Topics to address in partnerships

Over the course of my 20 years providing consulting services in ophthalmology, I have been involved in all aspects of a practice partnership. I have designed buy-ins from scratch and modified existing partnerships, represented both those offering the partnership and those to become a partner. The experience of being involved in all of the phases of a partnership has been quite educational in ascertaining what works best. My experience implies the following are the most important areas to address in a partnership:
• Valuing the practice for a buy-in or buy-out
• Creating uniformity in a buy-in or buy-out
• Compensation of the partners
• Handling an unplanned buy-out
• Decision making

Valuing the practice

A common mistake by many practices is they do not have a uniform valuation policy for deriving the practice’s value, forcing the practice to turn to an appraiser. I believe the use of an appraiser can be a precedent-setting mistake for two reasons:
1. A practice valuation is a “snapshot in time”—identifying the value at that moment. If there are no substantive changes to the practice, an appraisal can be good for a year, but typically no longer than that. Therefore, an appraisal is theoretically only good for that buy-in/buy-out and cannot be used for future buy-in/buy-out processes, requiring the practice to be dependent on future appraisals.
2. Each appraiser approaches valuation assignments differently. One can supply multiple appraisers with the same set of data on a practice, the appraisers may even use the same valuation methodologies, and the result can still be a wide range in opinions of value because each appraiser may interpret data differently and assign variables differently based on their own experience. This inherent appraiser bias could unintentionally skew a buy-in or buy-out.
To avoid this, I suggest a formulaic methodology for valuing tangible assets, accounts receivable, office and medical supplies, and goodwill. When designed correctly, the valuation formulas should be uniform (meaning they can be applied to a buy-in or buy-out) as well as “timeless” (meaning they can be applied anytime in the future). By using such an approach, anytime one wants to buy-in or be bought out, all one needs to do is run the practice’s numbers through the formulas to derive the current value.
Creating a methodology or formula for valuing tangible assets, office/medical supplies and A/R is fairly straightforward and easy to accomplish. Doing the same for goodwill can be another matter. There are many ways to identify goodwill value in a formulaic approach. Some I have used are:
• Base the practice’s entire goodwill value on a percentage of total gross collections. For example, national benchmarks can be used an applied to the practice and—once the total goodwill value is identified—one buys-in to their ownership share of that value.
• Base the goodwill paid by one buying in on the income they personally derive from the practice. A common approach is to have one pay 20% of their income each year over a five-year period. The downside of this approach is that one can have four partners each with a 25% ownership stake—and each paid a different goodwill amount.
• Have a nominal, set amount for goodwill that is not dependent on practice productivity or an individual’s income.
Either one of the above is fine provided it has been discussed and agreed to by all parties—and that all parties are comfortable the same approach shall be applied presently and in the future, for both a buy-in or a buy-out.

Uniformity

In a buy-in or buy-out, what most are seeking is to pay and receive a fair and reasonable price. I have been involved in situations in which there have been several partners in a practice and each bought in under different terms and conditions. The differences in each buy-in were incrementally different from each other, but the difference from the first to the last was substantial when all the incremental changes were viewed in total.
A standardized or uniform process creates a level playing field for all the partners and lays the groundwork for a smooth transition on a buy-in or buy-out. If a buy-in is paid for over a five-year period, it should be the same for a buy-out. If A/R and goodwill are paid pre-tax on a buy-in, then one should look to do the same on a buy-out. Part of the perception of fairness is that a buy-in and buy-out should be on equal terms and mirror each other as much as possible.

Compensation of the partners

I have come across many practices that have no formal compensation agreement in place. Often a “gentleman’s agreement” is all that exists. Such an arrangement works fine when everyone gets along. What about when he or she is not? What if outside pressures, (e.g., divorce, illness, bankruptcy, etc.) come into play? A compensation policy cemented in writing is always advisable.
There are two ways a practice can compensate its partners: by sharing profits or by allocating overhead.

Share profits

The sharing of profits is simple. All the A/R is combined to pay all of the practice’s overhead. What is leftover represents the profits of the practice. Those profits are then allocated among the owners by an agreed-upon formula. This allocation can be by ownership share, by productivity share, or by a combination of the two.

Allocate overhead

In an overhead allocation system, the practice’s overhead is allocated to each partner based on an agreed-upon formula. Each doctor keeps his or her own A/R and then pays their subsequent share of the overhead as allocated to them. Whatever is left over is that partner’s compensation for that period.
There are pros and cons of each approach but my experience has been that more practices opt for the profit sharing route than the overhead sharing approach.

Unplanned buy-out

A planned buy-out is something that occurs with notice, allowing the practice to plan for the transition and keep the productivity uninterrupted. An unplanned buy-out is just as it says, unplanned and too often unprepared for by the practice and remaining partners.
All too often practices do not have a mechanism for dealing with an unplanned buy-out. An unplanned buy-out can be necessary for several reasons: death, disability, loss of medical license, etc. In cases of death or disability the repercussions of an unplanned buy-out can be somewhat mitigated by use of key man insurance for life or disability.
Absent of proper insurance coverage, an unplanned buy-out can have a two-fold effect: first, the practice loses a productive partner the revenue they were generating. Second, the loss of productivity may put the practice in a cash crunch if a full buy-out is also due. To help a practice in this situation some precautions need to be taken. First, if there is not proper notice for the buy-out for any reason, some or all of the goodwill may be forfeited and excluded from the buy-out. Because the departing physician is not available to transfer the goodwill in a timely manner it simply follows that not all the goodwill be paid out.

Decision-making

A shareholder agreement or operating agreement will typically address voting rights. To affirm a decision a group may opt for a simple majority (51%-plus) or a super-majority (60%-plus, 70%-plus, or 80%-plus). However, there are other aspects to decision-making other than a vote requirement. What about day-to-day management?
In a situation, which one partner has a majority share—management responsibilities will usually fall to them. However, when there is an equal partnership, these duties must be designated.
Many practices have an administrator who can make most (if not all) of the day-to-day decisions without having to consult the physician owners. However, for those practices in which the doctor(s) act as administrator—or for those in which the partners want to be kept fully informed of all the administrator’s actions—I suggest using an agreement that clearly defines decision-making authority, which I refer to as the Managing Partner Agreement. The Managing Partner Agreement provides one of the partners with certain unilateral decision making abilities (with limitations), such as:
The managing partner can make no decisions of more than $5000 without first consulting the other partners.
The managing partner can make no contractual commitments extending past the term of their position without first consulting the other partners.
By default, these type of restrictions will require major decisions to be cleared by the other partners but will allow relatively minor decisions to be made unilaterally by the managing partner. This works well if it proves difficult to get all the partners in the same room at the same time for decision making. If the managing partner title is rotated among all the partners—one of the powers may also be that the managing partner has tie-breaking authority in voting. Any duty can be assigned to the managing partner as long as all agree to it. For acting as managing partner, a doctor may be paid a nominal salary beyond his or her partnership compensation. If the practice has an administrator, the same decision making parameters can be applied to their employment contract.
People make partnerships work, not policies, procedures or documents. However, a successful partnership will leave little to chance, and will properly address the areas touched on in this article by having the proper policies, procedures or documents in place.

ABOUT THE AUTHOR

Brad Ruben, M.B.A., is owner and consultant of MedPro Consulting and Marketing Services, Scottsdale, Ariz. He can be reached at 602-274-1668 and bruden@medprocms.com. For more information, visit the MedPro Web site at www.medprocms.com.