Examine buy-in provisions of employment agreements
■ A column examining the ins and outs of contract issues
By Steven M. Harris — is a partner at McDonald Hopkins in Chicago concentrating on health care law and co-author of Medical Practice Divorce. He writes the "Contract Language" column. Posted Aug. 18, 2008.
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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.
The future possibility of the physician-employee becoming an owner of the practice is sometimes addressed in the physician's employment agreement. 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 the associate is served. Because the circumstances of the individual parties will govern the terms of the buy-in, there is no standard contract language universally used in physician employment agreements.
There are, however, specific aspects that exist in many buy-in provisions contained in physician employment agreements. Such issues include the option to purchase an ownership interest; performance reviews; how the interest will be valued; and payment terms.
Option to purchase
The employment agreement should specify whether and when the employee-physician will be eligible to buy an interest in the practice. However, the parties may intend that the physician remain an employee and not have the opportunity to own any interest in the practice.
The idea of remaining an employee may be attractive to some physicians who prefer to have less involvement in the business and financial aspects of the medical practice. If that is the case, then the physician's employment agreement should not include an option to purchase an ownership interest.
However, if the parties do intend that the physician have the right to purchase an ownership interest, the time frame and conditions to 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."
One condition precedent to the right to purchase an equity interest may be satisfactory performance reviews by senior physicians.
While these reviews are frequently based on subjective standards, the employee-physician should seek a contractual commitment describing the evaluation criteria in order to make the reviews as objective as possible.
Standard criteria include statistical analysis, such as the number of patients seen a day or number of procedures performed a week. They also include the quality of care rendered and contributions to the practice's operations, such as marketing and community outreach. Patient satisfaction surveys are often considered.
The evaluation should be in writing and accompanied by an oral discussion orchestrated by the reviewing physician or physicians. In addition, the physician's employment agreement should specify the frequency of his or her performance reviews. I suggest that physician reviews occur at least annually and preferably semiannually, especially during the beginning years of employment.
Regardless of the frequency of reviews, 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.
Valuing the interest
In my experience, the employment agreement will either provide an exact purchase price or more often will state the method to be used in the future for valuing 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 bought by the purchasing physician.
Three of the most common formulations for valuing the equity of a medical practice are:
- Book value of tangible assets (equipment, furniture, fixtures).
- Current fair market value of all assets (tangible and intangible -- including accounts receivable and goodwill).
- Discounted present value of net revenue stream, a figure that represents a percentage of expected future receipts.
The appropriate valuation method will depend on a number of factors unique to the individual practice. Therefore, I highly recommend that the practice seek the assistance of an accountant or practice valuation specialist when determining 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.
In the event that the physician-employee exercises the right to buy in, the employment 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, however, the parties agree that the physician will either pay the owners in full up front or will make installment payments for a specified number of years.
If the physician is required to pay the total purchase price up front, he or she will be personally responsible for obtaining the necessary funding through bank loans or other sources. The practice is seldom, if ever, used as collateral for bank financing.
Alternatively, if the purchasing physician is permitted to make installment payments, he or she 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. In the event that the physician fails to make the installment payments, the practice can recover the equity interest.
These are some of the key issues that are frequently addressed in physician employment agreements that extend to the employee-physician the opportunity to purchase an equity interest.
It is imperative that both parties review and understand the terms and conditions of the agreement prior to signing.
Steven M. Harris is a partner at McDonald Hopkins in Chicago concentrating on health care law and co-author of Medical Practice Divorce. He writes the "Contract Language" column.