Buy-sell agreements are becoming more relevant to business owners nationwide. 415 Group Manager Chad Isler, CPA, MT, shares his perspective on the importance of these agreements:
As business advisors, we're seeing these buy-sell agreements become increasingly important for our clients everywhere, not just those in the medical and dental industry. As more baby boomers near retirement age, they're beginning to look for an exit plan. The key is to start planning early. Don't wait until the last-minute to think about the transition of ownership for your business. Establish an agreement, so you're prepared when the time comes.
When considering a buy-sell agreement, I tell our clients to pay close attention to the details. Leaving the language too ambiguous may make the terms open to interpretation. You want an agreement that's flexible, but clearly defined.
Even if a client already has an agreement in-place, I would suggest periodically reviewing it with a team of advisors. That's where we step in. We can assist in ensuring the agreement provides the most desired outcome from an income tax perspective and advise on different valuation methods and calculations.
In the wake of health care reform, you might find your practice inundated with new patients. With the extra workload, you might want to hire one or more physicians to help out.
If so, and if these physicians intend to take an ownership share of your practice, make sure each one signs a buy-sell agreement. Reason: It can safeguard your practice from disgruntled doctors and minimize disputes should they arise.
A Different World
When developing a buy-sell agreement, keep in mind that the world today is likely much different than when you started practicing medicine. Young physicians carry heavy debt loads when they finish training, so they typically can't afford to immediately buy into a practice.
They also might have multiple practice opportunities, so competition for them might be fierce. In addition, younger doctors may view working at a practice simply as a source of income, not as an investment opportunity or part of their retirement portfolio the way older doctors do. Because of these differences, you may find issues arising over division of income, asset valuation and retention of control.
The Nitty-Gritty Details
Framing the buy-sell agreement starts with defining and appraising the practice and its assets. Tangible assets include items such as equipment, supplies and leasehold improvements. The stock price of the practice takes into account these assets. The new physician pays his or her share either up front or over a period of years with interest.
Intangible assets, on the other hand, include accounts receivable. A new physician doesn't pay for these assets out of his or her pocket, but through a process called "income shifting." That is, the physician's net income is reduced during the first few years with the practice.
For example, a physician might start with a 40 percent reduction in the first year and 30 percent in the next, followed by 20 percent and 10 percent in the next two years, leaving the buy-in complete. This payment method helps ease the financial burden on young physicians.
A Piece of the Pie
There are many accepted methods for dividing practice income among partners, such as equal allocations and productivity. To preserve harmony, consider using the allocation method. Or use the relative productivity method (measured by services personally performed by the physicians) as the basis for apportionment. Some practices use a hybrid of these formulas, such as 50 percent equally and 50 percent by productivity.
There are numerous other contract terms you should consider. For example, terminating a physician "without cause" usually isn't a good idea, because it can breed acrimony and lower morale. Furthermore, even "with cause," termination frequently requires either unanimity or a supermajority of the vote.
Senior doctors often wish to retain rights to the practice name, tangible assets and location if there's a mutually agreed practice breakup. It's reasonable to allow these rights to expire after a new physician has been with the practice for a specified time, such as five or ten years.
In addition, a new doctor may be asked to sign as a guarantor of existing practice debt that has been personally guaranteed by the partners. That is generally fair, and so is a provision indemnifying the physician against liability for practice actions that occurred before he or she joined.
Control of the Practice
Practice owners are understandably concerned about power and control. The percentage division of stock doesn't have to be the same as the percentage division of control or the percentage division of profits.
A partnership agreement -- separate from the buy-sell agreement -- can provide otherwise, according to the wishes of the owners. It's common to subject critical decisions, such as adding partners or selling the practice, to a supermajority vote.
Beyond the points brought up here, there are many laws, regulations and legal doctrines that affect the terms of a buy-sell agreement. These include statutes that govern your practice's form of organization, confidentiality laws, non-compete agreements and liquidated damages clauses. So work with your health care consultant and attorney to draft an agreement that will not only protect your practice and keep it in compliance with various laws, but also help minimize disputes.