Medical Practices: Get Owner's Agreement in Writing

Family physician Larry Jacobs (we've changed the name of the doctor and practice at the doctors' request) started out in solo practice in 2000. Things went well, and over the next five years he brought two other physicians onboard to form Southeast Medical Associates. Together they built a profitable and well-respected practice.

They had talked about how they would handle the day when one of them wanted to retire, but they had never put their ideas in writing. When the founding partner decided it was time to step down, the once happy and successful partnership was thrown into chaos. Since everyone remembered the verbal agreement a bit differently, they disagreed on how much money the founder should receive.

If only, they thought, they had created and signed an owner's agreement — one that would have spelled out what happens when new owners enter the scene and existing owners leave, whether due to retirement, disability, disagreement, or death.

The provisions of the physician owner's agreement are similar to those in other professional practices or small businesses, with one important exception. “The one big difference is that ownership is tied to working in the business,” says Michael Shaff, who is in charge of the health care practice at Wilentz, Goldman, and Spitzer, a New Jersey law firm. “In a lot of businesses you can remain an owner even if you retire. Not so in physician practices." In fact, regulations restrict patient-referral payments, and doctors are all but prohibited from keeping an ownership share once they retire.

Setting a Fair Value

When Dr. Jacobs announced his retirement, he threw out a dollar figure based on what he thought his share should be of the practice's assets, accounts receivable, and goodwill. Unfortunately, his partners simply didn't agree with the value Dr. Jacobs put on his role as founder and elder statesman of the practice.

A signed owner's agreement would have specified any special consideration Dr. Jacbos was entitled to as founder. A practice's tangible value typically comprises fixed assets and accounts receivable. A clear agreement needs to cover how they will be evaluated — usually some combination of book value and depreciation for fixed assets, and a formula for accounts receivable that reflects the collection rate.

Each owner's share might reflect the length of time the partner was involved in the practice as well as any other special contributions, such as cash buy-in. A new owner may not get a share of receivables accrued before his or her arrival, while a departing owner may draw a share of those funds over a period of time after retirement.

One contentious issue at Southeast was what's called "goodwill." In the era when a physician's reputation was synonymous with the value of the practice, goodwill sometimes accounted for a hefty — but hard to verify — chunk of change. Schaff points out that these days, patients' choice of doctors are more likely to be dictated by their employer's health plan, and goodwill counts for a lot less. Part of the problem at Southeast was that Dr. Jacobs wanted more for goodwill than his younger partners felt it was worth. Setting a value for the founder's share at the outset might have avoided a conflict that left Dr. Jacobs feeling unappreciated by the colleagues he had worked with for years.

While it may seem somewhat distasteful to reduce a career to a set of formulas, those formulas may be your best guarantee that everyone gets what he or she deserves.

“An agreement that spells out how a practice will be valued and how a financial settlement will be made leaves the physician and their family feeling that they are being treated fairly,” says Cindy Brams, a CPA who specializes in medical practices for the South Carolina firm of Schleeter, Monsen, and Debacker. “An agreement doesn’t just protect you, the physician. It’s for your families, your advisors, and so on.”

Disability, Death, and Fraud

Retirement is not the only occasion that might trigger a buyout. Your owner's agreement should also have provisions for what happens if a partner dies, becomes disabled, leaves over internal differences, or is barred from practicing medicine. There should also be at least some discussion in the agreement for dividing assets if the partnership is dissolved outright.

When a partner dies, the buyout formula can be very much like the one used for retirement, calculating a share of assets and receivables based on how long the partner was with the practice at the time of death. Instead of going to the physician, the payout goes to his or her family. Having such a formula in place helps alleviate financial stress during a difficult emotional time for both the family and the surviving partners.

A buyout may also be necessary if a physician becomes disabled. Disability can be particularly contentious because it is not always permanent. Your owner's agreement should dovetail with your disability insurance. It should set parameters for what level of compensation partners will receive while disabled, when the disability will trigger a buyout, and how the disability will affect the buyout formula.

You will also have to deal with the buyout implications if a partner is accused of fraud or another criminal act or is otherwise barred from practicing medicine. The owner's agreement should cover how the practice can remove someone who has been charged or convicted, and how the removal — or any legal settlement that may be involved — will affect the buyout formula.

Because partnerships may split up for unforeseen reasons, there are some other buyout provisions that can be important. Here are a few:

• To soften the impact on a practice when one partner leaves, set a time that must elapse before another may leave.
• Address the rights of partners' spouses in the case of divorce. This is especially important in community-property states where the spouse may own part of the practice.
• Include a noncompete covenant, which bars departing physicians from practicing within a certain distance of their former practice (say, 10 miles in a dense urban area) for a set number of years. That way, your former partners can't set up shop across the street.

Although it's best to develop an owners' agreement, including buyout provisions, at the beginning of your partnership, it's never too late. And it's never too soon to review your existing agreement. To do the job right, find a good health care attorney as well as a CPA or other financial expert well versed in the special tax considerations of physician group practices. Do your homework. And most important: Never assume that a verbal agreement is good enough. Get it in writing!