There are a host of circumstances that can disrupt a partnership and have a powerful fi nancial impact on the business, including death, retirement, business disputes, disability, and divorce.
If you have partners in your medical practice, it’s a good idea to determine early on the value of the practice and decide how it will be divided if a partner leaves for any reason. There are a host of circumstances that can disrupt a partnership and have a powerful fi nancial impact on the business, including death, retirement, business disputes, disability, and divorce. How should the business be split up or paid out in these situations? Planning in advance with a written and detailed buy—sell agreement that addresses each possible scenario can help avoid costly litigation and fi nancial loss in the future.
Events triggering a buy-outThe first issue to consider is which events should be covered by the terms of the buy—sell agreement. Under what circumstances should a partner have the right to be bought out? Certainly, death and long-term disability would be included, as well as planned retirement. But what happens if a partner quits, is “fi red,” or wants to sell his interest to a third party? What rules should govern each of these scenarios? You may want to consider whether the buy-out amount can be reduced in these situations. Although everyone may agree that it’s fair to pay a “full” share on death, disability, or retirement, a partner who leaves voluntarily might face some type of penalty, such as valuing his or her share less generously, if the withdrawal creates a fi nancial burden on the remaining partners.
Valuing a partner’s shareIn addition to stipulating which events are covered, the buy—sell agreement should specify a method for valuing each share in the practice and how much will be paid under each circumstance. Sometimes valuation is pretty straightforward; in many medical practices, accounts receivable and equipment represent a signifi cant portion of the assets, the amount of which is easily determined. It is more diffi cult to determine the value of intangible assets—such as in the case of a practice with substantial goodwill—although there are a variety of techniques and formulas that can be used (See “Valuing Your Medical Practice” at www.rjmintz.com/pdf/medicalpractice.pdf).
A partner’s share of accounts receivable is usually discounted for collection losses and the amount of the liabilities of the practice directly associated with these assets. For example, Dr. A owns a 25% interest in a medical partnership that has $1 million in receivables. When he retires, his $250,000 share of the accounts receivable might be discounted by 20% (based on collection experience). It is important to also consider what share of other liabilities of the practice should reduce the payout. Is there an outstanding line of credit that Dr. A should pay back? Should overhead costs of labor and rent associated with the collection of the receivables be considered? Also, if there are possible chargebacks from Medicare or other insurers, who will be responsible for those payments? There is no right or wrong answer to these questions. Everyone involved should consider the economic impact of each decision before devising an appropriate formula. I have seen buy—sell agreements that did not factor in liabilities and the costs of collection, and the remaining partners were stuck with much higher costs than they anticipated.
Once the amount of the buyout has been determined, how should it be paid? Th is often depends on timing, the partnership’s cash fl ow, and whether the buyout event has been funded. A buyout due to the death of a partner can be funded with insurance, making a cash payout feasible. However, immediate cash may not be available if the buyout is based on a partner’s voluntary withdrawal, unless the partnership has accumulated a reserve for the payments. A payout schedule over a period of months can be tied to the collection of the accounts receivable so that impact on cash fl ow is minimized. If goodwill is included in the buyout amount, the payout may be deferred for a number of years, unless adequate insurance or a reserve fund has been maintained. Buy—sell agreements are an important legal component of every medical partnership. You should understand what will happen under each buyout scenario so that you can properly plan for this aspect of your fi nancial future. Discuss the buy–sell provisions of your partnership with your attorney, in advance, so that the agreement accurately refl ects the intent of the partners and all key issues are adequately addressed and resolved.
Robert J. Mintz, JD, is an attorney and the author of the book Asset Protection for Physicians and High-Risk Business Owners. To receive a complimentary copy of the book, call 800-223-4291 or visit www.rjmintz.com.