You’ve made the tough decision and have determined to add an associate physician as a partner in your practice. But how do you do that successfully? You aren’t just going to give away a piece of what you’ve worked so hard for, but what is it worth? How can you maximize the value but not make the price and terms so steep that your associate says, “No thanks,” and leaves the practice? Will the buy-in set you up for smooth sailing or will it create waves of conflict for years to come? How will it affect future associate buy-ins? How will it affect your ability to get bought out on retirement? Your practice is essentially setting the rules by which you will play for years to come – where do you start?
The Three Elements of Ownership
When we talk about owning a business, we are really talking about the following three distinct elements of ownership:
1) Voting Rights
2) Distribution Rights
People often think that if buying 50 percent of a business entitles them to 50 percent of the vote (voting rights), the cash flow (distribution rights), and the profit on the sale of the business (liquidation rights). That is not necessarily the case, however. Depending on the type of entity you utilize, a 50 percent interest in the business may not entitle you to 50 percent of the vote; rather certain decisions may be reserved to certain owners, or the day-to-day management can be placed in a single owner or group of owners’ hands. The ownership percentage also does not need to be tied to distribution rights. The documents can provide for unequal distributions or employment agreements can alter the method of distributing cash flow. Even on the sale or liquidation of the business, the right to receive sales proceeds doesn’t have to follow ownership percentage but can be altered to recognize such things as tenure or investment in the practice. Determining how you treat the three elements of ownership will have a great impact on the price and terms of the purchase.
Dividing the Practice Income
The most frequently discussed element of ownership is distribution rights, and it is the one that has the most immediate impact on the structure of a medical practice buy-in. Most medical partnerships divide a majority of their income on a productivity basis based on collections attributable to the physician. A smaller percentage of practices divide their partner revenues equally, based on share ownership. An increasing number, particularly those with significant ancillary services or a large number of profitable physician extenders, divide the cash flow in a hybrid manner–part based on productivity and part based on splitting the profits from ancillaries and extenders on a per share basis.
Primary Buy-In Methods
The most frequently used buy-in methods are the “valuation method” and the “a/r forfeiture method.” In the valuation method, an independent third-party values both the hard assets and the accounts receivable of the medical practice. Choosing the valuation method is important, as a liquidation of the assets tends to result in a lower valuation, whereas a multiple of EBITDA (profits) valuation tends to create a higher one, and there are methods in between the two. Keep in mind that maximizing the price for buy-in may not be in the best long-term interest of the practice, as discussed above.
In a practice with a hybrid compensation model or an equal split model, the valuation method makes more sense, because the assets of the practice are generating an overall return that is divided by the partners–therefore, it makes sense to buy in to a piece of that overall return. In the valuation method, the physician must come up with the cash to buy in, either from an independent source or a loan from the practice. The buy-in price is significantly higher than in the a/r forfeiture method.
In the productivity compensation model, and frequently in the equal split compensation model, the a/r forfeiture method is the more popular method of buy-in. In that method, the hard assets of the practice (exam tables, equipment, furniture, etc.) are valued, usually at their liquidation or replacement value. The accounts receivable are not valued. The new partner buys in to the hard assets. Instead of buying into the accounts receivable, the new partner forfeits all their accounts receivable, which are retained by the remaining partners. The new partner receives a “new physician” number in the practice billing and accounting system and starts with a zero a/r on the date of buy-in. Cash flow may be slow for the first few weeks, as collections may not be enough to cover the new partner’s expenses during that time. This lowers the overall cost to buy in, but the new partner may need to borrow during the first few weeks of partnership.
Now that you’ve made the decision to add an associate as a partner, you have a lot more important decisions ahead. Working with your team of accountants, attorneys, and partners can help you navigate the waters
and smooth the operation of your practice.
John L. Moore is a board certified health law attorney with Williams Parker in Sarasota and head of the firm’s Healthcare & Senior Living practice. He can be reached at [email protected].