Update buy-sell agreements to sidestep conflict when physicians leave

March 27, 2012

A lot can change in a practice over the course of a few years—the group’s culture can shift, its financial standing may improve or decline, it may lose or gain physicians—and a practice may be setting itself up for financial or legal troubles if it doesn’t keep its buy-sell agreement up-to-date to reflect these changes.

Buy-sell agreements are the cornerstone of most private physician practices because they establish a process for bringing new owners onboard and outline the financial and professional obligations of each member when a physician leaves the practice. But many practices leave these crucial agreements sitting on the shelf to collect dust for years at a time, which can be a “ticking time bomb” in this rapidly changing healthcare environment.

It’s amazing how these things get executed but they don’t get looked at for years and years, and the only time they get looked at is when an event happens that forces them to do it. That’s when all the land mines start getting stepped on, and in some cases, that’s when the lawsuits start occurring. That’s why it’s important to conduct brief internal review of buy-sell agreements annually, and a more thorough audit if there’s a drastic change to the practice’s structure.

The ideal time to do this is during the practice’s annual corporate meeting when a lawyer and accountant are present. It can take as little as five minutes to make sure the stipulations of the agreement still match up with the goals and realities of the practice. You’re not necessarily going to solve it at that meeting, but it’s an easy opportunity to take five minutes to see if you need to update your agreement.

When conducting a periodic review of a buy-sell agreement, look for the following: 

Ambiguous fair market value (FMV) calculations. Perhaps the most contentious area of a buy-sell agreement is the method for calculating buy out. One small misstep can lead to an overvaluation, costing the practice more money than it owes. However, if the practice undervalues the buy out, the departing partner may think he or she deserves more money, leading to an expensive and time-consuming legal battle.

Many groups still use a FMV approach, relying on lawyers and third-party appraisers to calculate the price of a buy out. Using FMV calculations gives lawyers and appraisers quite a bit of latitude to argue about what the buy-out price should be. One appraiser may value the practice significantly higher or lower than another, and this ambiguity can cause complications when a partner leaves.

Practices that opt to calculate a buyout using FMV should include language in the buy-sell agreement stipulating who can conduct the appraisals. You need to make sure that whoever does the valuation has demonstrated experience in valuations of physician practices.

In most instances I advise against using FMV in a practice that uses a productivity-based compensation formula, even if stipulations about the appraisals are included in the agreement. A FMV appraisal values the practice as a whole, overlooking the individual productivity and contributions of individual physicians. Thus, even if it isn’t time for an annual review, if you’re practice has recently revamped its compensation formula to emphasize productivity, it may be time to also revisit the buy-sell agreement.

Multiple physicians leaving at once. As demographics shift and more physicians approach retirement, practices should revisit provisions in buy-sell agreements pertaining to voluntary departure. The most common issue that I’ve seen recently is multiple doctors exiting the practice voluntarily around the same time. I’ve been working with a radiology group in South Carolina that recently had four doctors exit voluntarily, and it’s really going to bring the group to its knees.

When a partner leaves, much of his or her overhead stays with the practice, but the remaining physicians must ramp up productivity to make up for the loss of revenue. If multiple physicians leave within a few months of each other, not only can paying their buy outs become expensive, but the increased workload and demand on the physicians still practicing can become overwhelming.

So include language in the buy-sell agreement that requires a partner to give one year’s notice before retiring and, in a smaller practice, prevents two physicians from leaving within one year of each other. This allows the practice to plan the exit and recruit another doctor to replace the one that’s leaving.

Another option is to put a cap on the payouts the practice will make to departing physicians in a given time period. For example, a buy-sell agreement can stipulate that the practice won’t pay out more than 5% of adjusted gross revenue in a year, so if multiple physicians leave, the practice won’t be hamstringed with buy out payments. If you don’t think about this issue until their departure is imminent, you’re going to have some disagreement about whether you’re going put a cap and what the number ought to be.

Diminishing practice value. The value of physician practices has diminished in recent years—in part due to stagnant reimbursement and rising practice costs—leaving some of the formulas or fixed valuations in older buy-sell agreements out-of-date – Some of the older agreements have some unrealistic numbers or formulas and unrealistic buy-out prices.

One way to avoid the hassles of depreciation is to simplify the buy-out calculation and determine the practice value annually. This “certificate of agreed value” approach requires partners to agree each year on the value of the company. Any physicians who leaves within the ensuing 12 months—or before the value of the practice is recalculated—agrees to accept a buy out based on the predetermined value.

By getting physicians to agree upon a value, a practice can prevent some of the resentment felt by partners who remain behind to deal with reimbursement and other financial issues. It is easier for a physician in that situation to write a large check to a departing partner if he or she has had some say in how that amount will be calculated.

I always recommend at the end of the year, ask ‘What if someone was to exit as of today?’ and calculate that number. You then ask the people that are leaving, “Do you think this is a fair number?” and the people staying behind writing the check can’t argue that it isn’t a fair number.

Reed Tinsley, CPA is a Houston-based CPA, Certified Valuation Analyst, and Certified Healthcare Business Consultant. He works closely with physicians, medical groups, and other healthcare entities with managed care contracting issues, operational and financial management, strategic planning, and growth strategies. His entire practice is concentrated in the health care industry. Please visit www.rtacpa.com

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