Legal Ramifications of Dental Practice Buy-Ins and Partnership Agreements: 5 Issues to Consider
By Ali Oromchian, JD, LL.M.
Dental practice buy-ins and the partnership agreements they often require can be challenging issues for any practice, and carry with them a number of potential problems and legal ramifications for the unprepared. Understanding the legal aspects of practice buy-ins and partnership agreements will encourage you to solve problems even before they start. Like any change to a business, preparation is key. Once you have completed your due diligence, valued the practice, and agreed upon a purchase price and financing structure, a partnership agreement will need to be agreed upon and drafted.
While this article focuses on partnership agreements, a partnership is not the only legal structure used for dental practices. Many practices use corporations with the practitioners as shareholders, due to the liability protections offered by this structure. The issues pertaining to partnership agreements discussed below are equally applicable to purchase agreements used for corporations, in terms of protecting the practice and reducing hostilities between partners or shareholders.
Here, we will examine the legal ramifications of adding partners to your practice, and provide you with guidance to make this process as smooth and painless as possible. Uncomfortable or even difficult buy-in or buyout events are easily avoidable when everyone understands the terms in advance. Confrontations arise when parties are unprepared for different scenarios which can occur during and after a buy-in. A clear purchase agreement and/or partnership agreement allows you to consider issues which could potentially strain a relationship. Here are five topics which should be addressed in any partnership agreement:
1. Allocation of Income
As discussed in Dental Economics Magazine, “The method of allocating practice profits is often the most controversial issue in the practice buy-in.” So, let’s talk about this issue first. Basically, the partnership agreement should discuss how the profits of the practice should be divided, and whether the chosen method of profit allocation will change over time. Generally, income is apportioned by performance (output, days worked), ownership, or a fixed percentage. Also, keep in mind that with income comes expenses, and decisions pertaining to expense allocations will need to be made as well. Most practices split expenses such as rent equally, while some supply expenses may be apportioned based upon production. Whatever your approach, make sure you discuss these issues ahead of time and that all oral agreements are incorporated into the partnership agreement.
From a legal perspective, addressing the income allocation prior to purchase ensures there will be no disputes down the line. If the partnership gets into details as to how income will be awarded to partners and how certain events may change allocations, then no one can complain down the line or successfully seek a legal remedy if they are unhappy with the results. A clear purchase agreement protects the practice, legally, by insulating the business from expensive and stressful disputes in the future.
2. Management Responsibilities
Adding a new partner to a business means changes not just behind the scenes, but also in the office. The partnership agreement should outline who is responsible for which tasks, pertaining to both staff and patients. Remember that one of the legal ramifications of a partnership (if this is the structure of your practice) is that each partner acts as an agent of the others. This means actions taken by one partner can be attributed to the others. Therefore, you may want to consider addressing issues such as whether partners can enter into contractual agreements without the consent of other partners, or whether decisions as to discipline and termination of staff require additional consent. What may seem like small issues now could potentially insulate your practice from liability in the future if considered in advance.
3. Buy/Sell Provisions
If you are examining the aspects of a well-written partnership agreement, then chances are you’re already thinking about the buy-in terms. These include valuing the practice and establishing how the purchase price should be financed. But anyone who is buying into a practice will also one day buy out of it. Therefore, you should kill two birds with one stone by creating a formula now which will be used in the event of a buyout. Also remember that in addition to a buyout price, you need to establish buyout terms. Will payment be made in cash, installments, or both? A good approach is to have the buyout terms mirror the buy-in terms. Therefore, if a dentist bought into a practice via a salary reduction, he or she should receive the buyout via deferred compensation.
4. Death and Disability
No one enjoys discussing the impact of a partner’s death on a practice. But discussing and addressing this possibility is an earmark of a well-crafted partnership agreement. If a partner or shareholder dentist passes away, a common requirement of an agreement would be that the practice may, but is not required to, buy the interests of the deceased, or that those interests could be purchased by an individual partner or shareholder. Some agreements may even require the spouse of an interest holder to sign a spousal agreement approving of such an arrangement. The agreement should also discuss how the purchase price of the decedent dentist’s interests shall be calculated upon sale.
Alternatively, your practice may decide that upon the death of a fellow partner, you want the spouse and family of that dentist to continue to enjoy the financial benefits of the agreement. This scenario can also be addressed in the agreement, with the partnership interests going into a trust for the benefit of the family. There is no “right” way to address the death of a partner, but the “wrong” way is not to address it at all. While this situation may be an uncomfortable one to consider, the truth is that not addressing this event in advance can lead to chaos in the event of a partner passing.
5. Restrictive Covenants
Finally, let’s discuss what happens upon the buyout or termination of a partner, in terms of competition. This is a dicey subject for many practitioners looking to create a partnership agreement for the same reason that a newly-engaged person doesn’t like to discuss prenuptial agreements. No one likes to think about what will happen when things go wrong. A recent article in DentistryIQ addressed this issue head-on, stating that “Many co-owners view the restrictive covenant negatively, but a restrictive covenant protects co-owners equally from a departing co-owner competing with the practice.” Restrictive covenants should be considered, if not included, in every practice agreement.
Restrictive covenants are one aspect of the purchase or partnership agreement which must follow legal standards. A covenant which is overbroad, vague, or unduly restrictive will simply not be enforceable. Therefore, covenants must be drafted with care by a professional to ensure enforceability. Even if your practice decides against a restrictive covenant, you still need to address issues such as how to communicate with patients and employees during and after the departure.
By addressing these issues prior to the execution of an agreement, you can reduce the legal ramifications of miscommunications or unplanned events. A well-written agreement is your best defense when it comes to protecting your practice and allowing your business to succeed.
Ali Oromchian is a dental attorney at the Dental & Medical Counsel, PC law firm and is renowned for his expertise in legal matters pertaining to dentists. Mr. Oromchian has served as a key opinion leader and legal authority in the dental industry with dental CPAs, consultants, banks, insurance brokers and dental supplies and equipment companies. He is also the author of The Strategic Dentist: An Entrepreneur’s Guide to Owning a Dental Practice.
You can contact him at 925-999-8200 or email email@example.com
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