Physicians who join a medical practice often have the opportunity to purchase an equity interest in the practice after some period of employment with the group, an issue that is usually addressed in the physician’s employment agreement. If you think you may be interested in such a partnership, you should carefully review your employment agreement before signing it. The amount of detail in the employment agreement regarding potential ownership will vary depending on the practice and the negotiating power of the individual physician. Clearly, the more specificity found in the contract, the better you will be served.
The employment agreement should specify whether and when you will be eligible to acquire an interest in the practice. The idea of remaining an employee may be attractive to you if you prefer to have less involvement in the business and financial aspects of the medical practice. Sometimes cost becomes a critical issue.
If you intend to purchase an ownership interest, however, the timeframe and conditions for exercising that right should be specified in writing. The following is an example of a provision addressing the option to purchase an equity interest:
“The parties agree that it is their intent that upon X years of continuous employment pursuant to the terms and conditions of this Agreement, Physician shall be given the opportunity to purchase [a partnership interest or stock] in Practice.”
Your employer may require that you achieve satisfactory results on performance reviews conducted by senior physicians as a condition of purchasing an equity interest. While these reviews are frequently based on subjective standards, you should seek a contractual commitment describing the criteria to be evaluated in order to make the reviews as objective as possible. Standard criteria include statistical analysis (e.g., number of patients seen a day, number of procedures performed a week), the quality of patient care rendered and contributions to the practice’s operations (e.g., marketing, community outreach).
In addition, your employment agreement should specify the frequency of your performance reviews. I suggest that physician reviews occur at least annually and preferably semi-annually, especially during the initial years of employment. Regardless of how often the reviews are conducted, it is highly beneficial to both the practice and the physician-employee that the time periods for evaluations be strictly enforced. Consistent, formal performance reviews promote improvement and synergy between the physician and the practice.
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.
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.
Steven M. Harris, Esq., is a nationally recognized health care attorney and a member of the law firm McDonald Hopkins, LLC. He may be reached at email@example.com.