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ON COVENANTS FOR THE SALE OF A MEDICAL PRACTICE

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And … Medical Practice Good Will

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[By Dr. Charles F. Fenton III JD PC]

© iMBA Inc. All rights reserved. USA.

***

Good will should be protected in a sale of a practice because much of the value of such a practice is encompassed by the element of good will.  A medical  practice may include a building or suite of offices, either owned or leased; the equipment, furniture, and supplies on hand, records of patients, and other financial interests.

Propensity of existing patients

But, the biggest value of a practice is the propensity of existing patients to come to that location for medical services; and more recently, inclusion in insurance, hospital or third party provider networks.  The good will has been created by the practitioners who have provided those services in the past.  To the extent that patients have liked Dr. Washington and have been satisfied with his medical treatment, they will tend to come to his office after Dr. Adams has acquired the practice.  A large part of what Dr. Adams has paid for is the likelihood of transfer of that patient loyalty from Dr. Washington to him.

A necessary part of the sale of the practice then is a commitment from Dr. Washington not to compete with Dr. Adams in that location or nearby for some reasonable amount of time.  If Dr. Adams were not to require such a commitment from Dr. Washington, Dr. Washington would be free to open a new office across the street from the old one and attract the patients who were loyal to him in the old office to come to the new office.  Unless Dr. Adams only bargained for some second-hand equipment and shop-worn office space, he would not have gotten the good will he paid for.

Covenants not to compete

Covenants not to compete which are incident to the sale of a practice are favored by the law, almost universally enforced, and play a logical and necessary part of the sale or transfer of good will.  Disputes and litigation over these covenants arise when the seller tries to find a way to get around the commitment.

Example:

For example, “Yes, I signed the covenant not to compete with Dr. Adams, but my wife, Dr. Martha Washington did not.  She can start up a competing practice across the street from the old office.  She doesn’t use the business name “Washington Internal Medicine Associates” that I sold to Dr. Adams; she uses “Dr. M. Washington Internal Medicine, P.C.”  I don’t practice medicine in any way at her office; I just sit out in the waiting room and drink coffee and chat with the patients.”

***

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Reasonable terms

Sellers who try such tactics usually lose. In negotiating the sale of a practice, either as seller or buyer, use an attorney who is expert in the area of covenants not to compete.  Don’t use a real estate lawyer, your tax attorney, or your divorce attorney!  Don’t use your brother’s former college roommate just because he would do it cheap!  You would never have a psychiatrist set your broken leg; so pay for the appropriate specialist.  Make sure that the terms of the covenant are reasonable.  A covenant whose terms are draconian may be voided by a court, leaving the purchaser with no protection at all.

More:

  1. Restrictive Medical Practice Covenants
  2. Regarding Hospital Security and Financial Covenants
  3. Establishing Your Medical Practice’s Fair Market Value

Assessment

With HMOs and the various managed care initiatives, ACOs, and PP-ACA with “skinny networks”- is good will still as important as it was in the FFS past?

Even More:

Conclusion

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Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

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[PHYSICIAN FOCUSED FINANCIAL PLANNING AND RISK MANAGEMENT COMPANION TEXTBOOK SET]

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[Dr. Cappiello PhD MBA] *** [Foreword Dr. Krieger MD MBA]

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2 Responses

  1. New CMS Rules Could Make it Harder for Practices to Sell

    CMS reimbursement rules, along with the moratorium on physician-owned hospitals, has driven the growth in procedures performed outside the hospital setting, such as ambulatory surgery centers (ASCs). According to the Agency for Healthcare Research and Quality, for example, in 1980, only 16 percent of surgical procedures were performed outside of a hospital. In 2007, this number had grown to 57.7 percent. This circumstance was unquestionably financially devastating to hospitals and in order to assist hospitals, CMS developed reimbursement rules which pay more to hospital-based outpatient departments (HOPDs).

    Beginning Jan. 1, 2017, most services furnished at newly created or acquired non-provider based HOPDs will be reimbursed under the Medicare Physician Fee Schedule (MPFS) or Ambulatory Surgical Center Fee Schedule (ASCFS), both of which are not as lucrative as the current Hospital Outpatient Prospective Payment System (OPPS) under which most HOPD services are currently reimbursed. While the new Act reduces the payments to future HOPDs that do not qualify as on-campus or provider-based entities, it grandfathers in existing HOPDs. This has encouraged hospitals to buy-up physician practices at a blinding pace. However, the Act also eliminates a lucrative method of obtaining higher payments for most outpatient services delivered in the HOPD setting, potentially decreasing a practice’s value to hospitals seeking to acquire the practice.

    Source: Martin Merritt, Physicians Practice [5/31/16]

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  2. On Sale / Leasebacks

    Not long ago the Rapid City Journal did an excellent two-part series on the 1986 sale/leaseback by the State of South Dakota of many of its government buildings. The proceeds of the sale/leaseback put a total of $29 million into infrastructure improvement over several years, with no cost to taxpayers. It was described by then-governor Bill Janklow as “making money out of nothing.”

    While the transaction was viewed by many people as confusing, it really isn’t that difficult to understand. Sale/leasebacks have been a tool used by owners of real estate for decades, and the concept is not terribly complicated.

    Basically a sale/leaseback is a transaction where the owner of a property sells it to a buyer, then immediately leases the property back from the buyer. The seller, rather than moving out, stays in the building and rents the premises from the new owner.

    The seller ends up with cash and gets to stay in the building for the term of the lease. The tradeoff is that the seller now becomes a tenant. The buyer ends up with a building, a tenant (typically a long-term tenant), and income in the form of rent payments.

    Why would a seller and a buyer want to do a sale leaseback? There are many potential advantages and disadvantages on both sides.

    One reason is that the seller has a greater need for cash than for real estate. Perhaps they can use the cash in their business. Perhaps they can purchase a different asset at a significant discount, thus receiving a higher return that owning the real estate. Selling may also be a way to lock in high real estate values in anticipation of a real estate crash.

    For the buyer, the purchase may serve as an investment opportunity that comes with a tenant already in place, eliminating the risk of letting a building set vacant for months while searching for a new tenant.

    This is basically what the State of South Dakota did. It sold 118 buildings to investors, who then leased back the buildings to the state under an agreement where the state was obliged to buy the buildings back in 30 years. This is called a “lease/purchase,” where the buyer has either an option or obligation to purchase the property during the term of the lease. The state invested just enough cash from the sale to produce sufficient return to pay the rent on the buildings for 30 years and fund the repurchase. When that was said and done, the state had $12 million left over.

    The main factor that made this work was that the state was able to invest the money at a higher return than the cost of leasing back the property. Had the cost of leasing back been greater than the return the state could get on the sale proceeds, this would not have worked as the state would have lost money.

    Additional benefits a seller may realize from a sale/leaseback are tax advantages. For one thing, lease payments are 100% deductible. Or perhaps a seller may have large business losses that can be used to offset a large gain from selling their real estate. It’s a way to benefit from the unfortunate loss at the same time gaining money to put back into the business. The funds can be used for any purpose the business may have, including investing the proceeds to fund a lease/purchase as South Dakota did.

    While the details of a particular sale/leaseback may be complex, the basic purpose is straightforward. It’s a way to use a real estate asset to provide business benefits to both parties.

    Rick Kahler CFP

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