Most practice owners do not think that they are hiring their eventual successor when hiring an associate. Most associates do not believe that they will eventually buy the practice that they associate with. Therefore, associate contracts that specify a method for a buy-in at a later date are practically nonexistent. So both the associate and owner continue their agreement until one day the associate wants to buy and the owner wants to sell. This is how most associate buy-ins happen. But, most associates do not want to buy what they helped grow. It is somewhat difficult to retroactively calculate the contribution the associate has had on the practice and discount an amount from the purchase price.
For example, an associate joined a practice worth $1 million and over the next five years the practice grew from $1 million to $2 million. The owner decides that it is time to sell the practice and the associate decides that they would like to buy the practice. The owner says, “I’m prepared to sell my practice for $2 million.” The associate says, “The practice was doing $1 million the day I arrived and you were operating at capacity. I added that extra $1 million.” The owner says “Those were my patients you treated, in my facility, utilizing my staff and supplies, and you were paid well for your work. That is my $1 million.” What you have here is $100,000 in legal fees. Obviously, it is important to properly take into account all factors when structuring an associate buy-in.
The associate almost always has the perception that they helped build the practice and increased its value as a result of their production. As a result, it is standard for the associate to feel that they should not have to pay more money to buy into the practice as a result of increased production for which they were responsible. The question is whether an associate who has worked in the practice for several years should pay the same price as any other buyer or be given some special consideration for their relationship with the practice and the patients.
The primary methods for pricing a practice for an associate buy-in are fair market value, a discount, or a credit. Fair market value would be established by an independent appraiser and determined by the utilization of a capitalization rate or a market comparable method. In other circumstances, owners can discount the purchase price based on the years of association. For example, an owner may discount the price of the practice a certain percentage for every year that the associate has been associated with the practice. Finally, one can apply a credit towards the fair market value purchase price. Equity credit is similar to the old phrase “sweat equity”. The owner of the practice may take the growth of the practice into account and give the prospective buyer a certain percentage of that growth as a credit towards the fair market value price of the practice.
The question always becomes why would the owner of the practice even consider discounting the price or granting equity credit? The reason is because the owner may have profited handsomely from the association and earnings of the associate over the years. When the associate adds additional revenue to the practice, the only expenses associated with such additional revenue should be the compensation of the associate and the production related costs.
Another reason the owner of the practice might consider a discount is the possibility of the associate opening their own practice nearby instead of buying-in. The associate could take half of the practice with them, which would drive down income and drive up overhead. Also, any prospective buyer considering the acquisition of your practice would be extremely concerned that the remaining patients you do have in your practice would know the name of the associate and might prefer the associate rather than the new owner. In other words, if the associate moves down the street and takes a good bit of your practice with them, it is going to make it extremely difficult to sell the remainder. If the associate has signed a non-compete, this scenario is very unlikely.
A key factor in determining the associate’s discount is not only whether the practice grew, but why it grew. It is much less likely that the associate would get a large discount if the practice had more than enough patients for both the owner and the associate, or the associate had been extremely well paid for his work. Under those circumstances, the owner may feel that the associate was merely taking advantage of untapped business that was already available in the practice. In that case, the owner might feel that little, or no earned equity credit or discount should be provided. Conversely, if the associate had to go out into the community and build relationships in order to add clients and patients to the practice or perform procedures that the owner could not or would not perform thus adding revenue to the practice, there is a much stronger likelihood that a larger discount in the purchase price should be offered.
In circumstances where the associate is merely capitalizing on the current client base and not building it, the practice should be valued based on its present value at the time the associate buys in. However, if the associate actively grows the patient base, then the practice should be valued at its past value as of the date the associate joined the practice. Whether you use the past collection or your present collection as a valuation basis depends upon how the growth was obtained.
Whether the price should be set at the past value or present value, is often a matter of perspective. Whether there is a discount or credit for the determination of the purchase price, and the size of that discount or credit, can be difficult to determine without a historical reference. Bringing objectivity to the discussion often requires neutral and knowledgeable third party advice. We render that advice often. If we can be of service to you in your associate buy-in, please let us know.
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