Balance The Risks With These Suggestions
When it comes to selling a medical practice, there are basically two different kinds of payment arrangements: Lump Sum Payments and Installments.
In most cases, the two are mixed in some fashion.
There are also earn-out and stock swap deals, which we’ll touch on at the end of this article, but let’s stick to what’s most common for now.
Two Types of Payments
A lump sum payment, in the purest form, means that the buyer is paying for the whole cost, the whole price of the business, all at once at closing.
For most sellers, this is the dream scenario, not having to be concerned about getting the full payout for the business over time. Getting paid all of the total up-front is so desirable that, if your buyer is even considering it, the allure may be incentive enough to reduce the total price of the practice in exchange for getting the money all at once.
A more common and more realistic expectation for most of us is that the buyer will pay a down-payment due at closing in the form of an account transfer or cashier’s check, and pay the rest in installments, with interest, over time.
Regardless of the situation, the truth is that installment payments are inherently risky, as, until you have all of the money in-hand, there always exists the risk that the buyer could walk away before the payment period is over.
In order to balance the risks of installment payments, there are many things you can consider doing before the sale and as part of your sales contract. What follows are some of our most important recommendations.
Before The Sales Contract
Get a personal guarantee
If the buyer of your medical practice is a corporate entity (LLC, S-Corp, C-Corp, etc.), it may be that their corporation was just formed to buy your practice or otherwise doesn’t have a lot of resources or history behind it. In this situation, in addition to having the corporate officer signing the installment agreement in your sales contract, you should also have it personally guaranteed (signed) by the individual seller. In many instances, this is the same person, but it would show up on the contract as two separate signature lines.
Get a credit report on the buyer and their mate
This is what any lender would normally do, and you should as well. A credit report will allow you to get a sense of someone’s history of paying their debts, and will give you a snapshot of what your future may look like when you’re holding the bag. Say no to anyone with a funky credit history!
For more on how to obtain someone’s credit report, check out this simple article.
Get personal financial statements and/or the last few months of bank statements to prove that the buyer not only has the funds to pay the down payment, but also has reserves to keep them and their family in the black after the sale.
Get a third-party guarantee
If the buyer doesn’t have a lot of assets to back them up, you may wish to have them find a third-party. This is also something banks frequently do, get a co-borrower. In this case it may be someone with a lot more assets, such as a parent or relative, a spouse, or even a friend. Someone who is willing to sign on the dotted line such that, if your buyer defaults, the third-party’s ass(ets) are on the line.
One note here: Just as you are checking out the credit and financial history of the buyer, you should also obtain a credit report and financial statement from the guarantor.
Keep a legal interest in the business
This means the buyer doesn’t really own the business until all payments are made. In the mean time, if they default in their payments, you can have it written into your sales agreement that you can repossess the practice if they fail to pay. You see this all the time when financing a car or a house: If you fail to pay, the bank can repossess the asset, even if you’ve paid off 90% of it.
To make the repo option legally binding, most states will have you file a Uniform Commercial Code (UCC) financing statement with the Secretary of State. Check your Secretary of State’s website page for details on how to get and file a UCC in your state.
Use an acceleration clause
Putting this clause in your Promissory Note (the part of your sales contract that relates to the installment payments) means that, if the buyer does not make a payment (or a certain number of payments) on time, the whole unpaid balance of the Note is immediately due. This should help motivate a buyer to keep abreast of their payment responsibilities, especially if you have also taken the precautions listed above.
Put the fees on the other party
You can also add a clause to your Promissory Note that, if they fail to pay, the cost of your needing to collect from them (including collection agents, attorneys’ fees, etc.) falls on them. Though of course, if they have no more assets and that’s why they stopped paying, you may still be stuck with a bill!
In The Sales Contract...
Go for as large a down payment as possible
The larger the down payment, the less the remaining monthly payments will be, and the more commitment the buyer is showing to purchase the practice.
Be sure to charge interest
You’re not getting the full use of the financial value of your medical practice as long as it is being paid off, so it makes sense that you would charge interest.
You should charge interest regardless of whom you are selling to, even family. This also makes the buyer more motivated to pay you earlier to avoid interest.
The amount of each payment, with interest, is simply the amount remaining after the down payment + interest.
Amortization calculators are available online to help you out with this. Check this one out.
Make the payoff time at or under five years
Two to three years is preferable. The longer the payment period, the higher the risk. That said, it needs to be realistic for the buyer such that their profits will easily be able to accommodate that monthly payment.
No pre-payment penalty
If the buyer wants to pay you out early, more power to them (and you)! Again, less risk, more up-front reward.
Give your buyer a runway
Make the first payment due one or two months after they’ve taken over the business so they have some time to gather financial momentum.
This strategy can also be a card you hold in the pre-sale contract negotiations. They want something from you, and you may refuse or reduce their demand in exchange for the opportunity to have their first payments due a few months after they start running the business.
A Note on Earn-out and Stock-swap Deals
This is when a buyer with little money offers to pay the seller back for the price of the medical practice over time as they earn money, based on their volume in most cases. We see this a lot with small acupuncture practices and sellers who are desperate to sell. They’ll take a small down payment and then, say, $30 per patient seen per month.
There are three problems inherent in these types of arrangements. They include:
1. They're illegal. Sorry, but it's true. An arrangement where a practitioner is paid based on volume (per patient) is *not* legal. People do it anyway, but I advise my clients not to, as I don't want them to be exposed to a potential lawsuit (and because I don't want to incur the wrath of my wife, a high-powered contracts attorney).
Most states have provisions against these arrangements, and the federal government has the Stark Provisions, or Physicians Self-Referral Law. Here's an example from the California Business & Professions Code Section 650(a):
“… [The offer, delivery, receipt, or acceptance by any person licensed under this division or the Chiropractic Initiative Act of any rebate, refund, commission, preference, patronage, dividend, discount, or other consideration, whether in the form of money or otherwise, as compensation or inducement for referring patients, clients, or customers to any person, irrespective of any membership, proprietary interest, or coownership in or with any person to whom these patients, clients, or customers are referred is unlawful.”
Unlike federal anti-kickback law, this provision applies to “any person licensed” (as a healthcare licensee); however, there are other provisions under California law that mirror this basic anti-kickback provision and are broader, sometimes more specific.
You can sell a "patient list," but you certainly can't call it that, as that is not legal, either. Patient files, by federal law, belong to the patients, not the practitioner. The practitioner is simply the legal custodian of those records. What you can do is sell and transfer a practice's "goodwill," and make the custodianship of said records part of that transaction, so long as the sale is not based on the number of records or patient visits.
So how do you calculate the value of those "records?" We do it by looking at average annual net profit (adding back the obvious non-clinical write-offs). See our article on valuations for more on this.
Once exception here is that, say the practitioner is paying your company a fee for management and marketing, and this fee is *not* based on the number or value of patients referred, then it's ok (it's not considered a kickback or fee-splitting.) And under California law (and most other states), that fee can be based on a percentage of gross revenue. For example, the medical practice has gross revenues of a million dollars a year, and pays the selling practitioner 10% of its gross revenues on a monthly basis for management and marketing services until the total paid = $100k. That's the work-around we often see when a healthcare organization wants to buy an individual practice (most often with MDs). They call themselves a "managed care organization" and will pay the seller a monthly or annual fee, a percentage of revenue, but again, this canNOT be tied to a patient-by-patient tally.
Again, though it is not strictly legal to be paid on a patient-by-patient basis to refer out or sell a practice, that doesn't mean people don't do it anyway. But if you decide to do it when you sell your practice, and the buyer stops paying, good luck going after them in court or otherwise. Your complaint will be tossed out (and both parties may be fined or sanctioned and/or lose their licenses depending on jurisdiction).
2. Trust. As a buyer you have to trust that the amount of patient visits you are being paid for are accurate.
3. The buyer may fly the practice into the ground. No patients means no earn-out.
Occasionally a business will buy another business and will be paid in stock of the buyer’s business. We’d say, unless the stock the seller is offering is already public (on the stock exchange) and from an established company, say no. You may be left with nothing.
There are many ways of looking into how to buy or sell a medical practice, and hashing out the details of the payment arrangements are a key part of the sale.
We hope this information is helpful. At the same time, we’d love to talk about your individual situation. Contact when you’re ready and we’ll get on a free call to talk about it.
The Mandatory Disclaimer
It is important that you consult a CPA and a good attorney before making a final decision on how you transfer the business. The advice we give here is based on our knowledge and experience, but we’re not CPAs or attorneys, and we want you to know that.
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