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Different Structures – Varying Methods

[By Lawrence E. Howes; CFP™]

[By Joel B. Javer; CFP™]

All medical practice and other business agreements that dictate what happens to a physician’s property should be addressed in what is called a buy-sell agreement.  

Definition 

A buy-sell agreement stipulates what would happen to your practice should you die, become disabled, leave, or wish to retire.  The agreement states that your partner or partners will buy your interest upon your death and stipulates that your estate will sell your interest.  It is a binding agreement to both parties. 

The agreement will have a valuation method, which might be a stated fixed price, or a formula.   If a fixed price is selected, then a procedure should be in place to assure at least an annual revaluation of the practice. Economic formulas provide a better ongoing representation of the value of the practice.   

However, the dynamic healthcare environment might warrant a review of the validity of your existing formula. If the practice is valued highly – then having sufficient cash to buy out a deceased partner might be a difficult – and possibly an overwhelming financial burden.   

Varying Buy-Sell Structures 

Life insurance is commonly considered the best vehicle to provide the cash when it is needed the most, and there are a number of keys to creating a successful buy-sell agreement: 

• It must be decided who will buy the practice from the disabled proprietor or partner, or his or her heirs upon death.  It may be the remaining partner(s), or the practice entity itself, or, in the case of a sole doctor proprietor, a key physician employee.  
• The buy/sell agreement must be stipulated as mandatory.  According to the IRS, if the agreement is not mandatory, the value of the practice is not considered fixed.  As a result, the IRS might not consider the agreement binding in determining the value of the practice for estate tax purposes.
• The most important key is determining the correct value for the practice or share in question.  The IRS will rarely challenge a value for being set too high, but will challenge those deemed valued too low.   

Varying Buy-Sell Model Forms  

There are also a number of different forms of buy/sell agreements. The following is a quick overview of four different variations.

[1] Sole Proprietor Buy/Sell Agreement: 

Since a sole medical proprietor does not have a partner, other than a spouse, they usually must look elsewhere for a buyer.  Therefore, the sole proprietor is likely to turn either to a valued physician employee, a competitor to continue the business.  In this case, a life insurance policy is purchased on the life of the proprietor, and the agreement is signed between the current and the future owners providing the guidelines for the future practice transfer.  In addition to being the owner of the policy, the future doctor owner typically names him/herself beneficiary, as well.

[2] Cross Purchase Buy/Sell Agreement:

This type of buy/sell is normally used for any practice with multiple owners, although it is best used for agreements with only two owners.  In this arrangement, each owner purchases insurance on each of the others lives.  Again, the owner of each policy names him/herself beneficiary as well. Upon the death or disability of one partner, the remaining partner(s) are provided the funds to purchase a pro rata share of the deceased or disabled individual’s practice interest. 

[3] Entity Purchase Buy/Sell Agreement: 

This form is used for multiple owners, and/or when the owner(s) of the practice wants to use the assets of the business to fund the insurance policies.   In this arrangement, the practice owns the policies on each partner or shareholder, and is also listed as the beneficiary of each policy.  Upon the death or disability of the physician partner, the business would be able to purchase the shares from the disabled partner, or the deceased’s heirs. 

[4] Optional Purchase/Wait and See Buy/Sell Agreement: 

This type of agreement allows either the practice or the individual partner(s) the option of purchasing the deceased or disabled partner’s interest in the practice. Normally, if the practice does not initially exercise its option to buy within a set period, the remaining partner(s) would then have a period in which to exercise their option.  If they do not buy the outstanding interest, the practice would then be forced to purchase the shares. 

Assessment 

Often, a trusteed agreement is advisable.  It is not unusual to find situations where the practice partners work together smoothly and efficiently.  Their spouses, however, are another story.  So, in order to remove personalities from the transfer of ownership interests for money, especially at a very stressful point in their lives, it is often a good idea to let a disinterested third party (a trustee) conduct the transfer.

Example:

Dr. May has been the sole owner of The Family Physician Group, which includes six other physicians and twelve other employees, for over ten years.  He has often thought about who will continue this successful practice.  In the past month he has decided that Dr. Roy is the best candidate for the job.  She has also expressed an interest in becoming the successor to Dr. May.

As a result, they have decided to set up a trusteed sole proprietor buy/sell agreement that would provide for the smooth, mandatory, transfer of the practice in the case of the death or disability of Dr. May.  Once the practice is correctly valued, she plans to purchase a life insurance policy on the life of Dr. May, which will be owned by a third party trust, who will also be the beneficiary.  Upon the death or disability of Dr. May, the agreement is executed by the trustee and Dr. Roy becomes sole owner of The Family Physician Group.  

Conclusion

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