Getting Paid for Your Practice at Retirement

By Mike Kreager, Attorney & Author

Every day 10,000 Americans turn 65 (AARP website). As of the end of 2018, 28% of Texas’ physicians were over age 60 compared to 19% who were under age 40 (AMA Physician Masterfile 2019 n=64,382). A large bolus of physicians is approaching retirement. If you are among those physicians who want to retire, how do you get paid for your medical practice?

Pre-Planning

Selling your practice needs to start with the development of an exit plan, with target dates matched to key milestones. At the outset, identify your advisory team. The team consists of your CPA, financial planner and an attorney familiar with selling medical practices. Depending on your circumstances, a business broker may need to be added to the team. Often, a retiring doctor will engage a business appraiser to value the practice. There are many appraisers available at reasonable costs.

Practice Income Assessment

Ask your CPA to review your practice tax returns and financial statements. More specifically, ask the CPA to “normalize” the income statement to remove, or separately state, the costs associated with your employment and ownership. This exercise removes your salary, benefit costs (health insurance and retirement contributions), profit distributions, payments to your spouse and any extraordinary items that have been expensed, e.g., Spurs tickets, etc. The normalized income statement will show how much net income the practice generated in the prior three years. If depreciation, taxes and interest are added, you will have “EBITDA”, the practice’s earnings before interest, taxes, depreciation and amortization. EBITDA is a proxy for the practice’s free cash flow, an important indicator for pricing the practice, as discussed below. Buyers

Who are the target buyers? The answer to this question is very specific to your practice and its subspecialty. If you have associates or younger owners, the first choice for buyers are these folks. If there are none, then a possible universe are physicians coming from training. However, in the last fifteen years, these folks may no longer be good candidates due to student loans and their desire for income stability and an aversion to risk. Other practices similar to yours are potential buyers but usually they have a similar aversion to adding debt and may be facing the same impending need to exit.

Non-physician buyers include hospital systems, managed care systems and management companies (many backed by private equity). Much has been written about the cost containment goals of the hospital systems and managed care systems (those backed by the insurance companies). The former desires to capture the referral base of patients needing inpatient and outpatient care of hospital facilities and the latter desires to control provider costs to enhance profitability. Subspecialties are very attractive to non-physician buyers. If you have not already been previously approached, you can easily contact these buyers to gauge their interest in your practice. They will have standardized checklists for detailed information to be provided for their analysis.

Pricing

There is no formula that will define your selling price. Gone are the per chart or multiple of revenue models. The best predictor of price is EBITDA. This number shows the income that the practice can produce. In large part, this cash flow is the “goodwill” of the practice, meaning it represents the reliable income stream associated with the practice as a business. From this amount, a buyer can subtract the cost to replace you and possibly the cost to convert to electronic records, which gives a net EBITDA. The net EBITDA will represent the return on the buyer’s investment. If your practice produces $100,000 net EBITDA annually, asking a purchase price of $1 million, means the buyer must wait five years before showing a return on its investment, ignoring possible economies of scale the buyer can add to the practice.

Beware of hospital system buyers

Unless your practice is in high demand, the hospital buyer will often offer the least amount for your practice. This shortfall is attributable to their penchant to hide behind the Stark Law and erroneously conclude the hospital cannot offer a payment for your practice’s goodwill. It is true that the hospital cannot legally offer a purchase price based on your prior referrals to the hospital, but it is entirely legal to pay for the goodwill of your practice, as explained above, the recurring net EBITDA. Unfortunately, a history of sales to hospitals shows the hospital’s appraiser values the “hard” assets and possibly the value of a reduction in physician compensation, but there is no value attached to the goodwill of the practice—the recurring net revenue associated with it. Other non-physician buyers do not have the Stark Law concerns of a hospital system.

Payment Terms

Of course, you would like to receive the purchase in a lump sum at closing. On the other hand, the buyer will want to temper the risk associated with the possible future loss of recurring revenue by paying the purchase price in installments over three to five years. The deferred payments may also be contingent on the practice sustaining a level of annual revenue to earn the deferred payment, i.e., a milestone.

Management Companies

Management companies offer more complex payment terms designed to leverage the purchase price and to tie the practice to the management company. In this purchase arrangement, a portion of the purchase price, twenty percent is not uncommon, is reinvested into shares of the management company. The reinvestment leverages the purchase price since it is not paid and the risk of eventually monetizing the investment is deferred. These offers can be facially attractive with the promise of a potential IPO, but the details of the agreements gov-

erning the management company often show that the investment can be deflated upon separation, e.g., death, cessation of practice. Moreover, the investment is subject to exclusive control of the company’s management as well as the management of the PE fund backing the management company. In sum, the date when your reinvested purchase price will become money in your pocket cannot be predicted with any certainty.

Post-Sale Retention

Buyers are aware of your motivation to retire from active practice. However, they want your patients to stick with the purchased practice to sustain its ongoing value. They secure patient linkage by requiring the selling physician to remain with the practice, typically up to three years but sometimes as short as one year. The terms of your retention are negotiable. Your post-sale involvement can be at a reduced level compared to before the sale. You can also negotiate a requirement that the buyer immediately look for your replacement.

Concurrent with the sale, you will enter into a new employment agreement with the buyer or its affiliated entity that may legally employ physicians. The terms of this employment agreement will be rigorous, which is to say one-sided in favor of the employer. Your compensation under the new employment agreement will influence the purchase price and vise versa. In other words, if your compensation is less, then the net EBITDA will be higher and justify a higher purchase price. You may also ask for incentive compensation for achieving productivity thresholds.

Non-Compete

You can expect a rigorous non-compete covenant. Both your selling entity and you individually will agree not to compete with the practice after its sale to the buyer for five years. In addition, your personal noncompete will continue an additional two years after the end of your services. In other words, if you continue working for the buyer for five years and then quit, you will still have two years you cannot compete, for a total of seven years. The duration and restricted territory of non-competes must be reasonable to be enforceable. The reasonable duration associated with the sale of a practice is generally five years and the restricted territory is a radius of fifteen to thirty miles from the practice’s location or locations. If you truly plan to retire, the terms of the non-compete become less of a concern. However, you should ask for “carveouts” to permit you to act as a locum tenens or a part-time faculty or VA clinician.

Taxation

Your CPA will be able to estimate the amount of taxes that must be paid on the proceeds of the sale of the practice. These taxes can vary widely if you own the practice in an entity. The buyer will buy the assets of the entity and not the ownership interests, e.g., stock or PLLC interests. The purchase price will be allocated to the assets purchased in a descending order of priority prescribed by IRS rules. Under these rules, the accounts receivable and hard assets are allocated an amount of the purchase price equal to their fair market value. The remaining purchase price will be allocated to goodwill and the non-compete. If the selling entity is a C corporation, it will pay corporate tax on the gain recognized from the sale and the remaining amount distributed to you will be a taxable dividend. The impact of this “double taxation” can be minimized by selling personal goodwill associated with you.

Conclusion

Plan not for just the date you retire but for the sale of your practice. It takes a team of advisors to assist you and an execution plan with defined objectives that includes prospective buyer identification and pricing guidance.

Mike Kreager is a San Antonio business attorney at Kreager Mitchell. He has represented physicians and physician practices for over forty years and has advised on practice sales to all types of buyers. His last book “What’s My Practice Worth? A Comprehensive Guide to Practice Valuations and Sales” was published by the Texas Medical Association in 2016. Kreager Mitchell is a Gold Sponsor of the BCMS Circle of Friends Program.