Time to rethink this buy-out agreement

October 7, 2005

According to our small group practice's buy-sell agreement, part of the payout upon termination is return of capital invested. How does the practice provide for the payout without hurting the remaining doctors?

Q: According to our small group practice's buy-sell agreement, part of the payout upon termination is return of capital invested. How does the practice provide for the payout without hurting the remaining doctors?

A: If a buyout is properly structured, they won't be hurt. In a group practice of three doctors, for example, after one leaves with his payout, each of the two remaining partners now owns half the practice, rather than one-third. So, in effect, the remaining doctors have paid out some money in exchange for owning a larger share of the business.

Your group, however, has a major flaw in its buyout methodology. Returning a partner's initial investment is not a valid way to calculate payout when he leaves the practice. For instance, suppose a group's partners each invest $30,000 for equipment. Over the years as the equipment's value depreciates, each doctor's initial investment decreases in value, too. So by the time a partner withdraws from the practice, the $30,000 figure has no meaning as the basis for determining payout.

You need to draw up a new agreement. A healthcare consultant can suggest an appropriate valuation methodology.

To keep your practice on an even keel financially, anticipate upcoming buyouts and recruit new doctors to buy in, replacing the partners who are leaving.