Published 1/1/2008
Peter Pollack

Bringing someone in: A succession planning primer

Recruiting can be rewarding, if all parties are on the same page

Bringing a new partner into a practice can be an exciting yet difficult time, according to Michael J. McCaslin, CPA, of Somerset CPAs (Indianapolis). “What is succession planning? Ensuring that new physicians are in the pipelines to keep the practice going,” he says.

Although perpetuating the practice is one of the most important elements to keep in mind when bringing in a new partner, the primary focus for all parties initially will likely be economic.

Money issues, according to Mr. McCaslin, aren’t necessarily complex. “It’s the personalities that create the complexity. Cash is pretty easy to deal with. The hard part is determining who is due what.”

Over time, many practices add ancillaries, but neglect to update their buy-in and buy-out plans. When the practice opened, for example, the original partners may have gone several months without taking a pay distribution. In a mature practice, however, if a new physician buys in for the original buy-in price, a clash can result.

“It’s easy for a new person buying in to forget that he or she will be a seller at some point,” he says. “Or he or she may be caught in the future between a senior physician trying to exit and a new doctor coming in. There’s a life cycle to being in practice, and physicians need to broaden their view to cover all of the circumstances that they’re going to face.”

What is a practice really worth?
Much of the value of a practice, and therefore the buy-in, is based on the location of the practice itself. Practices in states known for unfriendly medical liability laws, for example, may be at a disadvantage when it comes to recruitment. Local reimbursement levels and state laws governing ancillary services are also factors.

But if no one is interested in buying into a practice, “what you are selling is not properly priced,” says Mr. McCaslin. “You can say your practice is worth a certain amount, but if you’re trying to recruit three physicians and none are interested, you have a pricing problem.”

Some physicians overstate the value of their practices—viewing the practice as part of a retirement plan. The value of a surgery center, for example, can be reduced or eliminated by sudden changes in a state’s regulatory environment, the simultaneous departure of several physicians from the practice, or a bad real estate deal.

“Physicians who build the value of a practice into their retirement plans,” he says, “will get burned more often than not because it’s not a real asset. It can be a bonanza—a great gift if it happens—but it can also be a bust.

“The best way for a practice to make money is not in the buying and selling of partnerships, but in the business itself. The goal should be to have a pipeline of physicians working together, generating net income, and not building something to be sold. That should be the focus when putting together a succession plan,” advises Mr. McCaslin.

Although the professional component of a practice may not carry a lot of real value by itself, revenue-generating ancillary services such as imaging and physical therapy, along with durable medical equipment and capital investments, can add substantially to the value. Such factors, however, may need to be valued using something other than a fixed-asset approach.

Determining fair market value
“The technical definition of fair market value,” he explains, “is, ‘The price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of relevant facts.’

“Among the facts to consider are the history and nature of the practice, the economy and the industry outlook, the book value of the stock or the assets, the financial condition of the practice, the earnings and dividend-paying capacity of the business, the estimated value of goodwill and other intangibles, a description of the stock or assets to be sold, and comparable market prices of similar businesses.”

Establishing the value of a business also includes the expectation of future benefit—a difficult aspect to judge in the medical world.

“The best indicator of future performance is most often the performance of the immediate past,” says Mr. McCaslin, “but in health care, that’s risky. For example, if a surgery center has 10 physician-owners, but most of the business comes from two very productive sports medicine doctors, what good would the historic financial information be if those two doctors died?”

The guiding principle for fair market value transactions is dealing with a willing buyer and a willing seller. “I would argue there are probably not a lot of willing buyers and sellers at $300,000 to $400,000 per unit. So the dollar amount affects—in my opinion—both willing buyer and willing seller, which gives the practice some flexibility,” says Mr. McCaslin.

A consistent approach
Whatever formula is used to determine a buy-in price, it must be consistent and deliver reasonably predictable results. If someone who bought in 5 years ago paid five times more than the person who bought in last year, conflict is inevitable.

Another potential source of conflict is self-interest. “In discussions about buy-in and buy-out programs,” explains Mr. McCaslin, “the senior physician can’t help but wonder, ‘What am I going to get when I leave?’ The new recruit is thinking, ‘What’s it going to cost me to get in?’ It falls to the physician in midcareer to be the arbiter. He or she will probably be the best judge in trying to determine what is fair.”

No secrets from new recruits
Mr. McCaslin suggests putting together a package of information that covers all aspects of a practice’s succession plan and making it available to all new recruits. Be sure to include information on salary and incentives; the associate employment agreement; the shareholder physician’s agreement; a stock purchase buy/sell agreement; and a description of everything covered in the buy-in, including the buy-in calculations for the last three people to join the practice.

“Don’t wait 2 years to tell the new person, ‘Oh, by the way, we’ve got this big real estate buy-in for the medical office building and the surgery center building and the surgery center itself.’ A new doctor should know upfront all those items that he or she is going to be required to buy into,” he says.

“Also, describe what happens when you have an audit, with either the government, on coding and compliance, or the Internal Revenue Service. If a fine is assessed, does the individual physician pay or does the group? Explain how the practice is governed and how decisions are made,” he advises.

Finally, Mr. McCaslin says practices should try to understand the needs of the spouse of a potential recruit.

“If you lose the spouse, you lose the physician. So find out right away what he or she wants. Use your own intelligence-gathering process, because the husband or wife has huge influence today on where that doctor will practice.”

Michael J. McCaslin, CPA, spoke on succession planning at the 2007 BONES meeting. Peter Pollack is a staff writer for AAOS Now. He can be contacted at ppollack@aaos.org