Practice Succession Success: Start Early

By Craig Hong, Director at Hillhouse Legal Partners
| 6 min. read

Key takeaways

  • To obtain the highest and best value for the business, you need to be able to demonstrate that you can transfer that goodwill i.e. patient and referral base.

  • You need to ensure that your practice has all the physical, accounting and legal features in place so that the buyer’s advisors can verify that what you say happens in the practice, can be demonstrated “on the ground” and in the records.
  • Well-performed practice succession requires that you take a holistic approach to the process and consider all the relevant issues, therefore we advocate choosing advisors who will communicate together.

Medical practice succession can be a daunting proposition when you have worked so long and hard to build a practice and want to ensure that it changes hands smoothly and in a fashion that enables levels of patient care and service to be best maintained and in a manner which sees you achieve maximum value. 

Too often we see Doctors who are effectively forced to “close the doors” on otherwise successful practices or sell their practice for the written down value of plant and equipment because they have left their succession planning far too late.

Generally, when someone purchases a business, they are paying for the ability to generate future revenue from that business. This is why business valuations and business sales are commonly determined based up the concept of future maintainable earnings.

Generally, the more revenue the business generates and the more confident a buyer is about that revenue continuing into the future, the more value a business will have.

Medical practices are generally strong at generating revenue, but because of the very personal nature of the work generated, it can sometimes be difficult to transfer the ability to generate that revenue into the future.

The main difficulty in obtaining a high value for a medical business is often a concern around whether there is any certainty or expectation of that revenue continuing because the goodwill of the practice can be so heavily tied to a doctor personally.

The potential buyer may not see a clear path to them being able to continue to attract the same level of patients and referrals because they may think that they are effectively tied to you personally. To obtain the highest and best value for the business, you need to be able to demonstrate that you can transfer that goodwill i.e. patient and referral base.

Once you are confident that you can pass on that goodwill and believe that you can demonstrate that to a potential buyer, you also need to ensure that your practice has all the physical, accounting and legal features in place so that the buyer’s advisors can verify that what you say happens in the practice, can be demonstrated “on the ground” and in the records. Your practice will need to stand up to third party examination in a due diligence process.

We have considered some of these critical considerations and condensed them into seven key areas. 

  1. Start early

The process of medical practice succession is not something you should commence days or months before you decide you are ready to move on or retire. Generally, it is something that should be considered as far as possible in advance so that you can plan and prepare for this critical time. A timeline of literally years is not unusual to successfully bring in new doctors, ensure patient and referral continuity, sell real property and smoothly transition out of the practice.

As discussed above, if you want to maximise the value of your business, you need to have something to sell which can produce a return into the future, generally this will either mean having a number of other doctors working in the practice who generate income which will continue independent of you or being able to effectively transfer over your own patient and referral base to another doctor so that they can continue to derive revenue from that patient and referral base.

Depending on which route is most appropriate, there may be a number of issues which need to be dealt with, including finance, premises, suppliers and patients, before you can successfully transfer control of your practice.

  1. Prepare the business

No matter which method of succession you are considering, the best method will always be to prepare the practice as though you are selling it to a third party with no prior knowledge of its operation.  

This means cleaning up and properly documenting any legacy issues that only you are aware of, ensuring that all systems and key agreements are in writing and simple to understand and putting accounts into a form that are readily understood by third party accountants. Normalisation of accounts is crucial and can take a long period of time and needs to be commenced earlier in the process than many traditionally anticipate.  

We have seen many practices that have had not had their service agreements and other key arrangements reviewed for several years (or at all), especially if everything had previously been done “in house”, so this process should be used as an opportunity to also review and modernise all agreements or implement agreements if the practice has traditionally been run with minimal or no formal documents.

This process should enable you to undertake a valuation and should ensure that anybody purchasing the practice - a family member, employees or a third party buyer - should be well placed to continue the operation smoothly.

  1. Consider the sale structure

There can be drastically different tax, duty and ongoing risk implications for both you and the transferee depending on the structure that you have in place and then whether you transfer the practice itself or transfer ownership of the entire underlying structure (such as shares in the company or control of a relevant trust). 

There are a large number of permutations and combinations and the right structure for any particular sale will not always be clear, so it is important that you obtain proper financial planning, accounting and legal advice to ensure that you adopt the best possible structure taking into account risk, tax and financial issues for your situation.

  1. Consider alternative funding structures

Often when you are transferring to family members or employees, they may not have the funds readily available to make the purchase and they may not be in a position to obtain bank finance for the full purchase price.

Even with third party buyers, you may be able to achieve a superior result by providing additional vendor finance or structuring the purchase payments over time.

There are a wide variety of options available, such as secured vendor finance, issue of different classes of shares, staged buyouts and many more that can possibly provide you with a superior result or fit better within your plans than a straight sale for cash.

However, these options are not without risk so you need to obtain prudent advice to ensure that you document these arrangements properly and that you are not exposing yourself to undue risk if a buyer does not have the capacity to pay when it is time. 

  1. Consider more than the purchase price

Sellers of practices may become blinded by an attractive initial purchase price discussed by a purchaser which, in turn, may see them reluctant to properly consider other issues such as warranty risk, earn-outs and retentions and restraints of trade. 

Obviously, the purchase price for the practice is one of the most important issues, but it is wise to properly consider all of the risk that may go along with that purchase price if it comes with significant “strings attached”. 

Some buyers may also be willing to pay a much higher price is a doctor is willing to spend some time either pre or post settlement to “bed in” key referrer and contractor arrangements, so capacity to do this should be taken into consideration.

In many instances, a seller may be better off taking a slightly lower price but with drastically reduced warranty risk and little or no earn-out requirements. Effectively, it may be better to take a “bird in the hand” instead of chasing “two in the bush” and agreeing to a high initial price with a difficult to achieve earn-out figure that would require your practice to have a very strong year or even outperform its own historical best.

  1. Document the deal properly

Even if you are transferring the practice to people you know and trust and who know and trust you, it is important that you properly document the transaction in its entirety and then undertake the transaction in accordance with those documents.  

This process will give both parties the most clarity around the transaction and should provide the most protection to the parties if they have been properly advised during the negotiation and drafting of the transaction documentation.

  1. Work with advisors who communicate

Well-performed practice succession requires that you take a holistic approach to the process and consider all the relevant issues. For that reason, we advocate choosing advisors who will communicate together to form the best overall strategy for you.  

By sitting down at first instance with all of your advisors to properly understand your current legal and tax position and align that with your financial and life goals, you stand a much better chance of having a smooth and cost-effective practice succession. 

If you would like to have a discussion about any of your future plans or any of these practice succession strategies, please do not hesitate to reach out to Craig Hong at [email protected]. We are here to help.

The information in this blog is intended only to provide a general overview and has not been prepared with a view to any particular situation or set of circumstances. It is not intended to be comprehensive nor does it constitute legal advice. While we attempt to ensure the information is current and accurate we do not guarantee its currency and accuracy. You should seek legal or other professional advice before acting or relying on any of the information in this blog as it may not be appropriate for your individual circumstances.