Small Practice Expansion: Part II

In last month's issue of Cataract & Refractive Surgery Today, I presented an overview of some of the issues to be considered when a practice decides to invite a new physician to become a shareholding partner. Topics included deciding on a candidate and the many factors involved in equity participation. This month, I will raise some of the problematic issues of collateral, valuation, insurance, and the impact of market forces.

COLLATERAL
The medical practice seeking to accept a new shareholder most likely desires some form of assurance that the incoming physician will fulfill his financial obligations to the practice or departing shareholder pursuant to the equity buy-in. If the physician is entering a practice in which the continuing physicians intend to maintain the same workload into the foreseeable future, the professional corporation may elect to hold the entering physician's shares of stock until the completion of the buy-in. Another option is for the incoming physician to participate as an equity owner without actually possessing shares of the stock until he has performed satisfactorily for the existing members. Although this does not meet the degree of collateral acceptable to a bank, the inclusion of a provision that mandates for the forfeiture of equity interest after a certain deadline provides a stable foundation for a performance guarantee.

If one of the practice's current partners is retiring, however, the situation is more complicated. In most instances, the retiring physician will not seek to return to his position in the practice. If for some reason the practice denies the candidate's equity buy-in, the retiring physician will remain a shareholder, but because he is no longer contributing to the success of the practice, he risks depreciating the value of his shares. This predicament may be solved with other means of available collateral, but it will nonetheless require considerable creativity.

If a new physician purchases shares of an existing professional corporation, those shares are subject to any claims brought against the corporation. For instance, if a patient files a malpractice claim against the corporation, the incoming physician has purchased his portion of that liability exposure. Finally, depending on the effective date of the equity ownership acquisition and the by-laws of the corporation, a “buy/sell” agreement may also be entered upon at this time. This agreement generally governs the potential transfer of shares in the professional corporation to third parties and as part of postmortem transfers of interest.

INSURANCE AND VALUATION
After the parties have agreed on employment, equity participation, and a buy/sell arrangement, the ugly issue of insurance arises. With medical practices, malpractice insurance is an ever-present factor. However, for the purposes of the business transaction, the insurance decision involves what is commonly referred to as key man insurance. Key man insurance effectively seeks to fund the buy-in in the event of the incoming partner's death; the buy-out in the case of the retiring partner; and the payment to the estate of a deceased partner. At this point, the parties must decide on the premium, quantity, and eligible beneficiaries of the coverage. The parties must determine the most effective way to facilitate the delivery of the insurance proceeds, including tax implications, to the correct party.

Valuation is the second hurdle to conquer in order to facilitate a smooth transaction. If the valuation of the buy-in is based on a formula, a potential dispute lies in its calculation. Issues regarding unexpected capital expenditures, a reduction in work product, and any changes in reimbursement rates could all create a valuation dispute. The inclusion of a binding-arbitration provision, wherein both parties pay the costs of their representatives and expert analyses of the valuation, should help in striking an appropriate balance between competing interests. Submitting the controversy to binding arbitration reduces the expense of resolving the dispute, and requiring the parties to pay their own costs ensures that the parties do not elevate disputes to an inappropriate level. No document is perfect, but controlling the field of dispute, as well as the cost of the resolution, aids in conserving resources and time.

MARKET FORCES
Once the troublesome issues of insurance and valuation have been settled, the mischief-maker, which can surprise even the most farsighted individuals, enters the picture. Market forces become a factor when a shortage of physicians in the practice group or local community creates an enormous demand for the incoming doctor's services. When you couple a high demand for the new physician with the overwhelming need for help on the part of the existing physicians, all of the previous agreement's terms may be subject to renegotiation. The professional corporation must decide upon its level of flexibility in this environment, and the incoming physician will have to consider the possibility of harming the future working relationship between him and the practice.

CONCLUSION
This article represents a nonexhaustive summary of some of the potential issues that may arise when a small practice decides to bring a new physician aboard. Indeed, medical practices are unique entities, tailored both to the needs of their communities and to the beliefs and preferences of their practitioners. However, in the context of bringing in a new partner, the business and practical issues that affect manufacturers and other service-oriented corporations are germane and must be addressed. Investing in a farsighted set of carefully considered agreements will pay larger dividends by preventing costly and disruptive litigation in the future.