Partnership as an Exit Strategy

How it can help smooth the transition from practice owner to seller

By Bill Nolan

Whether you are 35 and have been in practice for a decade or you're 65 and have practiced for 40 years, you must face the same decision and plan for a timely exit from your practice. All small business owners know that at some point they will want to leave their business and enjoy the fruits of their labor in retirement.

In optometry, many doctors see bringing in a partner as both a viable alternative to solo practice and a good exit strategy.

COLLIDING FACTORS

For many years, most optometrists who graduated from school in the mid-60s or before have believed and were taught that their practice would be a substantial part of their retirement portfolio.

As practice values have declined over the years and the cost of optometric education for young doctors has skyrocketed, selling a practice is not easy. These two factors have collided at a time when most optometrists are planning on a return on capital and the investment of proceeds from the practice sale to help fund or supplement their retirement.

Over the years, most optometrists have invested large sums of money in the capital assets of a practice. Ophthalmic equipment, computers, and leasehold improvements on a facility are all expensive.

Any financial manager must decide on the appropriate use of capital in a business. No matter how large or small the business, available capital is not unlimited. In making a decision to allocate resources, management must decide and gauge the return on investment that can be anticipated from the expenditure.

For example, it would make no sense to invest $50,000 in new ophthalmic capital assets if management could not anticipate an income stream from those assets. The ability to generate income and make the business profitable is a big part of solid financial management.

TIME FRAME

Generally, exit strategy is not complicated, but must be thought through and carefully planned in order to reduce stress and maximize return on investment. There are several factors in planning for an exit strategy.

First and foremost, what is the time frame for the transition out of the practice? This is a very personal and often very emotional issue.

There are many factors that go into making this decision, not the least of which is how individuals have planned for their retirement. Once the decision to leave full-time practice has been made, implementing an exit strategy to bring in an associate doctor or sell the practice outright should move forward.

THREE IMPORTANT ISSUES

An associate doctor is the logical step in making a smooth transition from practice owner to practice seller. That being said, taking a partner in the practice may be the biggest decision an owner makes outside of buying or starting a practice in the first place.

Whether a doctor is in solo practice or in a multiple-doctor partnership, there are three issues that need to be considered. I often describe this process as a “three-legged milk stool.” The three legs of the stool are:

■ Appraised value of the practice.
■ Terms and conditions of the partnership.
■ Compensation formula used for the partners.

Just like a three-legged milk stool with a missing leg that will cause it to tip over and not function, a partnership must work through these three issues successfully in order to function effectively for all.

APPRAISING VALUE

Regardless of an outright sale or a transition of ownership from one doctor to another, an appraisal of the practice value is necessary. All questions of forming a good partnership will be premised on one thing: the determination of practice value.

Whether taking in an associate doctor as a new partner or selling ownership interest to the remaining partners, negotiation for the sale of a practice starts with determination of value. It is very difficult to discuss terms or conditions of sale or compensation without first having established the value of the business entity.

An optometric practice is like any business. It is worth a combination of only two things: the assets and earnings. It might be helpful to have a common understanding of what optometric assets and earnings really represent.

Assets can be either tangible or intangible. Tangibles would include things like ophthalmic equipment, computers, frame inventory, contact lens inventory, furnishings, and supplies. Examples of intangible assets would be goodwill, a covenant not to compete, etc. (See sidebar above on how to value hard assets.)

TERMS OF THE PARTNERSHIP

Once value has been determined, buyer and seller can sit down to negotiate the specific terms of the transaction. Terms include things such as financing options, covenant not to compete, compensation arrangements, etc.

In structuring a purchase agreement to buy an optometric practice, the terms vary greatly because of the needs of the doctors involved. No two contracts are the same, though there are some general principles and guidelines that apply to everyone (see above for Terms and Conditions sidebar).

COMPENSATION FORMULA

The most difficult of the three legs of the stool is compensation. This is most challenging in the formation of a new partnership, as opposed to one that is already a multiple-doctor partnership.

If a doctor has been in solo practice his or her entire career, compensation has been easy and straightforward. At the end of each month or each quarter, the sole owner is entitled to all the money left in the checking account after the operating expenses have been paid.

Additionally, the sole owner of the business can use discretion as to what personal expenses can be run through the business.

Once a partner is brought in, however, the method of compensation for that partner or partners needs to be determined and incorporated into the partnership or shareholders (if a corporation) agreement. This change can be challenging for any doctor who has had great flexibility in determining how money is spent in the office.

The ideas on compensation have changed a great deal over the years.

■ STRAIGHT PRODUCTION MODEL. Historically, most partners paid themselves on a straight production basis. In this model, the overhead of the practice and the cost of goods of each partner are paid; and whatever cash flow is left is distributed to each doctor on a production basis.

The difficulty with this model is bringing into the partnership a new, young associate who doesn't have enough production to both support his or her student loan debt and the debt to pay into the practice.

■ EQUITY + PRODUCTION. The preferred model of compensation is a model that allocates some percentage of net income to be distributed based on equity or ownership, as well as some percentage of net income to be distributed based on production. This type of compensation is a big help to a new, young graduate because the ownership percentage can fund most if not all the debt to pay into the partnership and the production split can be used to live on.

Partnership is not a mode of practice for every optometrist, but when it is structured correctly, it will be both professionally and financially rewarding for all. EB

Bill Nolan is a vice president at Williams Group, headquartered in Lincoln, Neb.