Parables of Practice Management: A Tale of Three Clinics
Parables of Practice Management:  A Tale of Three Clinics

Chad Carlson

The Four Young Surgeons


Four young physicians started their surgical practice in 1988. Each contributed equally to the partnership. Over the years, they shared the cost of salaries, medical equipment, office rent, benefits, etc. They also drew up a buy/sell agreement in the event that one of them died prematurely. The took advantage of the low cost of term life insurance to fund the death benefit and purchased $250,000 of coverage each for the death buyout provision of the agreement.

Over the next 20 years, their practice flourished. They expanded their staff, built a private surgical center, and opened two satellite offices in surrounding towns. Everything was going right.

Then, one of the physicians died unexpectedly of a heart attack. According to the buy/sell agreement, the three surviving physicians were obligated to buy out their deceased partner's interest from his spouse.

Despite the fact that the practice now has a fair market value of $16 million, the original buy/sell agreement from twenty years ago states that the value for buyout purposes on death is the $250,000 amount of the life insurance. This uncomfortable scenario is likely to result in pressure on the remaining partners to fairly compensate the widow and may potentially lead to expensive legal costs if the parties are unable to agree to terms.

The Three Young Pediatricians


Twenty years ago, a pediatric clinic was started up by three physicians and they, too, had a buy/sell agreement. Their agreement stated that the buyout amount was the fair market value of the practice at the time of death, to be determined by an independent valuation firm. Their practice also grew. Over the years, they built a first-class pediatric facility and opened satellite offices in three neighboring towns. They hired three younger physicians to staff the satellite offices.

One of the partners was killed in an automobile accident. His third of the practice was valued at $4 million, but he had only $500,000 in life insurance.

The surviving partners are now obligated to pay off the required amount to the deceased partner's heirs with only the practice's current cash flow for funding. The surviving partners must support the ongoing expenses of the practice, the loan payments on the satellite offices, the salaries of the new physicians and now must also provide an additional $3.5 million to pay off the under-funded requirements of the buy/sell agreement.

The Two Young Obstetricians


Dr. Torres has one partner in her obstetrics clinic. She earns approximately $700,000 each year. The practice was recently reappraised at $7 million and their buy/sell agreement was updated to reflect the current value of the business. They relied upon life insurance to cover the buyout in the event one of them died prematurely. But they decided not to fund insurance in the event that either of them became permanently disabled, because they thought the premiums were too high.

During a recent family vacation in Utah, Dr. Torres lost control on a steep slope while snow skiing and collided with a tree. She suffered severe neck and back injuries, making it impossible for her to work. Her partner was obligated to buy her out of the practice, but there was no funding mechanism in place. Dr. Torres was left wondering how she would receive fair value for her ownership, while her partner was left to try to fund her obligation to buy out Dr. Torres and continue the practice.

Conclusion


When a physician has an equity stake in a medical practice and he or she is unexpectedly disabled or dies, the consequences for the rest of the partners (or the physician's heirs) can be severe. Failing to adequately prepare for forced transitions may seriously impair a successful practice and may even result in lawsuits.

Reasons for not planning include a perception that the cost of being financially prepared is too expensive (life and disability premiums are too high) or a belief that if these events do occur, the partners will just work it out. Others say they are just too busy. Many physicians or their office managers just haven't considered it. Some roll the dice.

While some physicians choose to retain the risk and not fully fund their agreements with insurance, the decision to do so should be carefully weighed to consider the availability and cost of making payments out of operating profits. If the value of your practice or the revenues generated by the practice has increased substantially and you haven't adjusted your coverage to reflect those changes, your funding sources could be inadequate. The practice that you've worked so diligently to build doesn't need to end up like these stories.

Whether you're just beginning to write your story or you're already deep into the storyline, make updating your buy/sell agreement a priority. Establishing, structuring, and funding an adequate arrangement is a team effort. You should always have the involvement of a tax advisor and legal counsel.

Plan well and ensure for yourself, your family, and your practice, a very happy ending.
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