Planning today for a successful exit later
The uncertainty of the Affordable Care Act has raised many new and recurring questions pertaining to the business side of medicine. Exchange patient referrals, accountable care, and technological concerns continue to loom on the horizon, but one notoriously overlooked question has been quickly thrust to the forefront of conversation: What is my exit strategy?
A past Medical Economics [1] article on planning for doctors appropriately stated:
If you are in practice with one or more colleagues, the departure, disablement, or death of a stockholder or partner can lead to bitter disputes and unforeseen complications. And if you’re the one leaving, you can lose your shirt.
Succession planning is often the largest gap seen in practice planning today. The importance of stabilizing and maximizing the value of the practice, transferring it under carefully controlled conditions, and minimizing the cost cannot be overestimated. Failure to do so will almost always be economically and emotionally devastating. While each situation is unique, below is a list of four suggestions that can help.
CREATE A PROPER BUY-SELL AGREEMENT
Buy-sell agreements are the cornerstone in the succession plan of any business. A buy-sell agreement is a formal document outlining the specific conditions and formulas by which a new physician may become an owner or an existing owner may depart the practice due to retirement or otherwise. The buy-sell agreement facilitates an orderly purchase or sale of an ownership interest within a practice at the occurrence of a specified triggering event. Typical triggering events include but are not limited to retirement, death, long-term disability, divorce, bankruptcy, loss of license, and the receipt of an outside offer to buy.
There are three major types of buy-sell agreements:
- Entity Purchase: The practice is designated as the purchaser. Upon the occurrence of a triggering event, the practice itself buys the agreed-upon number of the departing owner’s shares.
- Cross-Purchase: The owners are designated as the purchasers. Upon the occurrence of the triggering event, each remaining owner buys the agreed-upon portion of the departing or deceased owner’s stock.
- Wait and See: A unique option that allows the owners to wait until a triggering event occurs to see which buyer—or combination of buyers—will be best for the practice.
Each of these buy-sell arrangements has pros and cons. Choosing the correct path will be based upon entity type, number of providers, and scope of the practice.
ESTABLISH A FAIR AND ACCEPTABLE BUSINESS VALUATION
When it comes to a medical practice transaction, four significant elements determine its value:
- Equipment, tangible personal property and other assets
- Patient accounts receivable
- Real property
- Goodwill
The first three are easily quantifiable, but the last is not. Medicine is a service and patients repeat their business with the physician who provides his or her care. Unless a physician is part of a large organization, the individual physician is the brand and shifting that brand (goodwill) to another physician can take planning, time, thoughtfulness, and foresight. One of the best ways to maximize goodwill is to plan for a provider who is already associated with the practice to buy the practice. If you are currently a solo practitioner, planning should begin at least 10 years in advance. Each stage of the multi-phased process of finding the right successor, negotiating terms, then developing and executing the transition, can take several years to complete. The most successful—and lucrative—outcome for each party includes thoughtful, long-term planning.
For many physicians, the purchase or sale of a practice will be one of the largest and most complex transactions of their career. The agreement, regardless of whether it takes the form of an entity purchase, cross-purchase, or wait-and-see buysell, should specify a purchase price for the shares. That price should be established by 1) a stated fixed dollar amount, 2) a formula, or 3) a required appraisal. The preferred tax method is by a formula.
Understanding the factors that go into pricing a practice can help ease the process, and ensure that both buyers and sellers receive a fair deal.
BE CLEAR ABOUT WHAT’S INTENDED
An attorney will begin working with a boilerplate document that is fully customizable. Financial arrangements can be as imaginative as the parties involved would like or need them to be.
A few common areas to clarify are these:
- Malpractice: Tail coverage is rarely overlooked, but often misunderstood. The specifics of the tail coverage and the responsibility of premium payments (if required) need to be spelled out in writing and included in the buy-sell agreement.
- Real Estate: Many physicians own not only their practice but also their building. Irrespective of what the transaction entails, real estate should be addressed by its own buy-sell agreement. One particular complication is when the exiting owners are selling their equity in the practice, but holding their equity in the building. Remember that the practice and the building are mutually exclusive.
- Disability: Premature death is generally the first trigger discussed, but long-term disability should be of equal concern. Depending on age, physicians can have just over a 1 in 4 chance of becoming disabled before retirement.[2]
When thinking about disability, in addition to plans for a buy-out, consider these questions:
- Will the practice pay an owner who is unable to work for an extended period of time? What if that time period is permanent?
- What happens if an owner can return to work but has to cut back hours?
- What if the practitioner can work full time but cannot perform at the same level due to mental or emotional deficits? What if substance abuse is involved?
All points of clarification will depend of the nuances of your particular practice. Early brainstorming is helpful before meeting with a qualified attorney.
STRUCTURE THE FUNDING IN A WAY THAT MAKES SENSE
Ideally, buy-sell agreements are fully or at least partially funded. Frequently used funding vehicles include life insurance, disability insurance, and various investment products. After determining the value of the business, the practice and its advisors will next need to determine the best way to fund all agreed-upon triggering events.
Regardless of the financial vehicle used, practices must ensure that funding arrangements are affordable, unbiased, and straightforward for all parties involved. Young physicians have difficulty affording expensive buy-ins due to significant debt incurred from medical school, and medical practices have difficulty affording expensive buy-outs due to declining profitability. Unplanned funding obligations can affect the overall morale of newer physicians, impede physician recruitment and, ultimately, lead to the decline of the practice.
FINAL THOUGHT
Retirement should be a very exciting time, yet there are myriad decisions to be made. Developing a thoughtful exit strategy in anticipation of any kind of departure makes sense. To reduce the stress of such transitions, retain a qualified team of professionals specializing in health care—attorneys, accountants, financial advisors, and certified valuation experts—to help prepare for the future. Succession planning takes time and foresight, but working through even the most complicated of issues always starts with simple dialogue.
“The best thing you can do, in order to get the best price for your practice, may be to avoid slowing down in anticipation of retirement. When you sell a practice that has substantial recurring revenue, you’ll receive a higher price. If a practice has few active patient charts because the physician has slowed down, there’s little or nothing to sell.”
Donald Jay Korn, "Exit Strategies: Planning for Practice Succession," Doctor's Digest, May/June 2005, 110.
- Michael Hodes, “Why You Need a Buy-Sell Agreement Now,” Medical Economics, November 26, 1990.
- U.S. Social Security Administration, Fact Sheet: Social Security, 2013 Social Security Changes, accessed October 8, 2013, http://www.ssa.gov/pressoffice/factsheets/colafacts2013.pdf.
BEN WOODBURY is a partner with Leeds and York, where he works to protect and preserve his clients’ valuable assets through risk management and cost-saving programs.