Breaking up is hard to do, especially if your radiology practice does not have a well-written, well-thought-out, and up-to-date buy-sell agreement.
So goes the wisdom of Jeremy N. Miller, JD, founder of Miller Health Law Group in Los Angeles. Miller shared his professional expertise on buy-sell agreements at the 2005 Radiology Business Management Association Fall Educational Conference in October.
The purpose of the buy-sell agreement, Miller said, is to control who owns the group and the circumstances under which owners might have their ownership bought out. Its purpose is to ensure an orderly transition of ownership should someone leave the group.
“You want to make sure the shares end up being held by those who are supposed to own them,” he said. “If there is no agreement, or the agreement is out of date, it invariably ends up in litigation, and these suits are among the nastiest and the most costly. They often result in groups breaking up.”
VOLUNTARY AND INVOLUNTARY
Miller said the first thing in any buy-sell should be a provision that says partners cannot sell their shares to someone else for whatever price they can get for them. Options include banning share sales outside the group or giving the group a right of first refusal.
Even that can be tricky though. “What if a partner who is leaving claims a third party is willing to pay a high price, then tries to get the group to match that offer?” he said. “And if you do go for right of first refusal, how long does the group get to decide?”
Miller said that this is an area of real contention in buy-sells. The agreement needs to clearly lay out the circumstances where repurchases can happen.
Death. If a physician in the group dies, most groups do not want the heirs to end up owning shares. In some states there may even be a prohibition on nonphysicians owning an interest.
Disability. How does your group define disability? A month? Six months? Is the physician permanently or only partially disabled? What if they come back and work for a day, which starts the disability “clock” all over again?
Loss of license. What happens if a physician loses his or her license?
Termination. This is a big issue and needs to be integrated with the employment agreement.
Retirement. “One person’s retirement might be another person’s idea of part-time,” said Miller. “You need provisions for slow-down situations.”
Bankruptcy. Personal bankruptcy does not mean the physician is no longer practicing or has lost their license, but it could mean that their shares end up in the hands of creditors.
Divorce. “Spouses can be physicians, too,” said Miller. “If half of a physician’s shares end up in their spouse’s hands, do you really want their ex to be part of the group?”
MANDATORY REPURCHASE, BUYOUT
Another area that Miller said should be covered in a buy-sell is the mandatory repurchase of shares. This can arise in two forms: either the person who is leaving does not want to be bought out, or they want to be bought out and do not want the group to “sit” on the shares.
Miller warned that there can be big implications if the group does not have the right to repurchase the shares. Physicians usually do not want former group members to continue being owners after they have left. The person who is no longer with the group could still have a right to books and records and even to some distributions.
“The agreement has to make it clear that if the group has the right to buy the shares back, the physician has the obligation to sell them back,” Miller said. “It might seem like it’s axiomatic, but believe it or not, lawyers have made more out of less.”
The notion of a “fair price,” Miller said, is often in the eyes of the beholder. And it is often a conflict between older and younger physicians, between those who felt they built the group and those riding on their coattails. “The older folks who are close to retirement would like to get more money, and the people who are going to be left to pay the money usually want to pay less of it,” said Miller.
In his experience, if people did not pay too much at buy-in, then they usually do not expect to be paid a lot at buy-out. It is a philosophy of “you make your money while you’re working with the group.”
But if people did pay a lot of money to buy in and if, by the time they are ready for buy-out, the group is not worth that much, what may seem like a simple formula can result in people getting paid too much.
One solution, Miller said, is—instead of having a fixed buy-out price that is static—is to revisit it every year at the annual meeting. But even that method, he said, can create problems. “If the price was higher before and now people are close to retirement and it is lower, maybe they will not agree to do that,” he said.
Another solution is to get an appraiser to value the business. Miller cautioned that the numbers can vary widely. It depends on the appraisal assumptions.
“I’ve seen valuations vary by as much as 100%,” he said. “Some firms get three appraisals and either average them or throw out the high and the low. It costs more money to do that.”
Miller recommended giving the appraiser guidelines. Are they going to include everything? Receivables? Goodwill? Tangible assets? If appraisers are not told to not include those items, he said, they will include them, and that will result in a higher buy-out payment than the group was planning on.
Other factors to consider in valuation is the depreciated value of the group’s physical assets, accounts receivable, and goodwill (reputation, referral sources, contracts). “You could have a problem if your group needs to buy expensive new equipment and you have doctors getting closer to retirement,” Miller said. “People say, well, if we are expected to pay for some of this new equipment, the buy-out price won’t reflect what that equipment is worth so we’re not going to vote to buy the new equipment. So here’s an area where your buy-sell agreement could affect your operational needs and strategic planning.”
Payments. “Whatever the payment price is, if it’s more than a nominal amount, then there’s going to be an issue of how quickly it is going to be paid,” said Miller. “The people who are left are the ones who have to pay it, and if it’s overly burdensome on the group, where’s the money going to come from?”
Many groups, he says, opt to pay a 20% down payment and then have a note for the balance over 1 to 3 years. They might also include the right to prepay the note and the right to reduce payments if the person breaches a restrictive covenant after they leave.
Buy-sell agreements can have many other considerations: payment of interest, security, maximum payments, dissolution options, insurance funding for death or disability, tax treatment to the group, deferred compensation, and restrictive covenants just to name a few.
Miller says in addition to making sure the agreement is solid, groups should make a firm commitment to review it frequently and to have a process for how to amend it. If disputes arise, resolution can often be achieved with facilitation and mediation.
“A well-thought-out and drafted agreement is essential,” he said. “Just remember to focus on what’s good for the group.”
Tamara Greenleaf is a contributing writer for Decisions in Axis Imaging News.