination of factors exposed by COVID-19. You see, before COVID-19 came along, if you were a receptionist, assistant, office manager or hygienist, GENERALLY you would not get extended benefits (medical, additional leave, etc.) nor would you get a pension. That’s the nature of the industry. But at the same time, team members didn’t need to wear HAZMAT suits and sit behind glass barriers just to do their jobs. Plus they could drop their kids off at school or daycare without having to worry too much about them catching or bringing home a disease that could land them or their family in the hospital (or worse).
Now, when COVID-19 attacked job security with terminations and temporary layoffs, team members began to realize that their jobs weren’t as secure as they thought; they had to depend on CERB just to get by. And on top of that, they now had more burdens just to go to work (e.g. extra PPE, barriers, fallow times, wipe-downs, scared patients, etc.). Meanwhile, the government was doling out money for those wanting or needing to stay home. And some staff have families where kids couldn’t go to school or daycare (because of personal choice or health reasons). And some staff have medical issues that made getting vaccinated or going to work even more risky. All of this translated into a lot of staff resignations; for those who stayed behind, they were able to negotiate higher wages and benefits.
It’s so much harder today to find skilled labour in today’s market. That’s been driving up labour costs. Assistants used to make in the high teens per hour; now it’s $23-$30/hour to start in urban centres, depending on their level of experience. Hygienists are getting hired based on 45-50/hour in urban centres. Wages and salaries used to be around 22-25% of overall revenues for a healthy practice; but nowadays, we’re seeing labour costs going into the 30-40% percentile of overall revenues! What does that mean? Less cash flow to a practice’s owner and to a prospective buyer. So once again, there’s downward pressure on the sale price.
9. Increased Operating Costs
More and more expensive PPE. Shielding/barriers around the front desk. HEPA filters in every room. Closed-door environments (which often cost thousands of dollars to make happen). All of this adds to increased operating costs and lower profit. Hence, a lower value for the practice.
10. The Stress of It All
All of the above is no doubt creating a lot of added stress to an already stressful lifestyle (i.e. being a dentist, managing a team, dealing with hundreds of patients each year, dealing with vendors, running a business in a competitive environment, etc.). And there’s going to be a breaking point where a dentist decides that they need to do what’s best for them. They’re not enjoying the day-to-day COVID-19 grind; the difficulty of getting patients and staff to come to the office; and the dwindling profits due to increased taxes, staffing costs, rental rates, and suppliers. And eventually, and you can’t blame them, they’ll want out.
That’s when they contact us at DMC. And we talk them through the process of selling. But we always want to make sure that they’re ready to sell. No regrets. No pressure. It’s on them if and when they want to sell. And when they do, we create a plan to help make it as organized, smooth, and quick as possible; and we always try to get them the best deal possible, while educating and protecting them throughout the process (we are lawyers, after all). We also provide fixed-fee quotes in advance to prepare, market (including running an open house), and sell the dental practice. And our pricing is considerably lower than using a real estate salesperson plus a team of lawyers (because you need an employment lawyer, leasing lawyer, corporate lawyer, tax lawyer, and commercial lawyer) to do the entire sale.
