When should you offer equity to associate doctors? How can you determine the fair market value of your practice? For many practice owners, bringing on new associate doctors can propel growth and serve as a future exit strategy. However, keeping associate doctors engaged in your practice can be difficult without offering a financial incentive.
In this article, we’ll explore buy-in and buy-out arrangements, including reasons why you should consider offering equity to associate doctors, how to determine a fair price, common payment structures, and the legal and tax implications.
What are Buy-In and Buy-Out Arrangements?
Buy-in and buy-out arrangements facilitate a practice’s ownership transfer from an existing partner to a new partner. A new associate doctor will “buy-in” to a practice by purchasing a percentage of the practice’s value. Alternatively, an existing doctor may choose to “buy-out” and exit the practice.
Three Reasons to Offer Equity to Associate Doctors
Offering equity to associate doctors can be a great way to solidify the future of your practice. For one, there has been a significant decline in physicians working in private practices. In 2012, 60.1% of physicians worked in private practices; whereas now, only 42.2% remained as of 2024. Offering equity can improve retention efforts, especially among young doctors who may be more likely to move on to better opportunities.
Additionally, offering equity aligns actions with practice goals. When associates own a portion of the practice, they will be more motivated to improve revenue, control costs, and seek higher patient care standards.
Third, offering associate doctors equity can help unlock smooth succession planning. As senior partners begin to look toward retirement, it’s important to have young doctors to take over patients. Improper planning can lead to abrupt practice closure or needing to sell to private equity or a large corporate entity.
How to Determine a Fair Price
Determining a fair buy-in and buy-out price is a key decision when structuring deals. There are numerous valuation methods, but here are the three most common methods:
- Independent Appraisal – This method brings in a certified business valuator to assign the practice a fair market value.
- Earnings Multiple – Multiplying EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) by a business multiple is a straightforward way to determine the practice’s value.
- Book Value – Subtracting total liabilities from total tangible assets is a simple way to find the book value; however, this method doesn’t take into consideration factors that can increase fair value, like intellectual property or client relationships.
Structuring Payments and Financing
Whether a new doctor is buying in or the practice is buying out an existing partner, the payment structure matters. If the doctor has enough cash, they can make a lump sum payment to buy into the practice. Lump sum payments aren’t very common due to the upfront financial obligation. Instead, a phased-in approach or financing is much more common. A phased-in approach allows a new doctor to gradually acquire equity in the practice over the course of a few years. As the new doctor gains equity, an existing partner may slowly reduce their ownership percentage.
Another common financing avenue is seller financing. In a seller financing transaction, the exiting doctor becomes the lender. The new doctor makes payments to the exiting doctor based on a predetermined schedule. For example, an agreement might require a $200,000 buy-in. Instead of making a lump sum payment, the new doctor pays $25,000 for the next eight years plus interest to the exiting doctor. Seller financing is a great alternative to requiring the associate to take out an outside loan.
Legal Documentation Required for Buy-In and Buy-Out Agreements
Buy-in and buy-out arrangements are formal shifts in ownership. As a result, they require the necessary legal documentation for both sellers and buyers, as there are many items to consider as partners. Here is a short list of legal documents that may be required:
- Updated shareholder or partnership agreement that includes the new associate and removes any exiting doctors
- Buy-sell agreement that outlines all of the terms of the deal, including repayment periods and buy-in or buy-out values
- Non-compete agreements for any exiting partners
- Employment and deferred compensation agreements
- Promissory notes for any seller financing
- Updated real estate leases or title transfers
Buy-in and buy-out agreements can be very complex, which is why it’s important to work with a team of experts, including attorneys and accountants.
Key Tax Implications of Buy-In and Buy-Out Arrangements
Since buy-in and buy-out arrangements transfer ownership, there can be tax implications. The value that the new associate buys in is considered their basis in the practice. Their basis will determine future tax implications for distributions and any exits.
Doctors that are exiting the practice will have more tax implications, especially based on the sale method. The buy-out price may be taxable depending on the partner’s basis in the company (everything they’ve earned, contributed, and distributed during their ownership). Let’s say that a doctor receives $500,000 for their ownership. They have a basis of $200,000. As a result, $300,000 would be a taxable gain.
One of the reasons that many exiting doctors like seller financing is because it can spread out the gain on sale and lower their potential capital gains taxes. Using the above example, let’s say that the doctor agrees to a 10-year seller financing deal. Instead of reporting the $300,000 gain in the year of the sale, the doctor will only report $30,000, potentially unlocking 0% capital gains tax rates instead of 20%. It is important to note that any interest received from seller financing is taxable.
Oftentimes, we will see another version of a seller-financed sale, in which the doctor selling a portion of their ownership to another doctor will finance the sale through the annual profits of the business. As owners, profits are shared amongst each other, but a structured shift in profit from the buyer to the seller is a way to finance this. This creates an increase in ordinary income for the selling doctor, but decreases the ordinary income for the buyer, which is certainly very favorable tax-wise for the buyer.
Planning for Smooth Transitions
Regardless of whether a new doctor is buying into the practice or a senior doctor is leaving, ownership changes can send ripples through your team if not handled properly. Ensure everyone on your team stays informed and find ways to maintain morale. If you have any questions about buy-in vs buy-out agreements and how to structure a fair deal with associate doctors, please contact us.