Build a Better Buy-Sell Agreement to Protect Your Practice



Build a Better Buy-Sell Agreement to Protect Your Practice

Any medical or healthcare practice with multiple owners must have properly drawn, fully executed, and funded buy-sell agreement in place to protect the shareholders and their families from the death or exit of an owner. Not to have one in place can put your financial future in jeopardy.

What is a buy-sell agreement? Simply put, a “buy-sell agreement” is an agreement between all the owners of a practice as to how the business will continue after the death or exit of a shareholder, and how they or their family will be compensated when such an event occurs. Typically, the agreement provides for the purchase of the departing shareholder's stock by the surviving shareholders or the company itself.

The death of an owner is the most obvious and commonly addressed issue, however the disability of an owner is most likely. The buy-sell agreement should always include provisions for both the temporary disability of owner and a disability buy-out. Next on the list is the disqualification of an owner due to a criminal act, loss of license or certification, or a non-criminal act that makes them unwelcome in the practice moving forward.

A buy-sell agreement that is properly funded achieves several objectives: avoids liquidation of the business; provides orderly continuation of the business; replaces lost income for a deceased owner's heirs; set a purchase price that can fix the estate tax value of the decedent's stock; and provides evidence to clients and creditors of the firm's stability.

Here are our suggestions to safeguard your financial future, and to build a better medical practice buy-sell agreement:

1.    Don’t join a practice without one, and should you find you are already in a practice that does not have any buy-sell agreement at all, get all parties to agree to remedy the situation as soon as possible.

2.    Be sure the buy-sell agreement coverage to include all the “Ds”:

a.    Death - the practice can suffer a financial setback with a “key person” loss, made worse if the surviving shareholders have to take in a new owner practitioner, and especially if it is the deceased owner's spouse!

b.    Disability - usually poorly defined, and not funded or underfunded. A disabled shareholder would expect their salary to continue, and a share of profits. Consider if the disability was extended, how long could the practice keep paying? This should be outlined in the agreement, and the disability agreement needs to be fully funded.

c.    Departure - whether for regular retirement or early voluntary retirement, the business interest of the retiree should be purchased. The purchase price can be the same as or less than the death price (it cannot be more). A lower purchase price might be set for early termination.

d.    Divorce - an ex-spouse may end up with a portion of the business interest in their settlement, so there should be a provision in the buy-sell to have such a spouse forced to sell stock back to either the practice, original shareholder; or the other owners. Again, the price cannot be higher than the death price.

e.    Deadlock - If equal owners come to a major disagreement and the practice is unable to conduct normal operations, it may have to be liquidated.

f.    Disagreement - when ownership is unequal and there is a major disagreement, a minority shareholder might be forced out and their interest has to be purchased.

g.    Default - when individual shareholders personally guarantee corporate loans from banks and/or contribute payments to the bank or practice, a provision should exist so if a shareholder defaults, a buyout is triggered for their interest.

h.    Disqualification – in the event of a criminal or non-criminal act, or loss of license or certification, a provision should exist so a buyout would be triggered for their interest.

i.    Determination of Value (most important!) – nobody wants to over-pay for a practice. Each owner wants to be sure they or their family received fair value. Business Valuations should be required, and will fix the value in the deceased's estate for federal estate tax purposes. The value must be fair market value at the time the agreement is entered into. If appropriate life insurance is not purchased to fund the full value, then an installment purchase arrangement should be provided for the balance. Review periodically, so that when the value of the business has changed it is reflected in the agreement.
 
3.    There are two types of buy-sells, the "cross-purchase" agreement and the "stock redemption" agreement:

a.    In a "cross-purchase" agreement each shareholder buys, and is the owner and beneficiary of a life insurance policy on the other(s). Upon death, the remaining shareholder(s) receives the policy's death benefit, which is used to purchase shares from the deceased's estate. The cash payment gives the family income to offset the loss of the deceased's earnings. The premiums paid are not tax-deductible, but the benefits are generally received income-tax free. The advantage here is the surviving shareholder(s) gets a "step up" in the income tax basis for the stock bought from the deceased's estate. This could reduce income taxes if the stock is later sold. Additionally, the insurance proceeds are not subject to the corporate alternative minimum tax (AMT), nor to the claims of corporate creditors. But these plans can be hard to administer if there are many owners, and there may need to be a “trust.” Disability buy-sell insurance can also be used in a cross-purchase agreement to facilitate transfer of ownership upon the total disability of a stockholder.

b.    The “stock redemption” agreement is essentially an entity-purchase plan, where the business purchases an owner’s entire interest at an agreed upon price if a triggering event occurs. Whether life or disability insurance is used to fund the agreement, the entity itself buys and owns policies on the owners. When one dies, the entity buys the deceased’s stock with the insurance proceeds. Stock redemption plans make sense when there are multiple owners, there are large differences in age and ownership levels among the owners, or the entity is in a lower tax bracket than the owners. However, the death proceeds received may be subject to the corporate AMT, and the surviving shareholders do not get the benefit of an increase in the income tax basis of their shares when the stock is redeemed.

4.    Make sure your agreement is adequately funded with life insurance, disability, disability buy-out, and any other insurance required and that the insurance limits are reviewed every year or two and kept adequate to meet the valuation your buy-sell specifies.

5.    Failure to have a proper buy-sell may result in:

•    Having to run your practice with your partner’s spouse who knows nothing about how to run your practice, yet expects a salary and profits from the business;
•    Lawsuits;
•    Lack of consideration of related properties or entities;
•    Liquidation of personal assets for an emergency buy-out; and
•    Expenses, unintended tax consequences, delays, and interference with patient care and practice profit.
 
CONTACT US: Buy-sell agreements lay out how ownership will change hands and how the transfer will be paid for in case of a co-owner's death, disability or retirement. Too often the first time doctors or clinicians find out what they have (or don’t have) is when a crisis hits. If there is an older buy-sell agreement, best to have it reviewed and updated so all parties will be properly protected. Contact our Healthcare CPAs to identify the various issues, financial and tax considerations that will help determine what type of buy-sell agreement makes the most sense for your practice.


 

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