By John K. McGill, JD, CPA, MBA, and Patrick D. Craig, JD
For dental practice owners, careful business planning is an integral part of building a successful practice. A critical element of the business planning process for group practices is the development of documents that govern the relationship(s) between the owner-doctors.
The form of the governing documents will depend on the legal structure of the practice. If the practice is organized as a limited liability company or a partnership, its governing document will be an operating agreement or partnership agreement, respectively. Practices organized as corporations will typically have a combination of several governing documents, including corporate bylaws, shareholders' agreement, and employment agreements between the corporation and each owner-doctor.
Well-written governing documents accomplish a number of important objectives, including setting expectations regarding how practice decisions are made and disputes resolved, providing the method of calculating and paying owner-doctor compensation, controlling who may become an owner-doctor in the practice, and setting forth the rights and obligations of each owner in the event of an owner-doctor's departure from the practice.
Without effective governing documents, doctors risk a protracted legal dispute should an unexpected issue arise. An oft-cited example is the unexpected death of an owner-doctor. If there are no provisions in place to address how the deceased doctor's interest in the practice is to be valued and purchased, in addition to a host of other issues, the remaining owner-doctors will be left to negotiate with the deceased doctor's spouse (or other beneficiary), who may have outsized expectations regarding the value of the deceased doctor's interest in the practice and the remaining doctors' obligation to purchase that interest. The fallout from a contentious transition not only increases the stress levels of the parties involved in the transaction, but can also disrupt the efficient operation of the practice.
Here is a brief introduction to some of the major considerations that should be addressed by your practice's governing documents:
How will practice management decisions be made?
Although the governing documents do not necessarily need to specify how the practice will be managed on a day-to-day basis, they should include a list of major decisions that require unanimous approval by the owners. Additionally, they should provide a mechanism for settling disputes among the owner-doctors in the event of a deadlock.
How will practice cash flow be allocated and distributed among the owner-doctors?
A detailed formula should clearly set out how practice revenues and overhead will be split among the owner-doctors. Any number of methods (and combinations thereof) may be used to allocate practice cash flow (e.g., equally, based on ownership percentage, based on production/collections, and other options).
Additionally, doctors should consider how an owner-doctor's allocation of cash flow would be affected in the event of a temporary disability or substantial decrease in production (e.g., due to a scaled back schedule as the owner-doctor approaches retirement). For example, where overhead is allocated based primarily upon production percentages, doctors should consider business overhead insurance to help cash flow in the event a high producer becomes temporarily disabled.
What rules govern the purchase and sale of ownership interests in the practice?
Generally speaking, buy-sell provisions address the buyout of an owner-doctor when certain events occur (e.g., death, disability, voluntary resignation, involuntary departure, etc.). These provisions may provide for a mandatory obligation on the part of the remaining owners to buy a departing doctor's interest, or alternatively, a right of first refusal for the remaining owner-doctors in the event of a potential sale of an owner-doctor's interest to a third party.
The buy-sell provisions should also address the buyout structure, the method of determining the value of an owner-doctor's interest in the practice, payment terms, and funding issues (e.g., a buyout in the case of death is often funded via life insurance purchased for that purpose).
It is important to remember that there is no one-size-fits-all solution to most of the issues addressed in the governing documents of a group dental practice. Accordingly, owner-doctors should thoroughly discuss and consider these issues with an experienced advisor to determine the optimal solution for their particular circumstances. Further, by having these discussions now, when everyone is getting along, doctors can save themselves and their practice substantial time, money, and added stress as issues arise.
John McGill provides tax and business planning and Patrick Craig provides legal services exclusively for the dental profession. The McGill & Hill Group, LLC, is your one-stop resource for tax/business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. Visit www.mcgillhillgroup.com.
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