How to Evaluate a Medical Practice Buy-In

In a previous career, I was a corporate consultant for a Fortune 500 firm, and I oversaw mergers and acquisitions of financial advisory practices. During that same time, my wife was finishing her OB/GYN residency and was undergoing the process of potentially joining a private practice with an ownership option. It occurred to me that physicians generally receive limited financial education in school which can lead them to be potentially poorly prepared to properly evaluate investing in a private practice. Furthermore, many individuals train for residency at public institutions and have mentors who never took the risk of ownership in a private practice or who might have been burned by needing to buy out of a poorly vetted private practice structure. Hence, these mentors are ill-equipped to properly mentor residents to assess different options when approached with an offer to become a partner in a practice.

While there are underlying differences between medical and financial practices, the themes around business/practice ownership are very similar. My wife drew on my experience with practice buy-ins and sales when considering potential options for employment post-residency.

The trend of practice ownership is on the decline as only 31.7% of physicians under the age of 45 have ownership in their practice. Much of this decline can be attributed to rising practice costs, increased liability, larger administrative burdens, and diminished negotiating power with hospitals and insurers. However, small business ownership is a significant creator of wealth in the US, and it should at least be considered as an avenue for wealth creation for physicians.

From a financial investment standpoint, the quantitative factors of evaluating a buy-in are most important, and they should be the first focus when considering an investment. One can find the process and best practices discussed in this podcast. Conversely, through years of consulting on buy-ins, I wanted to highlight that the often overlooked qualitative factors can be just as important in avoiding pitfalls that can sabotage your investment and your financial plan. Aside from direct investment costs, unintended costs—such as needing to relocate outside of a non-compete area, sell a residence, purchase tail malpractice coverage, and rebuild a patient population—emphasize the need to ensure a comprehensive due diligence process before committing to buying into a practice.

While what I write below is not an all-encompassing list, it provides several considerations to be mindful of when a physician is evaluating a potential practice purchase (as a partner or outright). I also included several examples from both the financial and medical space that I have come across professionally or been re-told to personally from physicians to highlight the complexities encountered with buy-ins and buy-outs.

Does It Financially Make Sense? How Is Value Calculated?

It needs to be recognized that one is now investing in a business, not just getting a job. This adds significant levels of complexity to the process. An individual will now have two streams of income (physician and investor); each needs to be reviewed extensively within the due diligence process.

When it comes to the investment, we should re-iterate that looking at the “price/value” of the ownership interest is still the most important factor when considering a buy-in of a medical practice. If the business is losing money year over year without the ability to turn around or if it's priced 45% richer than similar practices for no discernable reason, it is easy to decipher that a buy-in should not be accepted. If you need more help, here's an extensive review of the most important elements of a medical practice valuation.

However, there are idiosyncrasies regarding the methodologies and assumptions when it comes to a “valuation” that an investor should be cognizant of during negotiations. These differences could create a vast variance in value that could be used to benefit or hinder a respective party during negotiations.

Regarding valuation, any certified valuation appraiser, accountant, etc., will agree that there is no silver bullet for methodology or underlying metrics used in the process. Some of the differing approaches that I have seen include the following.

Who Calculates Value?

• A certified third party, the existing partners via negotiation, a pre-determined formula, or a combination?

What Quantitative Metrics Are Used in Formulas?

• When using revenue: topline revenue, revenue after reimbursements, revenue after deductions?
• When using comparable sales: geography limitation, recency of sales, revenue size, intra-specialty definition?
• Profitability (EBITA): Is it recast/adjusted? Who decides what expenses are applicable/removed?
• Timeline assumptions: Last year’s revenue/EBITA, or the last five years? Future forecast revenue and growth rate? Normalization of any atypical events?

What Contingency Clauses or Certain Circumstances Can Impact?

• Death, disability, dissolution, new partner discounts, private equity premium, automatic sale clauses, and minority discount?
• Is a continued salary for the owner included?

Example: A physician signed her first contract at the end of residency with a practice near where she had finished medical school. She bought in two years after joining the practice, but three years later, she decided to leave to move to another state for personal reasons. (This is very common; statistics show that 50% of doctors leave their first job within five years.) She was then informed that her buy-out was at a 20% discount to buy in, as the practice included a “business interruption” clause. While the practice had grown 10% since she had bought in, overall she took a significant loss on her investment.

More information here:

Buying into (or Selling Part of) a Business

Ownership Has Its Privileges

Due Diligence on Practice Focus

Not all practices within the same specialty are equal. An individual needs to ensure that the practice is managed in the same vein as the individual would run their own practice independently. If not, a misalignment can cause friction in day-to-day operations among the partners in the practice based on how each individual wants to move forward for growth or to address any problems. Ultimately, any friction tends to undermine the business's success as a whole. Misalignment can also manifest itself in a range of issues at the patient level—the patients might not align with the incoming physician’s service offering, medical philosophy, or even patient cultural values.

Since client revenue is the main driver of value, any attrition would cause a negative effect. While some items will surface within the due diligence process for the investment valuation, it is important to ensure a comprehensive review of all aspects of the business.

Potential Areas of Review

• Historical and future business plan
• Future exit/sale plans of owner
• Marketing plan and current advertisements
• Client demographic list
• Patient complaints
• Patient outreach
• Prospecting and referrals
• Patient services utilized
• Employee census, contracts, morale
• Employee reviews
• Benefit programs
• Policies and procedures manuals
• Outstanding vendor relationships

Example #1: A solo practitioner was looking for a junior partner to help them slow down so they could travel and spend more time in their birth country. After preliminary due diligence, it was realized that a significant portion of revenue came in cash payments from patients from the individual's birth country pursuing “medical tourism.” While profitable at the time, this was not sustainable once the former partner retired, because the potential new partner had no connection to the native country. This would eventually erode the value of the enterprise. Additionally, this misalignment was foreseen to cause potential language and cultural issues within the care of service.

Example #2: An individual was interviewing with a practice and was presented with a standard buy-in option the group had been using, which offered a partial equity buy-in at year 5. There was also the potential of an outright purchase at the retirement of the two senior partners. Through the due diligence process, the individual discovered that the partners were looking to retire in three years. He mentioned this to his legal advisor, who cross-referenced the proposed agreement that stated if the group was to sell to an outsider or private equity before this individual's buy-in, this individual’s option was suspended. The team confirmed later that they were already in preliminary discussions with a private equity firm for succession purposes.

Is It in Writing? Is It Too Simple of a Contract?

While not as common for new partner buy-ins, this tends to manifest with individuals entering partnerships or formalizing ongoing working partnerships. Many handshake or verbal agreements tend to be “forgotten” or misremembered. The adage, “Nothing is ever needed in the good times, only the bad,” holds true in these circumstances. With that in mind, arguably one of the most important clauses is the “dissolution clause.” Much like a marriage, it is better to write a separation agreement before you get married rather than during a divorce. While every circumstance cannot be foreseen within a contract, it is important to have general guidelines that protect both parties and that can be a guiding light during critical and often heated conversations.

Example: Many practices have a “probationary period” of employment before a buy-in is offered. While this is a best practice (similar to dating before marriage), many practices only allude to a buy-in being available within their initial employment contracts. Further, certain practices do not include any more information or purposely use a separate document about the buy-in structure as they feel it is proprietary and confidential until the option is presented. My wife, after asking to review a buy-in document, was even told, “Don’t worry, just know it always works out.” Anything that “always works out” should make an individual wary, but many young physicians (and advisors) enamored by the idea of ownership have blindly agreed. There are timeless stories of individuals being told of the ability to buy in the future without any set date and then have the owner push the buy-in date in perpetuity or, worse, sell to another individual or private equity firm instead.

More information here:

The DSO Down-Low: How Private Equity Has Infiltrated Dentistry

What’s the Fine Print? Or Did You Even Actually Read the Contract?

It always astounds me how many people I speak with who made assumptions about what their contract stated or who did not read it before signing. While one might think there is no excuse for not reading a contract, there are a couple of commonalities in reasoning that I have noted over the years: 1) not thinking one can negotiate, making it futile; 2) not having the ability to understand the document even if it was read; 3) not having the time to read; 4) not having the funds to have an attorney review it. This notion that many individuals don’t read or don’t have the ability to negotiate creates the opportunity for practice owners to write contracts that benefit themselves.

From my experience, most practice owners are not explicitly looking to take advantage of an incoming partner. Rather they are looking to protect themselves and their financial interests. Unfortunately, this tradeoff usually comes at the expense of the junior partner who is benefitting from the sweat equity of the owner who built the practice.

Example: A financial advisor joined a practice that she had known her entire life. She had even worked there as a marketing intern during the summers of her undergraduate years. After several years of working together, the individual was told by the owner of the practice that he intended to sell the practice to a private equity firm at the end of the year. She notified the individual that she would be invoking a clause in her employment contract that allowed her to maintain her independence. However, it was brought to her attention that there was a non-compete clause in her marketing intern contract that could potentially impede her independence. Her current employment contract was written with a gap that didn’t suspend any previous agreement clauses. Such a clause is common in most agreements, and it would have been noticed by most attorneys. Ultimately it was not enforced by the owner, but it caused countless sleepless nights for the individual.

More information here:

A Step-by-Step Guide to Starting a Medical Practice

How to Get Out of a Non-Compete Agreement

Personality Test, aka “Airport/Thanksgiving Test”

Many physicians work up to 60 hours per week, so one will be spending a significant amount of time with their new business partner. More so than aligning on medical values and philosophy, it is important to get along personally, have trust in each other, and even share the same social interests. Many partnerships can fail due to a lack of commonality, empathy, and trust. The most successful partnerships that I have come across have inherent trust in one another and complement each other professionally. Successful partnerships can support each other and will do so without asking or expecting anything in return. At a bare minimum, it is important to evaluate whether someone is the right fit by asking yourself how you would feel being stuck in an airport with them, or if you would bring them to Thanksgiving dinner around your family.

Example: A solo practitioner of 30 years was looking for a junior partner to help them slow down as they geared toward retirement. It was proposed that the ownership and revenue would be split equally at 50/50. It was also stated that this was aligned with the notion that they wanted to share what they defined as an equal amount of work. However, the current solo owner mentioned in passing as the “senior of 30 years” that it was only fair that they chose 50% of the call shifts first and that they were looking forward to finally having all holidays off. Further “as a sign of respect,” they would have the final say on any disagreements. This obviously was very concerning to the prospective partner, as it seemed to be an indication that their opinion would most likely be dismissed or ignored. Partnerships need to be equal and equitable among partners.

As for my wife’s journey, she ultimately joined a physician group that is hospital-owned and, thus, does not have a buy-in option. The reasoning for not choosing an ownership path was a combination of factors. Primarily, the biggest driver was that no practice in our desirable locations truly fit her criteria on a day-to-day work basis (call shift schedule, in-house vs. home call ability, patient service offering, etc.) in comparison to the group she joined. Other precluding factors included not receiving enough information on the front end and conflicting information during the due diligence process. Lastly, coming out of residency, she wanted her professional focus to solely be on patient care and did not want to have the additional administrative burden of ownership decisions at this point in her career.

In my experience, the vast majority of practice purchases and partnerships work out beneficially and amicably for all parties involved. However, horror stories are both dire and a dime a dozen spread throughout the industry (just ask your colleagues). Extensive due diligence is a small price when it comes to protecting your career and your finances.

Have you ever had to evaluate a potential buy-in? What happened? Did you go through with it? Did you see any major red flags? Is ownership better than being an employee?