A handshake isn’t enough
Practice partnership agreements need to be tightly written and account for eventualities, such as how disputes are settled and how a buyout is accomplished.
After extensive deliberations, you take a leap of faith and decide to dive into a veterinary practice partnership. While excitement compels you to rush into the venture, taking a step back to evaluate the implications and properly structure the business arrangement will greatly benefit you and your partners in the long run.
A carefully tailored partnership agreement, sometimes referred to as an operating agreement or a shareholder/member agreement, is vital. Not only will it assist you throughout the duration of the partnership, but it also is intended to allow you to dissolve the relationship and the associated legal entity in a fair and efficient manner.
A well-written partnership agreement will function as your go-to resource for questions concerning the management and control of a veterinary practice, compensation and general decision-making. It will eliminate the guesswork as to which actions require your partners’ approval and how such approvals should be secured. It will provide you and your partners with greater flexibility and control in resolving issues or disputes.
PC or LLC?
A critical consideration when establishing a partnership is choosing the right entity structure. Today, general partnerships are rarely the entity of choice as the partners are each legally liable for the obligations of a partnership.
In most states, a veterinary partnership is generally formed as a professional corporation or a limited liability company. Each state has regulatory requirements with notable differences. For example, some states require that all the partners, or shareholders, must be duly licensed veterinarians and that they can only transfer shares to other duly licensed veterinarians. Consulting an attorney is important when selecting the appropriate entity type as each has unique tradeoffs.
Once you select the entity type, you can focus on other important aspects of the partnership, such as control. Typically, when two equal co-owners join forces, all major decisions, like acquiring assets, leasing or purchasing space or equipment, accepting new partners, and approving capital expenditures that exceed a predetermined threshold, require unanimous consent. Day-to-day operations and management responsibilities will typically be divided among the co-owners and won’t require the other’s consent.
When the partnership consists of three or more owners, especially if they have unequal interests, a more complicated decision-making structure will be required. In some states, major decisions legally require at least majority consent of the shareholders regarding a merger or consolidation, a sale, a lease or exchange of all or most of the corporation’s assets, and dissolution. Notably, owners generally memorialize in a partnership agreement that major decisions such as these will require a supermajority vote of two-thirds to 70%, or even unanimous consent.
When the time comes to make major decisions, especially ones that will not uniformly affect the partners, the agreement becomes a critical tool for the proper execution of contemplated transactions.
When Disagreements Occur
Now that you have learned about the critical factors in creating and governing your practice, understand that disputes may arise even among the most well-intentioned partners. Creating a thoughtful and forward-looking set of governing documents can often mean the difference between a dispute tearing apart a successful venture or having little long-term impact.
To limit the potential damage or drain on resources that may accompany a dispute among partners, governing documents should include clear, definitive rules for how the partners must raise, discuss and resolve issues, and formally approve and adopt resolutions that bind the partnership and partners. Creating such rules can be difficult and complex. Often, well-intentioned but poorly drafted rules and provisions only magnify the conflict.
An example of a provision designed to anticipate and resolve a source of dispute is the buy/sell. This provision establishes the process through which one or more partners may buy another partner’s interest when specified events substantially alter the group’s composition. These events are generally standard and may include death, disability, retirement and employment termination. The partners have flexibility in establishing the procedures and approaches for dealing with such events.
Any event that would cause the partners to question the business arrangement should be discussed well in advance. When partners are also practice employees, their termination should be planned for, often with different procedures and valuations that take into account whether the separation was with or without cause.
When partners have different specialties that account for a distinct and significant source of revenue, buy/sell requirements during an early retirement may be especially complex. Establishing a formula based on the length of services rendered or the amount of advance notice required can provide a more equitable resolution when a partner decides to leave.
Defining events can be a challenge, most notably with disability. Partners should be careful not to be overinclusive or underinclusive in how events are defined.
The Price Is Right
Once a buy/sell provision is triggered, the procedures governing the affected partner’s interest kick in. Purchases of the interest may be mandatory or optional, and they may be made by the entity itself — known as a redemption — or by the remaining partners. Partnerships may choose a combination of approaches, with the practice given the first option to purchase some or all of the interest and the remaining partners allowed to purchase the remainder in proportion to their ownership stake.
The buy/sell provision should require that a partner’s interest be purchased in its entirety to head off issues that can arise with minority owners. Partners must weigh many factors when deciding who should purchase the interest. These include tax and liquidity concerns, ownership structure, and statutory and contractual limitations.
Once the decision is made as to who will purchase the interest, a valuation mechanism needs to be determined. Most practices arrive at a fair market value through an appraisal conducted by the practice’s regularly retained accountant. The fair market value can be discounted to disincentivize bad actions such as early retirement or acts that result in termination for cause.
Lastly, how the practice or remaining partners pay fair market value comes into play, especially when the obligations are unforeseen and substantial. The common approach is either a seller-financed buyout in which a significant down payment is made by the practice or the issuance of a promissory note by the remaining partners. Considering how the initial down payment will be paid is important. Funding the obligations through the purchase of life insurance policies on each partner is common. This provides the practice or the partners with the ability to at least fund the down payment regardless of a lack of notice or financial constraints.
Another concept that every partnership agreement should contain is restrictive covenants, such as non-competition or non-solicitation provisions. These typically contain restrictions involving time, distance and scope.
A non-competition provision limits the ability of recently separated partners, whether by termination or withdrawal, to practice veterinary medicine. This covenant typically prohibits the separated partner from practicing within a specified radius of the practice for two years, or often five years when a practice sale is involved.
Non-solicitation provisions generally prohibit a separated partner from seeking to acquire the business of the practice’s clients. They also prohibit the separated partner from attempting to hire employees of the practice.
In determining the scope of these restrictive covenants, the practice location is important. While the duration of the prohibitions is generally the same — two years, for example — densely populated urban areas generally will have less-restrictive geographic terms. Although the language and the scope of these covenants will vary somewhat, their inclusion in partnership agreements has become commonplace and is vital to the protection of all partners’ interests.
Whether you are diving into your first veterinary partnership or have been a partner for many years, establishing a well-crafted partnership agreement, or amending an outdated one, should be essential to your business strategy.
Peter H. Tanella chairs Mandelbaum Salsburg P.C.’s National Veterinary Law Center, which provides strategic legal and business solutions to the firm’s veterinary clients. He can be reached at [email protected].