Forming A Group Practice Part 2: Allocating Income and Expenses
Often, the biggest sources of tension in forming and operating a practice revolve around money. Even when you go into business with good friends, resentment can build when one of your partners is perceived to not be pulling his weight, or taking too much out of the practice. Left unchecked, these resentments can become toxic and can destroy a practice. The best remedy for this is to have a frank discussion before the practice is formed, to determine what each partner intends to bring to the table, how expenses can be controlled, and how disputes can be resolved before they become distractions or worse.
Arizona law allows for considerable flexibility in how partners, shareholders and members create their practice entities. The following are some options to consider when preparing the shareholder agreement to divide the revenue and expenses.
Option 1: Equal Distribution
The easiest way to apportion income and expenses is to simply divide them evenly, and distribute the profits among the partners in the practice. When drafting the shareholder agreement, it would provide that all of the revenue would be pooled, all of the expenses paid out of that pooled revenue, and the remainder would be equally divided among all of the partners. This is the default rule under Arizona law when all of the partners have an equal ownership percentage.[1]
Although this is logistically easy, it may be unfair, as one partner’s portion of the practice, especially if it is a multidisciplinary practice, may carry with it substantially more overhead. Additionally, if one partner has a significantly larger client base, or works substantially more hours, this may provide an unintended benefit to the other partner.
Option 2: Percent of Collections/Pro Rata Share of Expenses
If you anticipate that there might be discrepancies in the amount of patients seen or the work done for patients, you can also choose to apportion the income based on a percentage of the collections. Under this approach, the doctors typically, but not necessarily, take a small set salary and then take an agreed-upon percentage of their collections, usually between 30 and 40%.
With respect to the distribution of the remaining profits of the practice, you and your partners can simply agree to divide them evenly, or based on the total percentage of work done by each partner. Therefore, if one partner is responsible for 60% of the collections, and the other is responsible for 40%, you can decide to split the profits evenly, or the partner who is responsible for 60% of the collections could also be allocated 60% of the net profit.
Another factor to consider is whether there needs to be any special allocation of expenses. If all of the partners are providing the same services to the clients, such as in a general dental practice or internal medicine practice, expenses are typically not separately allocated. Instead, the overall net profit, after all of the practice’s expenses are deducted, is distributed according to whatever formula the partners choose.
However, if the practice is multidisciplinary, or there is one partner or group of partners who incur a disproportionate share of expenses, those expenses are usually specially allocated to those partners. For example, if only some partners in a medical practice provide epidural steroid injections using fluoroscopy equipment that costs tens or hundreds of thousands of dollars, the partnership may allocate that expense specifically to the partners who use that equipment. Since the partners who use the fluoroscopy equipment are paid based on a percentage of their collections, they can presumably collect more through their use of the fluoroscopy machine than the partners who do not use it, and thus it would be fair that those doctors should also shoulder more of the cost.
Option 3: Pre-Set Allocations
Another option doctors can use when setting up partnership agreements is to allocate a set amount of the profit to each partner from the outset. This typically works best in situations in which a sole owner is bringing on a new partner, often an associate who is already working within the practice, and can also be a useful tool to transition a doctor who is looking at retiring in a predetermined number of years without having to go through a formal asset purchase agreement.
For example, if a doctor wants to retire in four years and brings on an associate, the existing owner could agree that the associate will have a 20% ownership interest and get 20% of the profit in the first year, moving up to 40% in the second year, 60% in the third year, 80% in the fourth year and 100% of the ownership and profits thereafter. This allows a smooth transition out of practice for the retiring doctor and a smooth transition into the challenges of operating a medical practice for the incoming doctor.
You have a multitude of options in deciding how to allocate the income and expenses of the practice. There are also other economic issues you need to consider when starting or merging practices, such as whether to personally invest your money versus opening a line of credit, whether to lease, finance or buy equipment, and where and under what terms you want to lease the office space for the practice.
However, perhaps the most important consideration when making these decisions is to consult with an experienced healthcare attorney early on in the process so that you and your partners can document what each party’s obligations and expectations should be going in to the practice.
[1] A.R.S. § 29-709; § 29-1031.