By Dennis Hursh, Esq.
Congratulations! Your colleagues have now finished “kicking the tires” on you for several years and are prepared to let you “join the club.” Now what?
The purpose of this article is to highlight several of the major issues you need to consider. These issues vary in importance (and applicability) from practice to practice. However, by reviewing the issues noted, you should be able to develop a better sense of how attractive an offer for potential partnership really is.
What Are You Buying?
Perhaps the most critical issue to be determined is if you are being offered an equal ownership interest with the other physicians. This issue should be more straightforward than many others. The document offering you the opportunity to purchase equity should clearly state whether you are being sold an equal ownership interest with the other physicians.
Have your advisors examine the methodology used for determining the purchase price. How is the practice valued? Hopefully it is not “fair market value,” since that simply invites a war between disagreeing appraisers. Your appraiser will conclude the practice isn’t worth much, while the appraiser hired by the practice will solemnly declare it is the most valuable practice on the face of the earth. A preferable methodology might be “book value” – the values of the various assets as shown on the books of the practice. Often there are variations to better reflect economic reality which are used to modify the book value. For example, if the books of the practice are kept on a tax basis (i.e., not generally accepted accounting principles) there may be an adjustment to switch depreciation of assets to straight line depreciation, and “bring back” any write-offs allowed by the tax code. A good CPA can be worth his or her weight in gold in reviewing the methodology and books of the practice.
You should not be buying the goodwill of the practice. Generally, goodwill in a physician practice tends to be personal to the physicians in the practice. Unlike a pizza parlor, people are not likely to go back to the same building to be seen by whoever shows up in a white coat that day.
Another issue to examine is accounts receivable. Generally, accounts receivable can be one of the largest assets of a professional practice. It is important to determine if you are buying accounts receivable, and how such accounts receivable are valued and collected. For example, if the practice still has accounts receivable on the books that are several years old, it is unlikely that money will ever be seen for them. To the extent you are paying for accounts receivable, you should only be paying the collectable accounts receivable, and only for the amount that the practice reasonably anticipates collecting. In other words, if the practice sees a patient insured by Megahealth, the local insurance goliath, the practice may very well have a billed charge of $100 but only expect to receive $32. Obviously, you need to make sure that that particular accounts receivable is valued at $32, not $100. In addition, accounts receivable over a year old are most likely worthless.
Some practices exclude existing accounts receivable from the buy-in, and specifically provide that the existing owners receive these receivables as a “seniority bonus” or similar language. This is not objectionable, so long as you are similarly treated when the next physician enters partnership.
As the purchaser of a portion of a business, it is incumbent upon you (or your representatives) to conduct adequate due diligence of the entity. Are there large debts of the practice? If so, are these liabilities offsetting the costs of assets you are purchasing? What is the trend of the liabilities? If it appears that the amount of debt has steadily increased over a period of time, it is possible that the physicians are borrowing to pay themselves. This would need to be carefully investigated, since it would indicate the practice is not as viable as it may initially seem.
In addition, the organizational documents of the entity should be reviewed. Will you have a voice in the governance of the entity? For example, if the practice is a professional corporation (PC) then you should be named to the board of directors of the entity. If the entity is a limited liability company (LLC), then you should be named to the board of managers. If the entity is a general partnership, then you should run, not walk away from ownership. A general partnership’s owners are jointly and severally liable for all debts of the partnership. Unlike a PC or a LLC, generally, a general partner is liable for the malpractice actions of the other partners. This is obviously not a situation that you would want to become involved in.
How Will They Say Goodbye?
Another important document that you will need to examine is the shareholders agreement, or operating agreement in the case of an LLC. Obviously, the methodology used when you buy into the practice should be roughly replicated in your buy-out. For tax purposes, it is possible that you will not be paid the accounts receivable of the practice when you depart. Rather, many practices provide that your accounts receivable will be paid to you as deferred compensation, thus giving a tax benefit to the practice. This is not objectionable, so long as any accounts receivable that you paid for coming in are also paid to you in some form as you leave. You should also examine the buy-out formula as it relates to the senior physicians. The senior physicians are very likely to retire before you. Will the current buy-out provisions allow the practice to remain viable if one (or several) of the senior physicians retire?
How Much Control Will You Have?
The need for review of the organizational documents has already been discussed. However, in addition to looking at the legalities of the control document, you should also look at the practicalities. Although “one man one vote” seems attractive, this could lead to a disadvantage if the senior partners as a group wish to impose their will upon the practice. One way to avoid this is to require insertion of “super-majority” provisions such that more than a simple majority is needed for certain major actions. Samples of these actions might be moving the practice, incurring debt in excess of some reasonably small figure, sale of the practice or its assets, and anything else you can think of that you would consider to be a major disruption in your professional life.
How Will You Be Paid?
The obvious assumption is that you will be paid better than you are being paid now. However, you should realize that many practices compensate the owners on a pure productivity basis. You should have a firm understanding (in the form of an employment agreement) as to how you will be compensated for your services. You should also request to see the senior physicians’ agreements, which should be utilizing the same methodology. Beware of “side deals” where a senior partner is paid a “management fee” for serving as an executive. It is very possible that you will not be able to change this scenario, but you should realize that whatever that physician is receiving will not go into the pot for distribution to the other owners.
What Else Is Out There?
You need to determine what other arrangements exist between the senior physicians and the practice. For example, it is quite common for the senior physicians to own the office building and to lease it to the practice. There is nothing objectionable in this arrangement. However, if this is the case you should attempt to arrange to buy into the real estate entity as well. Otherwise, you may find that the practice is paying above-market rent to that entity, and all the other physicians owners are quite comfortable in paying too much.
As noted above, this article cannot be exhaustive as to the issues to be examined. It is imperative that you retain competent legal counsel (and potentially also a good accountant) to carefully review the entire offer given. Although it is not the usual way of things, you may determine that the gold ring that you have been reaching and striving for for so long is an illusion, and you would be better either remaining an employee of the practice or looking for other, more viable options.
Dennis Hursh, Esq., is a principal in Hursh & Hursh, P.C., a Middletown, Pennsylvania law firm concentrating on representation of physicians and physician group practices.