July 1996 Bulletin

Time to change buy-in, pay-out policy?

Younger orthopaedists concerned about big commitments

by Daniel M. Bernick, JD

Daniel M. Bernick, JD, is a consultant and attorney with The Health Care Group, based in Plymouth Meeting, Pa.

It may be time for your orthopaedic practice to change its buy-in and pay-out policies. In many orthopaedic group practices, younger members are raising concerns about buy-in and pay-out arrangements. Increasingly, younger orthopaedists are concerned about undertaking big-dollar commitments to the more senior members of their groups.

In orthopaedics, as in medicine generally, practices are no longer assured of a continuing stream of reimbursements, or that reimbursements will rise or even remain constant. Payers will continue to try to limit their costs of orthopaedic care by authorizing fewer procedures and insisting on lower payment amounts per procedure.

As payers ratchet down reimbursement levels-and as managed care penetration increases-younger physicians face a double-edged fear:

"Exact" method

The "exact" buy-in method is the traditional approach to buy-ins among orthopaedic practices, and is still commonly used. In this method:

Once established, the buy-in amount is "fixed in stone," regardless of practice performance during the buy-in years. The rationale is that the practice has a value, and by becoming a partner, the young doctor is buying a percentage of that value (50 percent in a two-physician practice; 33.3 percent in a three-physician practice, 25 percent in a four-physician practice). Therefore, the buyer should pay for that amount of value.

Consider flexible approach

Practices facing concerns about uncertain future income levels should consider a more flexible approach, which has preserved harmony in many practices. It reduces the young physician's income share not by a fixed number, but by a percentage of his or her full-partner income share.

This "inexact" buy-in approach recognizes the difficulty of determining goodwill value with certainty. Instead, it strives for "rough justice" in terms of the relative income shares of the younger and older doctors during the buy-in period.

Assuming the group is dividing net profits based on relative physician production, the young doctor would receive his or her production share of the net profits, discounted according to a pre-
established formula. One common method calls for discounts of 40 percent in the first year, 30 percent in the second year, 20 percent in the third year, and 10 percent in the fourth year.

By the start of the fifth year, the buy-in is complete, using this formula. An asset of this system is that each year the young physician essentially receives an annual "raise," which usually generates the incentive to work harder.

The beauty of this approach is that the total buy-in dollars transferred from the younger partners to the more senior partners reflect the ongoing performance of the entire practice, and thus is equitable all around.

The above model (40 percent, 30 percent, 20 percent, 10 percent buy-in complete) is common but by no means mandatory. The percentages can be customized to fit each practice's particular financial profile and circumstances. For example, some practices may desire to reduce the early percentages and increase the latter percentages, so that the new partner does not take a big financial "hit" right away.

Used for payout

An inexact approach also can be used on the pay-out. Rather than specify a fixed dollar figure of "deferred compensation" or "severance pay" to a departing partner, your practice agreements can establish a specified number of months of "continued W-2 salary."

Each physician's salary reflects both work effort and practice financial success; thus, this type of formula:

This proviso limits the pay-out liability to former practice partners if practice revenues subsequently fall. If it is chosen carefully, the percentage limit will not be triggered by a minor decrease in practice revenues, thus avoiding potential injustice to former partners.

Two inexact buy-in scenarios

The inexact buy-in method is generally regarded as fair to all parties, as illustrated hypothetically below:

If the practice does well, net profits will increase, and the percentage reduction will operate to give the senior members more buy-in dollars. This increase is appropriate because the practice's success indicates that the practice has substantial intangible value.

Further, if the practice does well, the young orthopaedist should receive more take-home pay than he or she would have if the buy-in discount amount had been smaller but the practice had not performed as well.

Thus, in most situations, the young physician is satisfied and does not resent the higher dollar transfer to the more-senior practice physicians.

If profits are lower, the percentage reduction translates into fewer buy-in dollars transferred. The senior doctors should accept this, because it reflects poorer-than-expected practice performance and a smaller practice intangibles value.

If the practice performs poorly, the young doctor's share of lower-than-anticipated profits is offset by a reduced buy-in figure.

How to fine-tune inexact buy-in

The inexact buy-in approach is not perfect. However, establishing the proper percentage for your group will improve the probability of satisfaction with this method among all members of the practice.

Beware of unfair "taxation." Of course, the reduction should not be so high that it works as a punitive "tax" on effort and earnings. Generally, it should be set no higher than 50 percent in any year, and 40 percent is preferable. Further, most young physicians realize that it is better to keep 60 or 70 cents of every $1 than it is not to earn the dollar at all.

Customize the percentages. Consider employing an experienced health care consultant to determine percentages that make sense for your practice. Many practices have successfully employed the
40-30-20-10 percentages, but an equal number have used different percentages. Using projections of practice revenues, expenses, and physician income shares will help establish the appropriate percentage reduction levels.

Focus on fairness. When choosing the percentages, groups are often influenced by the estimated amount of buy-in dollars that will be generated by these percentages. This is certainly one factor. However, the primary objective should be to provide a good salary progression for the young doctor and a reasonable return to the senior physicians, rather than generating a specific amount of buy-in dollars.

Opportunity for growth. Phasing up the younger doctors' income share in this way also gives the practice time to grow. Ideally, by the time the younger orthopaedist is entitled to a full income share, the practice profits will have expanded sufficiently to accommodate the new income sharer without undue impact on the senior physicians.

Floors and ceilings. Your group can control the results of this inexact method by specifying a minimum buy-in "floor" and maximum buy-in "ceiling." This works to satisfy the minimum dollar expectations of the senior physicians and the maximum dollar expectations of the younger doctors. However, these floor and ceiling restraints limit the (desirable) correlation between practice performance and buy-in. Further, negotiating the buy-in floor and ceiling amounts may provoke the same heated disputes over numbers that often occur in exact buy-in negotiations.

Business factors affect values

Certain well-defined business characteristics strongly influence the economically reasonable expectation of the future success of a medical practice.

In fee-for-service business, the practice characteristics that are critical to continued success include referrer loyalty; patient loyalty; practice name recognition; practice reputation; positive community history/involvement; pleasant staff; and modern facilities

These same factors are important in getting and keeping HMO and other managed care contracts. Other critical factors in the managed care area include responsible utilization patterns; efficient operations; and willingness to embrace the requirements of managed care.

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