Key issues to a successful practice buy-in

Doctors contemplating a buy-in to practice ownership face numerous decisions, even after agreeing on the price.

Feb 1st, 2011

John K. McGill, MBA, CPA, JD, and Blake Hassan, JD, CPA

For more on this topic, go to www.dentaleconomics.com and search using the following key words: dental practice transitions, buy-in/buy-out, buying a practice, selling a practice, John K. McGill, MBA, CPA, JD.

Doctors contemplating a buy-in to practice ownership face numerous decisions, even after agreeing on the price.

Structure/resulting entity - The structure of the buy-in as well as the payment terms must then be determined. There are several different options in how the practice will be structured after the buy-in begins including: 1. a single corporation with the doctors as co-shareholders; 2. a partnership or limited liability company (LLC), with the doctors (either individually or through another entity) as the partners; or 3. two separate practices that share space and perhaps staff and other resources.

Income allocation - The method of allocating practice profits is often the most controversial issue in the practice buy-in. The possibilities are numerous, and require that doctors focus on both revenue and expenses. In an "eat what you kill" system, the revenues are allocated to the doctor who did the work, whereas in other systems some or all revenue may also be allocated based on 1. ownership, 2. days worked, or 3. fixed percentages.

Allocation of expenses may be done in a variety of ways as well. Under any system, it's important to break out expenses that are personal to each doctor and ensure they are paid by the doctor who incurred the expense. Examples include continuing education, meals, travel, entertainment, automobile costs, health insurance, and others.

There may also be expenses the doctors want allocated equally, regardless of their relative production, ownership, etc. Examples include rent, certain staff salaries, property taxes, accounting and other professional fees, etc.

It is wise to run specific illustrative calculations (e.g., using year-to-date or prior year numbers) to ensure the doctors see and understand the potential results of each option before reaching a final agreement.

Buy-sell provisions - Every practice buy-in transaction should look "down the road" and include buy-sell agreements to address what happens when one of the doctors leaves the practice. The threshold question here is whether there will be mandatory obligation to buy out a departing doctor, or simply a right of first refusal.

If there is a mandatory obligation, the structure, determination of the buy-out price (e.g., appraisal or formula), and the payment terms should be covered in the legal documents. Cash, accounts receivable, and the responsibility for practice debts and other liabilities should be covered as well.

Under a mandatory buy-out scheme, the senior doctor often reserves the right to leave first. If the junior doctor voluntarily resigns out of order, or is terminated for cause, his buy-out price is usually reduced. Conversely, for the protection of the junior doctor, the senior doctor may agree not to voluntarily resign prior to a certain date. If he does so, the penalty would be a reduction in his buy-out price.

Doctors often fund a mandatory buy-out with life insurance on each owner. In such cases, who will be the policy owners and beneficiaries, who will pay the premiums, and who keeps any insurance proceeds in excess of the buy-out price should be addressed in the legal documents.

Whether or not there is a mandatory buy-out scheme, each doctor should have the right of first refusal, giving them the opportunity to match an offer by a third party and buy their partner's interest rather than allowing a sale to a third party.

Finally, the buy-sell provisions should require the departing doctor, who is being paid for his practice interest, to sign a restrictive covenant agreement prohibiting him from competing against the practice and soliciting patients and staff. The rules governing restrictive covenants vary by state; however, as a general rule, they can be enforced if reasonable both as to duration and restricted territory.

Real estate matters - Where the practice real estate is owned by the senior doctor, the junior doctor will want the rental rate and other lease terms to be fair. The junior doctor may also want the option to buy into the real estate ownership. Most banks will not loan money to the buying doctor to purchase a fractional interest in real estate without being granted a mortgage on the entire property. Accordingly, bank financing often involves the senior doctor's participation. Alternatively, the senior doctor may finance the real estate buy-in.

Blake Hassan provides practice buy-in/buy-out and other legal services through McGill and Hassan, P.A., Attorneys at Law, an affiliate of The McGill & Hill Group, a one-stop resource for tax and business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. John McGill provides tax and business planning exclusively for the dental profession and publishes The McGill Advisory newsletter through John K. McGill & Company, Inc., a member of The McGill & Hill Group, LLC. For information on webinars presented by the firm, visit www.mcgillhillgroup.com/webinars.asp.

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