Medical Practice Series: Buy-sell Agreements

It’s no secret, the baby boomer generation is nearing retirement age.  As a result, we are expecting a large scale ownership and management transition for all kinds of businesses over the next ten to fifteen years, including medical practices.  This demographic reality raises many questions for those medical practices affected.

For the physicians of the baby boomer generation:

 

  • Will I be able to sell my practice?
  • What will I be able to sell it for?
  • Who will I sell it to, and how do I find potential purchasers?For the next generation of physicians:
  • Will I be able to afford to buy a practice/buy out my older partners?
  • Will the financial burden of the buyout put the practice or my family’s financial wellbeing at risk?
  • What is the ideal buyout structure to minimize risk and provide a fair payout to the retiring physician?

 

The transition planning issues for medical practices are unique from any other type of business because of the legal and regulatory overlay of a licensed profession.  Because of the uniqueness and urgency of transition planning for physicians, we are devoting a series of articles to this topic, of which this is the first.  As the first article, we will start with the most fundamental and probably the most important legal agreement that a medical practice should have – the buy-sell agreement.  Every medical practice with more than one owner needs to have a buy-sell agreement, which must be well-thought-out, carefully drafted, and up-to-date.  An absent or obsolete buy-sell agreement can wreak havoc on a medical practice during a time of transition and even threaten the practice’s survival.

The buy-sell agreement may be a stand-alone agreement, a portion of a shareholders’ agreement if the practice is organized as a professional corporation, a portion of the operating agreement if the practice is a professional limited liability company, or a portion of a partnership agreement if the practice is a partnership.  A buy-sell agreement should cover many issues, but the heart of the agreement is the right or obligation of one owner to buy the ownership interests of another owner when certain events occur, typically a practitioner’s death, disability, retirement or other departure from the practice. Buy-sell agreements may also address what occurs if an equity owner divorces or wishes to voluntarily depart from the medical practice for some reason.

The transition will be much less disruptive to the practice if the buy-sell adequately addresses what happens in each of these situations in a way that is fundamentally fair to all involved.

No issue is more hotly contested than the purchase price for the ownership interest to be purchased.  For this reason, it is critically important that the agreement address how the practice will be valued.  The determination of value set forth in the agreement is sometimes formulaic (for example, a multiple of revenues or earnings or based on some other economic formula), is sometimes based on a stipulated value agreed upon by the parties annually or is sometimes based on an appraisal by an independent appraiser acceptable to all parties.  In any event, the methodology needs to be clear and unambiguous and should also include a dispute resolution procedure in the event of a disagreement about the value (for example, mandatory arbitration) that will prevent a long and costly courtroom battle.  A reputable appraiser with experience valuing medical practices should be consulted during the preparation of the buy-sell agreement to make sure the agreed upon methodology is appropriate and equally important, will stand up to legal scrutiny.  The methodology should be reexamined from time to time as circumstances change.

Even if everyone agrees on the method of valuing the practice, there still needs to be an effective funding mechanism in place.  In the case of death or disability, the buyout can typically be funded, at least in part, with the proceeds of an insurance policy, but the situation is more complicated in the case of a retiring physician where insurance proceeds are not available.  To fund the buyout of a retiring physician, the practice will have to generate sufficient cash flow to fund a promissory note or the remaining physicians will have to use their personal funds, or a combination of the two.  It is also important to structure the payment terms so that the practice isn’t financially handcuffed, and to assure that the retiring physician is paid in a reasonable amount of time.  Since retirement buyouts are not usually paid in a lump-sum and medical practices are typically organized legally with limited liability for the practice itself, it is also necessary to consider a security arrangement for the departing physician.  Security arrangements may include, in addition to the equity interest itself being purchased in the event of a stock or unit purchase of a corporation or a limited liability company,  personal guarantees, mortgages, letter of credit, or a collateral pledge of the assets of the practice in the event of an asset sale.  Arrangements must also be made for the continuing treatment of all patients of the departing physician as required by law.

Planning ahead is crucial when it comes to entering into a buy-sell agreement.  When the potential buy-out events are unknown and in the future, the interests of all of the parties to the buy-sell are aligned with a common goal of fundamental fairness.  Once an event occurs that actually triggers a buyout, the motivations diverge and often become adversarial, with the departing physician on one side and the remaining physicians on the other.  At that point, it is often too late to structure a buyout without resort to the courts.  The moral of the story is that there is no time like the present to reexamine your practice’s buy-sell agreement to make sure it suits the needs of the medical practice, today and for the future. Qualified attorneys, accountants and insurance agents familiar with the nuances of buy sell agreements in the context of a medical practice are a critical part of the planning team.