One of the more common transactions that occurs in any business is new owners buying in, while established owners are bought out. Medical practices are no exception.  The existence of buy-sell agreements that spell out the terms under which these transactions will occur can make these transitions in the practice much easier.

Buy-Sell Agreements

When developing a buy-sell agreement, remember that the world today is much different than it may have been when you started practicing medicine. Young physicians typically cannot afford to immediately buy into a practice, since they usually carry heavy debt loads when they finish their training.

They will also be offered multiple practice opportunities, so competition for these new physicians will most likely be fierce. Moreover, younger doctors may view working at your practice simply as a source of income, not as an investment opportunity or a piece of their retirement portfolio. Because of these differences, you may find issues arising over divisions of income, asset valuation and retention of control.

The first thing to determine is exactly what is being paid for. Your practice likely has tangible assets, such as equipment, leasehold improvements, assuming that you lease, or a building, if you own your office space, which have value.  Is the new physician expected to buy a share of these?  Is the retiring physician entitled to his or her share of the value of these?

Your practice also has intangible assets, for example, the value of the practice’s name, patient lists, and other assets, that are typically referred to as goodwill. In addition, assuming that you report on the cash basis of accounting, your practice also has accounts receivable that are not reflected in the practice’s books, but which have value at the time of an ownership transition.

From the perspective of the new physician, payment for both the tangible and intangible assets are often accomplished by a reallocation of compensation in the first few years. For example, a new physician might start with a 40% reduction in the first year and 30% in the next, followed by 20% and 10% in the next two years, leaving the buy-in complete. This payment method helps ease the financial burden on the young physician.

For the retiring physician, payment is often spread over a defined number of years. This keeps the payments to your former partners from diminishing your income too severely in any given year.

Partnership Agreements

Moving beyond the buy-sell scenario, you may also want to spell out in your partnership agreement how you are going to divide income. There are many acceptable methods of doing so.  Some examples include equal allocation, productivity, which can be measured in many different ways, including charges, collections, value of personal services provided by the physician, or a hybrid method that recognizes that some of your expenses are fixed in nature and should be split equally, while others vary with productivity and are allocated accordingly.

There are numerous other contract terms you should consider. For example, terminating a physician “without cause” usually is not a good idea, because it can breed acrimony and lower morale. Furthermore, even “with cause,” termination frequently requires either unanimity or a supermajority of the vote.

In addition, a new physician may be asked to sign as a guarantor of existing practice debt that has been personally guaranteed by the partners. That is fair and so is a provision indemnifying the physician against liability for practice actions that occurred before he or she joined the practice.

Voting Rights

Your agreements may also spell out voting rights. Do you want each physician/owner to have an equal say, or should they earn those rights over a period of time?  Are all decisions made by majority rule, or are there some topics, such as adding partners or selling or merging the practice, that require something greater than a simple majority?  Your partnership agreement, separate from the buy-sell agreement, can address these questions.

Many of these questions have no single, correct answer. The right solutions will vary from practice to practice.  In addition, beyond the points brought up here, there are many laws and legal doctrines that affect the terms of both buy-sell and partnership agreements. These include statutes that govern your practice’s form of organization, confidentiality laws and non-compete and liquidated damages clauses. So make sure you work with your accountant, health care consultant and attorney to draft an agreement that will not only protect your practice and comply with the law, but also help minimize disputes.

For more information on buy-sell agreements, contact Larry Sophian at 312.670.7444. Visit ORBA.com to learn more about our Health Care Group.