News
Briefs
Making sure you can afford your partner’s retirement
Medical and dental groups have co-owner buy-out arrangements to deal with the inevitable but often unpredictable event of a member’s leaving the practice. These arrangements are typically set out in corporate or partnership documents which may have been written and signed many years ago.
Having advised about and drafted such agreements for many clients, we routinely urge reviewing them at almost every practice annual meeting. Times and circumstances change over the years, and what may have seemed appropriate before may not be so workable now or in the near future. Even though we point that out, “partners” find it difficult or unpleasant to deal with the question.
The price itself
Especially as senior partners approach retirement age — often surprisingly low in medicine and dentistry — they become seriously concerned whether the provisions will work out as long expected. Both the seniors them- selves and their younger partners ask, “Is the buy-out price too expensive?” As practice appraisers, we are comfortable evaluating the price figure and advising how to proceed.
Sometimes the answer is double-edged. The price may be “fair” as a matter of proper valuation — in effect, on paper. And yet the ongoing practice may or may not be able to afford it. Let us explain what appears to be an anomaly.
Three major “asset classes” commonly determine a member’s buy-out: cash and physical equipment; accounts receivable; and — the most debated — ongoing earning power (goodwill). A practice co-owner presumably deserves his or her proportionate share of each as when leaving them behind in retirement. Medical and dental practice appraisers generally act properly when they determine that those values exist.
Paying the price
Under normal economic conditions, those values should be readily affordable. Even as to goodwill, the practice can typically earn and pay over a reasonable figure as it continues on its financial path without the departing partner. Perhaps the other partner(s) can carry it, or else they can recruit and hire a new doctor(s) to assume the load at initially lower compensation. Lowering the actual pay-out figure may thus be both incorrect and unfair.
However, the conditions may or may not play out as expected. Especially in medical practice, declining reimbursement rates and increasing price competition may make the projected revenue stream less certain than the ongoing partner(s) feel they can assume. And whether medical or dental, the practice’s ongoing provider make-up may not be conducive to its continued earning capacity. A disparity in the partners’ ages, for instance, whether because of poor planning or mere happenstance, sometimes comes into play.
Projecting and spreading the payments
In such circumstances, we may recommend keeping the pay-out figure — based on the practice’s fair values — but updating pay-out limits designed to protect the ongoing group. This is part of our long-held overall philosophy: A group should be generous to a departing longtime partner so long as it protects itself and its ongoing members. Taking it further, the practice’s continued success must be the primary concern.
Some agreements, for example, call for paying out most of the agreed values over a fairly short time period. Sometimes a group must pay for the partner’s interest in the equipment, almost simultaneously pay a substantial malpractice insurance tail premium and also start distributing a portion of monthly accounts receivable over just a few months. The combination can strangle an ongoing practice just hit by a valued member’s departure, sometimes planned but sometimes due to death or suddenly arising disability. Hence we urge carefully projecting the agreed obligations and planning a pay-out schedule that enables meeting them comfortably.
Such an effort leads to phased pay-out provisions spreading much of the overall figure over as long as five years. Even an apparently hefty goodwill valuation, if appropriate, may be surprisingly affordable when paid for over sixty months.
Gross income limitation
Even so, five years is a long time. Who knows how the practice will function down the road in view of economic and doctor-level uncertainties? The question often leads us to recommend what we call the “gross income limitation.” It accepts the basic pay-out duty but attempts to ensure that meeting it will not strap the ongoing practice. In its simplest form it caps the retirement payments so they will not in any year exceed a moderate percentage of practice revenue.
We have seen situations where declining revenue left a group unable to pay out its former partner(s) and have enough remaining to fairly compensate its ongoing members for their work. Little can be worse for everyone involved, both those ongoing members and the ex-partner, than to see the group itself splinter and even dissolve. Sometimes only one doctor remains, and s/he decides it better to close the practice and relocate than to continue.
The gross income limitation helps prevent this situation if it is carefully drafted. We ourselves are updating our earlier format to make sure the limit applies currently rather than retroactively. Ample language would limit each monthly payment to a departed partner or partners so it will not exceed a set percentage, sometimes as low as 2% or 3%, of the previous month’s gross revenue. This way, the payments will fairly currently track the practice’s economic conditions and ability to pay.
Of course, monthly revenues may vary substantially in medical and dental practices. Therefore, we include provisions to carry over any shortfall(s) and pay them in the succeeding months, subject to the same monthly percentage limit. If the shortfalls continue on to the end of the pay-out period (often five years), a carry-over provision can extend the pay-out pattern, but not for more than, say, two additional years. After all, the obligation must end sometime.
Non-competition
Other provisions may also help ensure that the ongoing group can afford to buy out its longstanding partners. For one, a former partner should not receive continuing payments if he or she leaves and practices even slightly competitively. That doctor hardly deserves payment for what remains behind if s/he takes any advantage of it. We do not consider such a provision equivalent to the much-questioned and maligned restrictive covenant, for it merely reduces or eliminates a contracted payment for “competing.”
For these and other reasons, look again at your arrangements for a member’s departure. Consider, too, that one never knows which partner may be the departing person. While the senior member will presumably retire first, a younger partner may instead die, become disabled or just plain decide to leave for reasonable personal or professional reasons. If so, the pay-out burdens may be vastly more difficult to meet even if they were not the main subject of earlier planning.
___________________________________________________
Copyright ©
2006 Kalogredis, Sansweet, Dearden and Burke, Ltd.
