Structuring a buy-in that works

February 21, 2003

Employment contracts that respect associates as well as owners can avoid legal problems later.

 

Structuring a buy-in that works

Jump to:Choose article section...Spell out the buy-in process in detail Make the buy-in price within the associate's reach Don't play around with promised bonuses Sidestep court battles with an arbitration clause Draft an enforceable, effective noncompete clause

Employment contracts that respect associates as well as owners can avoid legal problems later.

By Michael D. Brown

It was the kind of panic call I receive several times a month. On the verge of screaming, Joel Leonardo told me that Gary Mayfield, an associate en route to becoming a partner, had left a handwritten note announcing his resignation, effective immediately.

Leonardo soon learned that the seemingly sudden resignation had been planned for some time. Within two weeks, Mayfield opened his own practice just 100 feet away from Leonardo's in the same building. What's more, he recruited two of Leonardo's employees. And Mayfield's patients? The vast majority had originally belonged to Leonardo.

"You've trained your competition," I told Leonardo. "Now 25 percent of your practice is going down the hall."

It shouldn't have turned out that way. Mayfield jumped ship because he was dissatisfied with foot-dragging on a practice buy-in, as well as a promised bonus. A more precise, properly crafted employment contract would have helped Leonardo retain Mayfield as a partner. As it is, Leonardo is now suing Mayfield (I'm not using their real names), and he expects to spend $100,000 in legal fees before the dust settles.

If you're thinking about recruiting an associate who'll eventually buy into your practice, heed these lessons from the sorry saga of Dr. Leonardo.

Spell out the buy-in process in detail

When Leonardo brought Mayfield aboard in early 2000, he thought he was looking at his ticket to retirement.

The plan was straightforward. Mayfield would work as an employee for two years. In year three, he would buy one-third of the practice with money deducted from his compensation over five years. In the eighth year, he and another associate on a partnership track would buy out Leonardo's share.

Mayfield's employment agreement set forth this timetable, but it didn't say enough about putting a value on the practice, which would determine the buy-in price. The agreement did call for an appraisal, but Leonardo didn't seem in a hurry to arrange it. Whenever Mayfield inquired about the appraisal, Leonardo would reply, "I'm working on it; there's no rush." Leonardo's vagueness only made Mayfield more anxious about his future. By the time Mayfield hit the two-year mark, there was still no practice appraisal. Mayfield's resignation came two weeks later.

Many senior physicians delay getting their practice appraised for a buy-in. Sometimes they're simply too busy seeing patients. They'd just as soon not pay for an appraisal anyway. A proper evaluation costs between $5,000 and $10,000. And procrastination can produce a short-term benefit: If the senior doctor is making money off his associate, keeping him in that role is all the better.

In the long run, though, delaying an appraisal can—and probably will—alienate an associate. A good contract should specify that the senior physician will secure an appraisal three months before the associate's term of employment ends. The choice of appraiser must be acceptable to both parties. The associate should receive the results of the appraisal one month before his contract expires. If he objects to the value assigned to the practice, the contract should give him two options: Negotiate the value with the senior doctor, or remain an employee for another year.

One of the worst things you can do is cite a number off the top of your head. That's what Leonardo did in a tense conversation shortly before Mayfield's two years were up. "The practice is worth $1 million," Leonardo announced. In my opinion, he was about $600,000 too high. His inflated figure made Mayfield wonder if he'd be overpaying for his share.

Make the buy-in price within the associate's reach

Mayfield's employment contract also neglected to address another key issue that affected the buy-in: Once he became a partner, how would each doctor be compensated?

Between Mayfield's resignation and the launch of his own practice, I talked to both doctors, trying to salvage the relationship. I discovered that Leonardo wanted to maintain the status quo when it came to compensation. Each doctor's income had been based strictly on productivity, and Leonardo wanted to keep it that way after Mayfield and the other associate bought in. Naturally, Leonardo was the busiest of the three.

Then I did some math. Leonardo thought his practice was worth $1 million. Mayfield would be acquiring one-third, at a cost of $333,333. When I prorated that amount over five years and added interest, I came up with a yearly buy-in payment of $100,000. But Mayfield's estimated compensation under a productivity formula would have amounted to only $150,000. So he'd effectively earn only $50,000 a year—clearly an intolerable figure.

To make the buy-in more affordable, Leonardo needed to not only lower the buy-in price, but increase Mayfield's income. I proposed a new formula. Half of the entire practice's income would be distributed equally to each doctor, a contract term that would favor Mayfield. Another 30 percent of income would be distributed based on productivity. Finally, 20 percent would be divided among the partners—Leonardo and Mayfield until the associate bought in.

I broached this proposal with the physicians, but both sides had become so embittered since Mayfield's resignation that a meeting of minds was impossible. A professional divorce seemed inevitable.

Don't play around with promised bonuses

Mayfield's contract contained a provision about bonuses that became another sore spot in the relationship. The contract specified that if Mayfield grossed more than three times his salary, he'd receive a year-end bonus equal to one-third of the excess, payable 90 days after the end of the year. He didn't qualify for a bonus his first year, but he did in his second, to the tune of about $45,000.

Leonardo wasn't eager to pay the bonus. The practice's cash flow had dropped off. Still, Mayfield had the money coming to him. Leonardo brushed him off with a curt, "My accountant is figuring it out. You'll get your bonus when the contract says it's due." His brusque, legalistic answer only served to sow more distrust.

A better employment contract might have made this a nonissue. An associate shouldn't have to wait three months before he receives a bonus for the preceding year. If you really want to keep an associate happy, specify that you'll pay out bonuses on a quarterly basis.

Sidestep court battles with an arbitration clause

If Mayfield's contract had contained an arbitration clause, he might have been able to hammer out his differences with Leonardo without resigning or fighting in court.

Under an arbitration clause, conflicting parties can take their dispute to an arbitrator who's mutually acceptable. Or, each party can pick an arbitrator, with those two individuals selecting a third one. You can find such Solomons by turning to the American Arbitration Association ( www.adr.org). Most of its arbitrators are lawyers and retired judges. Some have expertise in employment contracts.

Arbitration takes far less time and money than litigation, and spares you the publicity of a court battle, too. It may not preserve a medical marriage, but at least it's bound to produce a more amicable parting.

Draft an enforceable, effective noncompete clause

Noncompete clauses, also known as restrictive covenants, are designed to discourage a doctor from leaving a practice and then competing directly against it. Common fixtures in physician employment contracts, these clauses have a bad reputation, and understandably so. Often, the conditions are so harsh that the departing doctor may be unable to earn a living unless he moves out of town. Courts frequently declare such noncompete clauses unfair and unenforceable.*

However, you can craft a noncompete clause that shows consideration for the departing doctor while still protecting the practice he's leaving. It may convince a discontented associate to make the best of his situation instead of bolting.

Mayfield's contract was a good example of how not to write a noncompete clause. For one thing, it specified that if Mayfield resigned during his term of employment, he could not practice within 10 miles of Leonardo's office for two years. That might be fine in a rural area. But they practiced in a big Northern city. If Mayfield had been confined to practicing more than 3 miles away from the practice, he'd still have plenty of patients to draw upon. The 10-mile restriction amounted to overkill and probably would never hold up in court, making it easier for Mayfield to set up shop wherever he liked.

Furthermore, his noncompete clause was missing some legal teeth. It didn't prohibit Mayfield from soliciting either Leonardo's employees or his patients. And it also didn't require Mayfield to pay punitive damages if he breached the noncompete clause. Such damages amount to a ransom—pay it, and you're free. I recommend an amount that's double a doctor's annual salary. Mayfield's contract lacked this safeguard.

The causes of debacles like the Mayfield/ Leonardo split usually boil down to inadequate planning for the transition from associate to partner. When it comes to nitty-gritty issues such as buy-in terms, the motto of the senior doctor is, "I'll figure that out later." And it never gets figured out.

A good employment contract will lay out the road to partnership so that everybody knows what to expect and when. To craft such a document, you need an attorney who specializes in the medical field. Likewise, to get a practice appraisal that's right on the money, hire an accountant or a practice management consultant who routinely appraises medical practices.

Granted, you may pay a bit more for expert advice. But that's less expensive than going to court after a buy-in deal explodes in your face.

Or watching former patients walk down the hall to an ex-associate.

*See "8 ways to escape your employer," Feb. 22, 2002.

 

The author is president of Health Care Economics in Indianapolis and an editorial consultant to this magazine.

 

Michael Brown. Structuring a buy-in that works. Medical Economics Feb. 21, 2003;80:69.

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