Buy/Sell Agreements — Part III Special Situations May Require Some Creative Solutions, Modifications

This is the third and last article on medical practice buy/sell agreements. The first two installments covered the strategic, structural, and financial aspects of these arrangements. This piece will focus on special situations that may require creative solutions and modifications to existing arrangements.

Divorce Settlements

A question often asked is, ‘How is my practice interest valued in a divorce proceeding?’ First of all, your practice’s articles of organization and stock certificates should clearly indicate that the stock is restricted as to ownership and can only be transferred either back to the practice or its existing owners. You also need to have a written stock purchase or stock-redemption agreement predating any divorce proceeding that clearly sets the terms, restrictions and price at which the stock is to be transferred.

This protects the group practice and other owners. If one of your partners is in a divorce proceeding, he/she may not be so fortunate. Regardless of the value placed on the medical practice by internal contracts, the value for divorce settlement purposes may be determined by state laws or judicial precedent. Therefore, although the practice may be protected, the individual doctor may be subject to a higher valuation.

Multiple Retirements

Some practices may have several doctor owners retiring or leaving within a short time frame of each other, requiring a large financial commitment to the remaining doctors that is unfunded. This can be addressed by a provision in the stock redemption and/or employment agreements that limits the annual unfunded payments to a certain dollar amount or percentage of distributable income. It protects the practice and merely extends the payout period of retirees.

Ownership versus Employee Status

Some practices pay their owners and non-owner doctors on the same basis. This creates problems. Ownership in a medical practice requires more personal commitment in terms of administrative time and often more financial risk, e.g., personally guaranteeing bank loans and other liabilities of the practice. Accordingly, there should be financial rewards that are notably disparate between owner and non-owner doctors. Practices that pay non-owners compensation and benefits similar to owners leave no incentive for doctors to want to buy into the group, assume more responsibility, and pay out retiring members. No matter how well crafted your buy/sell arrangements are, they will likely fail you if an employed doctor has to take a pay cut to buy into the practice.

What Valuation Method to Use

There is no hard and fast methodology to valuing a practice for purposes of an internal buy/sell arrangement. It is different from a valuation for purposes of selling to an outside party. Some practices use a fixed agreed-to value that they review annually. Some use a percentage of annual compensation, while others determine value based on hard assets (furniture, equipment, investments) and accounts receivable, net of liabilities. Whatever methodology is used, be cognizant of the ability of new owners to afford it, be consistent with its application, and be sure the buy-in and buy-out mirror each other.

Part-Time Doctors

Senior doctors nearing retirement are desiring to reduce their patient schedule and call schedule. This should be addressed in the employment and stock-redemption agreements. With the ballooning cost of professional liability insurance and other fees, it is very costly to hire part-time doctors. Accordingly, it is recommended that doctor owners who reduce their work schedule below 75{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} be required to sell back their stock and to enter into a new employment agreement with compensation based on a percentage of revenue collected.

Real Estate Ownership

Doctors that own their office are generally advised to place this asset in a separate entity and to execute a lease agreement with the medical practice. The real estate entity has a separate buy/sell arrangement that is usually tied to the same events that trigger the practice’s arrangement. It is generally recommended that new owners of the medical practice be required to buy into the real estate entity and that retiring owners of the medical practice be required to sell back their interest in the real estate. This avoids conflicts with the level of rent being charged and other landlord tenant issues such as maintenance.

Seek Legal and Tax Advice

Most accountants have seen too many buy/sell arrangements that were written by the doctors themselves or their administrators to save on professional fees. This is one area you do not want to go it alone on. If you try to save on professional fees up front it could cost you dearly later. A CPA or other consultant experienced in health care can assist you in outlining most of the critical financial and operational aspects. A CPA can advise you on the tax pitfalls of a poorly worded arrangement, but can’t give you legal advice. Be sure the documents are drawn up by an attorney experienced in health care law.

James B. Calnan, CPA, is partner-in-charge of the Health Care Services Division of Meyers Brothers Kalicka, PC, Longmeadow, MA Certified Public Accountants and Business Consultants; (413) 567-6101.