Succession Planning – When it’s time to hand off the keys to the practice, owners must be prepared for the transition

Contributed by Paul J. Welk

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Vol. 18 • Issue 6 • Page 14

If you’re in private practice, you’ve probably noticed more articles and information discussing ownership transition and the concept of succession planning. After all, succession planning is an eventual step in any business plan.

The demographics of physical therapy private practice clearly illustrate the need for owners to become familiar with the succession planning process. The American Physical Therapy Association’s equity task force surveyed private practice owners 3 years ago to identify who owns these businesses and determine how clinicians intend to divest their ownership interests. The survey discovered that 64 percent of private practices are solo-owned and the average age of an owner is 45.6 years.

The task force also found that 34 percent of current private practice owners had left a prior setting where there was no ownership opportunity, and only 13 percent of current owners had been an employee of the private practice prior to holding an ownership interest.

In addition, the majority of private practices had no plan to develop ownership opportunities for other employees; less than half of the owners had even considered what to do with the business when it was time to retire.

While private practitioners can consider a number of ownership transition strategies, such as selling to a clinician-owned or corporate provider, you need to be aware of key documents to consider when developing an internal succession plan. This plan should be designed to transition ownership to one or several current employees.

DEVELOPING AN EMPLOYMENT AGREEMENT

After identifying a potential candidate for future ownership through external recruiting or based on a candidate’s work history at the practice, you need to consider how an employment agreement can promote ownership succession.

A well-drafted employment agreement can promote employee retention, an essential element of internal succession. The objective of employee retention can be achieved by including disincentives for the employee to terminate the working relationship and incentives to continue the employment relationship and have a vested interest in building the practice.

Examples of common disincentives include non-competition agreements, non-solicitation provisions and confidentiality clauses, which may collectively or individually be called restrictive covenants. The enforceability of restrictive covenants depends on state law.

It’s important to review a proposed restrictive covenant with legal counsel to determine its enforceability. A non-competition agreement limits an employee from providing rehab services that compete with the current employer within a geographic area over a period of time.

A non-solicitation provision serves two purposes: to restrict the employee’s ability to solicit patients and restrict the ability to induce other employees to leave the facility and provide services in a new practice. A confidentiality clause prohibits the employee from using confidential information, such as patient lists, trade secrets and marketing concepts, other than for the benefit of the current employer.

At first glance, it may not be apparent how these disincentives promote retention and succession opportunities. Essentially, these contractual provisions restrict the ability of an employee to take the goodwill of the current practice and transfer it to a new practice or competing provider. Goodwill is the intangible, salable asset that arises from the reputation of a business and its relations with customers; it’s distinct from the value of stock and other tangible assets.

Without the ability to freely transfer the practice’s goodwill, an employee may think twice about alternate employment opportunities.

Less obvious is the fact that restrictive covenants may allow an owner to openly share proprietary information with an ownership candidate, given the reduced risk that information could be shared with a competitor.

Some clinicians may disagree with the concept of using restrictive covenants as a disincentive. However, any practice owner who has mentored a key employee, only to have that person become a competitor, is aware of the business reasons behind such contractual provisions.

From an incentive perspective, an employment agreement establishes incentives to promote employee retention. These options can include basic benefits such as vacation time, health insurance coverage, professional organization dues, continuing education funding, disability insurance, automobile allowances and tuition reimbursement programs.

In addition, an employment agreement provides a document to establish the employee’s monetary compensation package, which may consist of a base salary along with incentives or productivity bonuses. For example, an employment agreement that provides a base salary along with bonus opportunities based on clinical productivity, other benchmarks and the financial success of the practice may facilitate a mutually beneficial employee/employer relationship and promote retention. By allowing an employee to benefit from financial success of the practice, this type of compensation model incorporates some ownership characteristics, aligns goals of the owner and employee and helps determine if an employee is a good ownership candidate.

KEY TRANSFER DOCUMENTS

When it comes to ownership transfer, you must consider several key documents. A stock purchase agreement is often the main document used for the sale of an ownership interest. In the case of an internal succession plan, based on the familiarity of the parties, this document is generally simplified. When selling to an unaffiliated third party, the agreement is more complicated. A stock purchase agreement covers issues such as the number of shares to be sold, the purchase price, payment provisions and other relevant terms of the sale.

Depending on how the purchase price is paid, a promissory note evidencing the purchaser’s future payment obligations may also be necessary. When putting together a succession plan, it’s important for the seller to consider potential options for receiving payment for the transferred ownership interest. For example, should payment in full be required at the sale?

While this option may be beneficial for the seller because it eliminates the risk of having to collect outstanding money, it may not be feasible for the purchaser, especially if the purchaser is required to seek third party financing to fund the purchase.

Other payment options include a partial cash payment, with the remainder payable over time in the form of a note to the selling shareholder, or establishing a deferred compensation arrangement, where the selling shareholder receives deferred compensation following the sale. Once a sale is complete, the purchaser is generally issued a certificate, such as a stock certificate, evidencing the ownership interest.

If the private practice doesn’t already have a shareholders’ or buy-sell agreement prior to the transfer of ownership, and if there will be more than one owner, you should draw up this type of agreement. A shareholders’ agreement is between the owners and the practice and puts limits on ownership transfer. It also sets forth the terms for purchase of a withdrawing owner’s interest in the practice. For example, a shareholders’ agreement governs the process by which a retiring shareholder is required to sell his ownership interest at retirement. The shareholders’ agreement should also include the valuation process for the departing owner’s interest, payment terms for money owed to the departing owner, and restrictions as to who may and may not purchase an ownership interest in the practice.

Finally, if an employment agreement hasn’t been established prior to ownership, it’s important to consider if one should be executed at the time of purchase. An owner has open access to the practice’s proprietary information and an employment agreement with a restrictive covenant to protect the practice’s interests.

While it’s impossible to cover the numerous issues that may arise in a practice’s particular internal succession plan, there are a few important considerations that apply, regardless of the particular facts and circumstances.

First, it’s never too early to consider the options for an internal succession plan. It can take years to identify ownership candidates and complete the transfer of ownership and the payment process. Also, a well planned ownership transition may improve the financial position for all parties.

Second, the employment relationship, the transfer of ownership and the relationship among owners following a sale should be well documented. While specific paperwork may vary, it’s always better to have written documents in place for succession and ownership issues when everyone is getting along, instead of trying to deal with these issues when a dispute among owners arises.

Paul J. Welk, PT, JD, is a licensed physical therapist and attorney with Tucker Arensberg P.C. in Pittsburgh, Pa. He advises rehabilitation practices in areas of corporate and health care law, including ownership transition and succession planning matters. He can be reached at pwelk@tuckerlaw.com.