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Health care attorney Dennis Hursh discusses his article, “What every physician should know before buying into a medical practice.” He emphasizes that while receiving an offer to buy into a practice is typically a significant honor and opportunity, physicians must perform thorough due diligence to avoid potential pitfalls. Dennis advises physicians and their legal counsel to meticulously review corporate governance documents, watching for unequal voting rights or tiered partnership structures that limit influence. He stresses the importance of examining shareholders’ or operating agreements to ensure the buy-in methodology matches the buy-out methodology and scrutinizing employment agreements for parity with other partners. Dennis also highlights the necessity of assessing the practice’s financial stability by reviewing recent tax returns and understanding any existing debt, distinguishing legitimate asset-backed debt from potentially problematic borrowing used to pay owners. The core message is to celebrate the opportunity but proceed with caution and professional advice to ensure the buy-in is a genuinely good deal.
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Transcript
Kevin Pho: All and welcome to the show. Subscribe at KevinMD.com/podcast. Today we welcome back Dennis Hursh. He is a health care attorney, regular on the podcast by KevinMD talking about all things contracts. His latest article is “What every physician should know before buying into a medical practice.” Dennis, welcome back to the show.
Dennis Hursh: Oh, thanks. It is great to be here.
Kevin Pho: All right, so today we are going to talk about private practice buying into a medical practice, which affects a relative minority of physicians, a decreasing number of physicians, but still very important because again, physicians do not get any real training or education when it comes to private practice situations like this. So tell us what this latest article is about.
Dennis Hursh: Well, I think it talks about some of the things that can go wrong when buying into a medical practice, but I think you have to start off with the caveat that the things I am mentioning are very much outliers. I have done, if not hundreds, certainly many dozens of buy-ins, and I have seen two or three issues where there is really something bad.
Generally, if you get the opportunity to buy into a medical practice, it is generally a great deal and it almost always works out great for the physician.
Kevin Pho: All right, so before going into some of these outlier situations, like I mentioned before, a lot of physicians are not familiar with the whole concept of buying into a medical practice. So just give us some context and potential common scenarios that something like this would typically arise.
Dennis Hursh: Well, a typical one is you leave training, you go to work for a practice as an employee, just like you would be an employee of a hospital. But usually your employment contract should say something about being considered for partnership in so many years, and hopefully it will give the criteria that they will use and the methodology for buying in.
So let us say it is three years, about two and a half years into your thing, they come to you and say, Hey, you are doing great. We really like your practice. We would like to make you a partner and here are the documents that you are going to need to sign to become a partner.
Kevin Pho: And tell us the pros and cons of becoming a partner in a private practice.
Dennis Hursh: In my mind, it is almost all pros. The idea is that, as an employed physician, you get a salary, you may get a productivity bonus, but if we have labs, maybe an X-ray, all of that we are making money from that, and we are not sharing it with you generally. So generally the practice is doing well. A lot of times the partners own the real estate and they are leasing it to the practice. Maybe it is fair market value, maybe it is not, you know, it is a good deal for the owners.
So it is almost always pros. The cons are, and I say it as a con, but I am not sure it is that much of one, is you are definitely going to be in an eat what you treat situation. Ultimately, the partners get paid after everybody else gets paid. And usually they get the biggest chunk. I say it is not that much of a con because if the practice is losing money and we are losing patients, guess who the first to go is? It is going to be the employed physician. So I am not sure that that is that much of a negative.
Kevin Pho: And in terms of the typical amount one needs to buy in, give us some common scenarios in terms of what kind of dollar amounts are we talking about?
Dennis Hursh: All over the board. I have seen some where a hundred bucks you come in and it is a really valuable practice. It has valuable assets and a hundred bucks, and you join the club, which actually kind of scares me a little bit. I have been in situations where medical practices just split apart. Because a private equity group will come in or the hospital will come in and say, Hey, we want to buy you out.
So if you are 30 years old and starting your career, you are probably saying, Hey, I am making a ton of money. I like being in charge. I am not going to do it. But if I am 60 years old, getting near the end of my practice and I have a hospital going to pay me six figures or more for my share of the practice. But you guys are going to give me a hundred bucks. It is going to be some real tension there.
So most of them have something around a methodology. I would say the most common is a methodology where you buy into the fair, not the fair market value, the book value of the assets. I do see some fair market value deals, but I see more book value, which is just, you know, if we bought a… Whatever it is showing on our books. If we paid one hundred thousand dollars for that X-ray machine five years ago, it may be depreciated down to nothing, you know, but that new gizmo we bought is going to be on the books at its price. If you are a one-fifth owner, you are going to pay a fifth of that.
A lot of times you will also buy into the receivables, but sometimes they will say you do not have any right to receivables that were generated before. You know, you become a partner July 1, anything up to June 30 you do not have a right to the receivables. The existing partners are going to take those receivables and then you share and anything after that. So, I mean, there is a huge variety of the buy-ins. I had one very recently where somebody feels her solo practice is worth six million dollars. And, which I think is crazy, but so it is all across the board.
Kevin Pho: All right, so talk to some of these new physicians who may be listening to you and maybe they have been employed in a private practice for a couple years and now they get this offer to potentially buy in. And again, they do not know where to turn to as to whether this is a good deal or not. Tell us the steps that one would go through to evaluate a proposed buy-in.
Dennis Hursh: Well, one of the things is you have to look at the, you want to see the governance documents that may be bylaws for a corporation. It may be an operating agreement for an LLC. Most of the time, if you are coming in, there are five of us and we are bringing you in, most of the time you are going to have one-sixth of the vote, you are going to own one-sixth of the practice. You know, we are, everything is going to be majority rule and that is it. We may have super majority for some things. Maybe we need, you know, five-sixths to bring in a new partner or something. But that is the general case. You come in, you are either a shareholder or you are a member, you are an owner. You have equal votes with everybody else. That is the most common.
Right? I have actually seen one where it was a five-person group and the founding shareholder had 20 percent of the stock as you would expect in a five-person group, but he had a 51 percent vote in any decision. So basically, you know, I, this is the way I want it to be. You do not like it. Well, let us take a vote, you know, before we do, you know, 51 percent went forward, everything is majority rule. So again, that is really weird, but you just want to make sure if that you are coming in basically as an equal.
I have seen classes of owners: radiology practices are notorious for this, but to a lesser extent, sometimes oncology practices too, where you have got founding members or founding partners, you have got senior partners, which is kind of not quite the same profit share, not quite the same votes. And then you have got junior partners, which is you. And if you will look at it, you are basically just still an employee. You do not have much say in anything. You do not have a very good share of the profits. It is almost like now your guaranteed income is taken away and it is eat what you treat, but you do not get too many benefits of ownership. So you need to look at that.
You, again, looking at governance, if it is a four, five, six person group, usually everybody is going to be on the board of directors. So all the decisions are going to be made jointly and including you, you know, your first day as a shareholder. If it is a huge group, you know, if there are 50 owners, obviously 50 people do not need to crowd into the room for every decision. So on a larger group, a lot of times they will have a smaller cadre that is the board of directors or the managing members or something like that, and that is completely reasonable, but you want to make sure that certain things are a super majority, like bringing in a new partner should be a super majority. It should not be half of us say this or the four people on the board decide if a new partner comes in. I mean, that is the kind of thing that everybody should have a say in.
I think one of the, one of the other things is you want to look at the how you are bought out, and hopefully it is the same way that you bought in. You know, if we say you are getting book value for your shares is what you are paying, that is what you should get when you go out too. And weirdly, I have seen some where people are paying a lot of money to come in and then a reduced amount when they leave, which again is very rare, but it is just something you want to make sure coming in costs the same as what you are going to get going out.
And I think really buying point. But another thing I look at is if you are paying for your shares over time, you know, for over five years, you are going to buy five shares most places I think you should get five votes on day one. Even though you are not completely paid for the shares and it is reasonable for them to take a security interest, say, look, we are holding the shares until you pay for them. But I have seen some where you have got a five-year buy-in and we hold the shares as a security interest for five years. So it should be, you know, security interest released as you are paying off the shares.
Kevin Pho: So in a typical scenario, one would work as an employee for a couple years before they are offered the details of the buy-in. Now, in most cases, are they aware of some of the issues that you are talking about, the governance and whatnot during that employee period?
Dennis Hursh: No, no. I mean, you report to somebody who tells you, this is what we are doing. Hey, we are opening a new office, you know, across town. OK. You know, no, you are not involved and you probably do not know how the decision was made. I mean, hopefully if it is, you know, if it is a dysfunctional practice, then sure. You know, Joe comes in and says, eh, Cindy insisted on this, and she got Fred and Sue to go with her. And, but hopefully that is not the case. It is generally, you know, a united front. And it is just like working at a hospital. They tell you this is what we are doing and that is how it goes.
Kevin Pho: So what if you have already invested a few years in a private practice and they come to you with a partnership offer? And you do not like some of the things that you talk about. You know, the governance structure is not favorable, and some of these red flags are raised when they offer you to be partner.
Dennis Hursh: Yeah, I usually ask when somebody is joining a private practice, I ask to see the shareholders’ agreement then because, you know, in some of the governance documents, just so you do not get that nasty surprise, you know, you invest three years of your life and you find that you are a partner in name only. So I usually ask for it. You do not always get it, and it is kind of a — and I also ask sometimes for financial information on the practice, but if you think about it, it is kind of a big ask. It is like you want, you are coming in, you do not even work for me yet, and you want to know what I make. You want to know how, you know, sometimes they do push back and it is tough to get.
But I always ask for the governance documents and the shareholder agreement as part of the buy-in.
Kevin Pho: So if they do not give you that information and you begin to work for a private practice, are you just going on faith that eventually when they do offer you partnership, it is somewhat favorable?
Dennis Hursh: No, I keep asking. I mean, I would rather see the document. OK. But I think it is safe to say, well, how does, you know, if I become a partner, do I have an equal vote? Is there anything weird with the voting? You know, am I going to be the same as everybody else? So, you know, they can lie to you, but that is probably the least of your problems if they are lying to you. You know, becoming a shareholder probably is not going to be of interest anyway once you deal with those people.
Kevin Pho: All right, so tell us about some of these outlier situations, some of the stories that you have heard?
Dennis Hursh: Well, I mentioned the one where the bylaws said that the founding member had 51 percent of the vote; everything was done by majority rule. I have also had, and the different classes. I also had a case where we came in and we asked to see the financials and we are looking at it, and this was many years ago, and it was something like eight or nine hundred thousand dollar line of credit. I asked what the line of credit was for, and they said, oh, you know, reimbursement dropped. Things were getting tight, our expenses were going up, but we are kind of used to making what we were making. So we just borrowed the money from the bank and paid ourselves. So now we owe all this money to the bank.
And guess what? When you come in as a new shareholder, you are going to take a portion of that. I mean, that sets up red flags in a lot of ways. One, why are you taking debt that was used just to pay my salary is one, but two, why are you buying into a practice that you know cannot pay its shareholders what apparently they could make if they work someplace else? So that raised a whole host of red flags, and I think those are the biggest things, not being treated fairly and just bad financial situation in the practice.
Kevin Pho: So you mentioned earlier that the majority of buy-in offers are generally favorable to the physician, so it is fair to say that they should obtain some counsel in terms of evaluating the contract first, when they joined the practice, and again, when they are offered the buy-in. Is that fair to say?
Dennis Hursh: Oh, yeah. I mean, obviously I am biased, that is what I do, but yeah, I think of what would have happened to these clients if they had, if they had just signed it and then learned later think it would have been a pretty nasty surprise.
Kevin Pho: What are some typical negotiation points that you can discuss during the buy-in process?
Dennis Hursh: Well, a lot of it, the biggest thing is you are going to get probably a new employment agreement. And the biggest thing is, is this exactly the same as what everybody else signed? I mean, if I am signing an employment agreement that says I get three weeks of vacation, I assume that even though you have been there 30 years, you know, but you are getting three weeks of vacation too. Or if it says something like, you get X number of weeks until you have worked there this long, or something like that. But the biggest thing is, hey, if I am an owner, I expect to be treated like an owner, I expect to be treated the same as the other partners. So I think that is something that you definitely want to look at.
Other things you see and, and again, I usually do not talk too much about the shareholders agreement because if everybody signed it, unless there is something just glaring, Hey, this is really scary. If everybody signed it, they are not going to negotiate it. You know, unless it is a glaring mistake and everybody says, I did not notice that we should change. It just happened once in my career.
But so I think those are the things. Looking at it, you are going to get a purchase agreement, and you want to know how that purchase price was done? I mean, I have had people say it is a hundred thousand dollars because about eight years ago we had the practice evaluated and they said it was worth, you know, X, and it was worth one million dollars, and you are going to be a tenth owner. So, you know, that is not too reassuring. At 10 years ago, that is what this practice was worth.
So, and as I said, it is important that, however, the price of your buy-in is calculated, the price of your buyout has to be the same. So again, looking at the financial stability of the practice and just trying to see, I mean, if, you know, I can go work at the hospital for two hundred thousand dollars a year, if the shareholders are making two hundred thousand dollars a year, and I have got to pay four hundred thousand dollars to become a shareholder. That does not make sense. You know, the presumption is that I am going to buy in and it is a good investment for me. And as a shareholder, I will make enough money to get that investment back. Hopefully many, usually, many times over. But, but that is the kind of thing you need to look at.
Kevin Pho: I think we are talking to Dennis Hursh. He is a health care attorney. Today’s KevinMD article is “What every physician should know before buying into a medical practice.” Dennis, what are some take-messages you want to leave with the KevinMD audience?
Dennis Hursh: Yeah. I think the biggest thing is if you are becoming employed by a private practice, you should try and find out everything you can about what is going to happen when I become a shareholder. And I think the second thing is, if you are offered a buy-in, just look at it. Do not go for the title. This is great. I am going to be a partner. Look at, does it make financial sense? Will I make more, will I get my investment back? Will I be treated fairly?
Kevin Pho: Dennis, as always, thank you so much for sharing your perspective and insight and thanks again for coming back on the show.
Dennis Hursh: Sure. It is my pleasure. Thank you.