Pre-marital counseling for business partners (Proceedings)

Co-ownership issues often arise when veterinary practitioners enter into a partnership with other owners, or when two or more associates jointly venture into practice acquisition. In most aspects co-ownership of a veterinary practice is akin to marriage, and it is vitally important to agree on the principal terms governing the relationship before getting hitched. The fundamental issues that need to be addressed upfront are how "power", "money" and "risk" will be allocated among the partners. Contrary to "common sense thinking", these 3 criteria are not related proportionally. For example, a partner with a 10% interest in the company, may get "10%" of the profits; "0%" the power, and "100%" of the liability.

Of all the business arrangements with which individuals become involved, partnerships are the most challenging. This is because the relationship may span decades, during which time the dynamics of these relationships are inherently subject to significant change. Parties of healthy partnerships revisit the terms of their partnerships no less frequently than every 3 years, thereby ensuring that the changing circumstances of their co-ownership relationship are addressed. While most veterinarians seldom allocate much time outside of the practice of veterinary medicine to address such matters, it is far preferable to resolve co-ownership issues at an early stage rather than to wait until a dispute arises, as denial and misunderstanding are the handmaidens of messy divorces.

Consider the following key co-ownership issues:

1. What type of Legal Entity is Your Partnership?.

     • What basic form should the practice take? ("C" corporation, "S" corporation, Limited Liability Company (LLC), partnership (general or limited), sole proprietorship) When buying less than all of a practice, the buyer usually must accept the existing structure. Even when buying 100% of already existing entity, adverse tax consequences often preclude transforming that entity. Those purchasing assets or starting from scratch generally have greater latitude. Selecting the right entity is a complex decision that should be thoroughly explored with the owners' accountant and attorney. Generally, tax considerations are determinative, but liability is also an important aspect. For example, while general partnerships often permit added flexibility, each partner is responsible for his share of the losses run up by the other partners (i.e., joint and several liability). Thus, if a partner incurs malpractice losses exceeding the practice's insurance coverage, the other partners will be responsible for the shortfall.

2. How are Salaries and Profits Distributed Among the Partners?.

     • How will owners be paid for their efforts as veterinarians? Will their compensation be based on their individual gross revenues, on practice gross revenues, or will they be paid a flat salary? Or should it be a combination of the foregoing? Note that owners are almost always also employees of the practice and permitted to take advantage of various tax advantaged employee benefit plans.

     • How will the practice's profits be shared? Should each owner's "take" be based on his ownership interest in the practice, his relative contribution to the practice's gross revenues, his ability to bring in knew clients (i.e., "rainmaking"), other factors, or a combination of several? Some business entities, such as partnerships, allow more flexibility than others in distributing profits. Beware of the double taxation consequences of distributing dividends from a "C" Corporation. "S" corporations are less flexible because the profits are distributed in proportion to ownership interest.

3. How is Your Partnership Governed and Managed?.

     • Governance of the selected practice entity are addressed in its constituent documents or more frequently in a shareholders' agreement (partnership agreements for partnerships, operating agreements for LLCs). When two equal co-owners join, typically all decisions will require unanimity, subject to perhaps dividing the day to day management duties among themselves. Three or more owners, particularly if they don't have equal shares in the practice usually require more complicated schemes. For example, majority vote needed for all decisions, other than certain enumerated strategic matters such as the acceptance of a new partner, or approving capital expenditures over a certain threshold, which require a super majority vote (e.g., 66.66%) or even unanimity.

     • Will the owners oversee the day-to-day management of business operations themselves, hire a practice manager or delegate the duties among several support staff members? Co-owners should consider their respective roles in this area and how their efforts should be compensated since they may be foregoing income generated from practicing veterinary medicine if their compensation is based on revenues. Even if partners don't actually perform the management tasks, they should be prepared to supervise others doing the job. (see attached list as Schedule 3) Compensation for management duties usually ranges between 2 and 4 percent of the annual gross revenues of the practice, depending on how much the owner is actually doing.

4. How Does Your Partnership Deal with Transfers, Withdrawals and Buy-Outs of Partnership Interests?

     • Should your partner be allowed to sell without your approval? Because it is unthinkable to let strangers into the practice without the approval of all the owners, the shareholders' or operating agreement usually prohibits an owner from selling his interest to a third party...without at least first offering it to his partners. This is called a "right of first refusal".

     • What happens when an owner dies, is disabled, goes bankrupt, has his license revoked or plans to retire? Additionally, what happens to an owner who divorces and the divorce settlement awards an interest in the practice to the spouse? In all of these cases, the owners typically have either the option or obligation to buy-out the affected owner at a price based on the practice's appraised value. (In many agreements, the practice entity instead of the owners may purchase the affected owner's interest.) In the case of death and/or disability, some owners subscribe to life and/or "buy-out" disability insurance policies, the proceeds of which are used to fund the purchase.

     • What if your partner divorces? If the divorced spouse has, or is awarded, a portion of your partner's practice equity interest, the divorced spouse becomes a partner. Ménages à trois make great literature and film themes but ALWAYS end badly.

     • What if your partner goes bankrupt? Do you fancy your partner's creditor as your new partner? It won't be fun to have a bank running, or having a say in running, the practice. Worse, the bank likely will want to sell your partner's share to a competitor.

     • Owners selling a portion of their interest in the practice in anticipation of retirement sometimes wish to penalize the junior partners for withdrawing from the business before they have sold their remaining interest in the practice (i.e., "you should not get out before I do"). These penalties usually reduce the price the junior partner can get for selling his interest.

     • How are interests transferred to minority owners? Do minority owners have "options" to purchase additional interests once they have worked for the practice a set number of years or fully paid off the debt associated with the initial purchase?

5. How Does Your Partnership Deal with Partner: Death, Disability, Mental Incompetence and Retirement?

     • What happens when you die? Will your heirs receive a fair price, or any price for your investment in the practice? Will they remain locked into that investment forever? Will your heirs collect profits from the practice? What if the other partner (who is getting paid under his practice employment contract) has voting control and decides not to distribute profits? If your heirs are to be bought out, who sets the purchase price? How and by whom is it paid? If part of the purchase price is paid with a promissory note, is same secured? How? What if the practice is not profitable enough to pay the note?

     • What happens when your partner dies? Your deceased partner's heirs are now your new partners. Barring a fluke, your new partners will not be veterinarians. Does your State permit non-veterinarian practice owners? Will they want to be bought out or stay and collect profits from the practice? (Without contributing to profit generation of course.) If the deceased partner was a large shareholder, or the majority interest holder, the heirs will also inherit your deceased partner's voting rights. Do you want to share practice management with, or be managed by, such persons? What if the heirs squabble among themselves, leading to management paralysis and/or litigation? Do you fancy having the practice run by a court-appointed receiver? If the heirs are to be bought out, who determines the purchase price? How and by whom is it paid? If there's a note, is it secured? How?

     • What if you are permanently disabled? Will you receive a fair price or any price for your investment in the practice? Will you remain locked into your investment forever? Will you collect profits from the practice? What if the remaining partner decides not to distribute profits? If you are to be bought out, who sets the purchase price? By whom and how is it paid? If there's a note, is it secured? How?

     • What if your partner is permanently disabled? Will your disabled partner want to be bought out or stay and collect practice profits (without generating any of same)? A disabled partner's interests will be different then yours, so if he was the managing and/or majority partner, how will he run the practice? Will he be able to run the practice? What if the disabled partner is mentally disabled? If your disabled partner is to be bought out, who determines the purchase price? How and by whom is it paid? If there's a note, is it secured? How?

     • What if your partner goes nuts? You don't want a mentally unstable person practicing veterinary medicine. But if such partner is the majority partner you can't fire him, because he, not you, controls the practice entity. The same problem arises for equal partners. Sure your mentally disabled partner could voluntarily remove himself, but can you rely on that? What if the majority partner has a guardian? How will the guardian run the practice? What if the majority partner or guardian fires you?

     • If your partner is not your retirement plan, then who is? If you don't have a firm agreement with your partner to sell your practice interest to him (or someone else) upon your retirement, then how are you going to retire using your investment in the practice as your nest egg? What if both partners want to retire at the same time? Can you force your partner to buy you out? (Yes, its called a "Put")

6. How Does Your Partnership Deal with Partners that Are No Longer "Good" Partners?

     • What if your partner should be fired as veterinarian-employee? Suppose your partner becomes lazy or his child becomes ill and decides to work significantly fewer hours or stop working altogether. Suppose your partner becomes a substance abuser and consequently unfit to practice veterinary medicine. Or he steals from the practice. Or he harasses employees and/or abuses clients and/or patients. The foregoing would be grounds for terminating a veterinarian employee. But if your partner is the majority or an equal partner you can't fire him (as explained in the preceding paragraph).

     • What if your partner wants to drop out, buy a boat and sail around the world? Should your partner be permitted to withdraw? If not, how do you keep your partner from just resigning as an employee (in light of the constitutional prohibition of involuntary servitude)? If so, should withdrawal be subject to your partner reaching a certain age (e.g., 55 or 60)?

7. How is Your Partnership Valued?

     • When a partnership interest is transferred due to a partner's retirement, death or long-term disability, what will be the price of such partner's interest? Does the agreement provide for a valuation methodology? By whom? Does the methodology explicitly exclude incorporating "goodwill"? Many partnership agreements base the value of the interest on "book value" and ignore the most valuable intangible asset of the business: its goodwill.

     • What is the date of the valuation? Is it from the date of death? Retirement? Are any discounts applied for transfers that result from a partner's "bad conduct"? Such as termination due to loss of license? Drug use?

     • How will the purchase price be paid? By whom (the company? the other partners?) How is it paid? If there's a note, is it secured with collateral, such as insurance or a "stock" pledge agreement? If purchased by the company, is the loan guaranteed by the remaining partners?

8. Does Your Partnership Agreement Have Restrictions Pertaining to Non-Competition; Confidentiality and Non-Solicitation?

     • A clause prohibiting the owners from directly or indirectly competing with the practice, keeps the owners focused, preserves the goodwill of the practice and reduces conflicts of interests. These provisions typically prohibit a partner from competing with the partnership for a certain "restricted period" and "restricted area". This restriction typically applies during the partnership and for 5-7 years after the partner had left the partnership.

     • How does the partnership protect the practice's confidential information, including the client lists? Can departed partners starting up their own practice, solicit the partnership's clients? Employees? Are there any limitations in direct or indirect "advertisement"? What if a former partner wishes to list their name in the phone book within the partnerships trade area?

9.How Are Disagreements Addressed?

     • In a 50/50 practice how are disagreements handled? What if you no longer get along? What's to happen when each party has equal voting/management rights and a serious disagreement arises? Should the practice be dissolved? Should disputes be resolved by binding arbitration? Much more entertaining ways of dealing with deadlocks among equal owners include methods titled: the Russian roulette, Texas shoot-out, and Dutch auction (all of which are defined on wikipedia.org).

     • In partnerships where there is a partner who owns the majority of the practice, disagreements are typically resolved by majority vote. There typically are no deadlocks, unless, the minority owners have "minority rights" which enable them to retain a "say" on certain issues.

REFERENCES:

Partnership Charter; By David Gage (2004)

Form a Partnership: The Complete Legal Guide; By Ralph Warner, Denis Clifford (2008)

Schedule 3

SAMPLE MANAGEMENT DUTIES

FINANCIAL

          » Establish an annual budget.

          » Set up internal controls to prevent embezzlement.

          » Review all accounts payable.

          » Reconcile the check book.

          » Review and evaluate income by department.

          » Consider various pension and profit-sharing options and oversee administration of the one selected.

          » Produce monthly and annual financial reports - with assistance of practice's CPA.

          » Establish an inventory control system for all OTC products, dispensable products, and hospital supplies.

          » Work with doctors to review, update, and evaluate the effectiveness of and compliance with the practice's established fee schedule. Adjust fee schedule twice yearly.

          » Maintain a hospital credit policy, establish credit application forms, and monitor accounts receivable.

          » Select and monitor a collection agency to pursue past-due accounts receivable.

          » Work with CPA to produce and review all federal, state, and local income, sales, and use taxes.

          » Review existing insurance coverage, meet with insurance agents, and determine which company provides the best medical, hospital business package, life, disability, workers' compensation, and professional liability coverage.

          » Determine whether it is more economical to hire an automated payroll company to do payroll or complete this task in-house. Select payroll company with assistance of CPA should that be the decision.

          » Attend continuing education programs focusing on business tax planning and financial affairs.

PERSONNEL MANAGEMENT

          » Develop and enforce consistent personnel policies.

          » Listen to and resolve staff complaints.

          » Develop and implement a cohesive staff training program.

          » Develop and maintain a hospital procedure manual.

          » Responsible for hiring and firing of support staff, assist with hiring and firing of employed veterinarians.

          » Create and review job descriptions for all support staff members.

          » Implement a routine performance appraisal system for all employees.

          » Handle personnel regulatory matters dealing with I-9s, OSHA, Toxic Hazard Communication Act, payment of overtime, sick leave, pregnancies, etc.

          » Establish contracts for employed veterinarians and any support staff who should have them.

          » Oversee the scheduling of support staff.

          » Review and tabulate employee payroll and report hours to automated payroll service.

          » Help employees develop personalized continuing education plans.

          » Develop support staff compensation incentive programs.

          » Attend continuing education seminars devoted to personnel management and motivation.

MARKETING

          » Revise and/or develop hospital brochures, newsletters, and hand outs.

          » Review and develop all forms of client reminders and written communications.

          » Select and oversee appropriate size and content of Yellow Page ads or entries.

          » Develop client education messages printed in conjunction with and on client receipts.

          » Create and/or implement training programs that enhance the marketing knowledge of support staff members.

          » Review effectiveness of current point-of-purchase sales area for over-the-counter products and determine whether this should be further developed.

          » Review various types of external marketing techniques such as elementary school visitations and presentations by staff members, open houses, membership of veterinarians in local service clubs, etc.

          » Attend continuing education programs dealing with marketing of veterinary services.

MAINTENANCE

          » Develop and oversee a maintenance plan for the physical plant and all hospital equipment. Locate and keep a list of qualified plumbers, electricians, flooring contractors, and other handymen as needed.

          » Fix various equipment or furnishings in need of repair or determine who is best qualified to make such repairs and arrange for repairs to be completed.

          » Evaluate cost-benefit and cost-effectiveness of new equipment purchases. Obtain prices on competitive equipment before any purchases are made.

          » Maintain a warranty and repair file for all purchased or leased equipment.

          » Maintain all documents pertaining to the lease of the physical plant and equipment.

          » Fix or hire someone to repair any problems that occur with the phone system and/or intercom.

COMPUTER

          » Oversee computer-generated reminder system.

Review new computer programs offered by vendor, determine what type of software or hardware upgrades should be made.

          » Resolve problems with computer glitches, disk drive problems, cables, batteries, memory cards, printers, etc.

          » Develop effective staff training program to educate new personnel as expeditiously as possible.

Please find below a check list for co-ownership agreements. This list should be reviewed after reviewing the article accompanying this list. Please note that the questionnaire applies to all types of co-ownership agreements, regardless of whether the legal entity is a Corporation, Partnership or LLC.

This questionnaire assumes that 1) the agreements are available and signed by all the parties; 2) if the company is a corporation, that the corporate minute book is in order and the share certificates properly reflect the ownership interests, and 3) any insurance polices are up to date.

The answers are "yes" or "no" or "short answer"