Last month, Rob Wade discussed four keys for getting a better employment agreement. This month, Jim Herz looks at employment negotiations that may involve a buy-in, and how to know if such an arrangement is worth the investment.
It’s the biggest career decision you’ve faced since choosing your residency: you’ve been presented with the opportunity to “buy in” and become a partner at your firm. Or maybe you have a burning desire to strike out on your own and buy a practice. In either case, the critical question you face is, “Am I getting a good deal?” Fortunately, there are some basic steps you can take on your own to evaluate the “buy-in” without spending a small fortune on an accountant.
The most logical reason to buy into a partnership is the opportunity to make more money than you would as an associate. There are non-financial benefits of course, such as more job security, greater influence in management decisions, etc. But, fundamentally, the most critical benefit is monetary. The task before you, then, is to determine how much additional money you stand to gain as an owner, and whether that gain will provide you with a reasonable return on your investment to buy in.
Step One: Determine Compensation
The first step is to develop a clear understanding of how you will be compensated. Some practices compensate their doctors purely on individual productivity, some base it on the number of shares owned by each partner and others still use a hybrid approach. If you buy a practice, you can decide your own compensation system.
When it comes to a buy-in, start by requesting the collection reports for the past three years. Also ask for three years of financial statements and tax returns for the practice. The key metrics you should be looking for in these documents is partner compensation and distributions to shareholders, which reflect what the owners are taking home.
Once you know what the other partners are earning and your overall contribution to it, you can begin to estimate what your compensation as a new partner might be. If you’re buying a practice, you can make a reasonable assumption that your compensation will be similar to the departing owner’s.
The numbers should show positive growth in partner compensation from year to year. If the numbers are trending downward, it could be a sign of trouble. Armed with this information, you can answer the most basic question of whether your buy-in makes sense, “Will I make more money as an owner than as an associate?” If the answer to this question is yes, then keep reading. If the answer is no, then it’s not a good deal and you should walk away.
Step Two: Weigh Compensation and Buy-In Costs
The next step is to determine whether your additional compensation as an owner is worth the price of the buy-in. Or put another way, “What’s my return on investment?” The second basic step, then, in evaluating your buy-in deal is to determine whether it provides a reasonable rate of return consistent with investments of similar risk.
It’s important to reiterate that your focus should be on the additional compensation, above and beyond what you would earn as an associate. After all, that’s really what you’re paying for to become a partner.
Let’s illustrate with a simple example. Assume you’re making $170,000 a year as an associate. After the buy-in, you expect your compensation as a partner will rise to $270,000. The buy-in will cost you $500,000. Based on these numbers, your compensation as a partner will be $100,000 above and beyond your compensation as an associate ($270,000 – $170,000). The price you’re being asked to pay for this extra compensation is $500,000. Therefore, your annual return on investment would be 20 percent ($100,000 / $500,000).
How do you know whether your return on investment is good enough? One useful benchmark to compare against is the stock market. Data show that the long-term average return of stocks is approximately 10 percent. Using this benchmark, the buy-in example seems reasonable, as it provides a greater return than stocks. But, keep in mind the different risk factors and other intangibles associated with each investment alternative. Stocks can be bought and sold with the click of a mouse. However, partnership buy-ins sometimes take years to sell. It could be difficult to recover your $500,000 buy-in if you ever decide to leave.
This illustrates one of the reasons why partnership investments are inherently riskier than stocks. Therefore, you should demand a much greater return from of your partnership investment than you would from the stock market.
Smart investors in partnerships tend to look for returns of at least 20 percent to 30 percent. If the buy-in deal offered to you doesn’t provide at least a 20 percent return, then you’re probably better off investing your money in the stock market. Or, alternatively, you should negotiate a lower buy-in price so that your desired return on investment becomes achievable.
In Summary
There are many ways to evaluate the financial worthiness of a buy-in deal. The method described above is but one basic test that can be performed quickly and easily by physicians who don’t have a degree in finance, and without the high cost of hiring an accountant. If the buy-in passes the two basic tests described herein, then it may be time to seek expert advice on the best way to negotiate and structure a final deal.
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About the Author: Jim Herz is a professional staff member for the Budget Committee in the U.S. House of Representatives. He and his wife, YO Editorial Board member Natasha Herz, MD, purchased an ophthalmology practice outside of Washington, DC, in 2007. Jim earned his masters in business administration from Rice University in Houston, Texas.