Equity Interest Value
Typically, an employment agreement will either provide an exact purchase price or, more often, will state the method to be used in the future for calculating the buy-in price. Ordinarily, the buy-in price will be a function of the valuation of the total equity of the practice and the percentage of that total equity which is represented by the interests to be acquired by the purchasing physician. There are numerous formulas for valuing the equity of a medical practice. Three of the most common are book value of tangible assets (equipment, furniture, fixtures), current fair market value of all assets (tangible and intangible, including accounts receivable and goodwill) and discounted present value of net revenue stream.
Explore This IssueMarch 2011
The appropriate valuation method will depend on a number of factors unique to the individual practice. Your practice, therefore, should seek the assistance of an accountant or practice valuation specialist when determining the value. Stating an agreed upon valuation method in the employment agreement will limit surprises and “sticker shock” to the buy-in price when the ownership decision is made down the road.
If you do decide to buy in, the employment or purchase agreement should provide terms governing how the purchase price will be paid. Often, the practice will be flexible in negotiating payment terms that meet the physician’s individual financial needs. Frequently, the parties agree that the physician will either pay the owners in full up front or make installment payments over a specified number of years. If you’re required to pay the total purchase price up front, you will be personally responsible for obtaining the necessary funding through bank loans or other sources.
You should know that the practice is seldom, if ever, used as collateral for bank financing. Alternatively, if you’re permitted to make installment payments, you may be required to sign a promissory note in which the payee is the practice and the note is secured by a security interest in the equity granted to the physician. There are important tax strategies that can be implemented when installment payments are agreed upon. In the event that you fail to make the installment payments, the practice can recover the equity interest.
Most importantly, you should review and understand the terms and conditions of the buy-in so that you and your practice partners enter the employment relationship with the same expectations for future ownership.