Reduce conflict by ensuring your operating agreement addresses these 15 areas.
Even in the best ophthalmology practices, conflicts arise with regularity. It seems the old saying is correct: “The only time business partners fight is when the business is doing well or the business is doing poorly.”
This month let’s get back to basics and discuss some of the foundational terms in your group practice’s operating agreement. These terms don’t guarantee harmony but can at least foreshorten conflicts and make them less bitter.
We will not discuss these from a technical/legal perspective — you and your attorney can discuss and refine that. Instead, we will review contractual terms between doctors that our combined 75 years of experience in the business trenches of practice work have shown to be effective.
You will probably find that most areas of this list are covered in your corporate documents, but you may find a few missing terms to discuss with your partners and legal counsel.
1. VOTING THRESHOLDS AND FINANCIAL SPENDING AUTHORITY
Every owner’s group, over time, develops its own comfortable working relationships and voting rules. Some boards prefer consensus — decisions that require everyone’s approval. But, with growing scale, practices can bog down under a pure consensus model, and some variation on majority voting is adopted.
This is quite often staged at various financial levels. Small financial decisions (let’s say with a $5,000 or smaller off-budget impact) can be made by the administrator acting alone. The next-higher level of financial impact decisions (let’s say up to $10,000 off budget) might be at the discretion of the administrator and managing partner. For decisions above $10,000, you might require a simple majority vote of the board. And for even larger decisions (above $50,000, $100,000 or more, depending upon the size of the practice), you might impose a super majority or even unanimous vote requirement.
2. VOTING THRESHOLD FOR DIVESTITURE OF THE PRACTICE
In recent years, one of the most contentious boardroom decisions around ophthalmic America has been whether to sell a private practice to a private-equity firm or health system. A major decision like this is fraught with significant clinical, financial and personal import. The decision to sell often cleaves along generational lines, with senior doctors happy to trade autonomy for a large payout and younger doctors understandably apprehensive about how it will impact the long remainder of their career.
Many practices have decided that, at the very least, a super majority vote should be required for such change of control events. It may also be appropriate to waive non-compete restrictions on dissenting partners who would rather withdraw from the group than work for a corporation or institution.
3. TIE-BREAKING MECHANISMS
In practices with an even number of votes, ties are a common problem. Half of the board (even if it is only one doctor out of two) may want to buy a new laser or fire an associate provider while the other half is against this move.
What are the options to break ties like this? In some practices, they may decide that unanimity on all matters is preferable. As a practical matter, they may decide that some tie-breaking mechanism allow the practice to be more nimble.
There are several options. They could use the simple toss of a coin. They can agree that a subject matter expert from outside of the practice will be selected to break the tie. If the tie vote involves financial issues, everyone might be comfortable with the practice’s CPA breaking the tie. (Or the practice’s attorney, consultant or trusted outside physician colleague, depending on the matter at hand.)
One creative approach when Doctor A wants to invest in a new clinical device (let’s say a $50,000 laser) and Doctor B does not is to have Doctor A pay for this equipment and rent the equipment back to the practice on the per-use basis. In this manner, Doctor A still gets the equipment they feel they need, and may even profit from it, in a manner leaving Doctor B without any risk.
4. PRACTICE VALUATION AND PAYMENT TERMS OF A PARTNER BUYOUT
While some practices have a fixed formula for practice buy-ins, valuation and payment, other practices leave this open in their operating agreement. In today’s environment, with declining good will component values and harder-bargaining partner track associates, the transaction model often shifts from one young doctor buy-in to the next. That said, pricing levels are generally comparable between buy-in and buy-out events for a given share of company stock, unless these are separated by long time periods.
5. BUYING OUT A WITHDRAWING PARTNER
In a large group practice, let’s say with 10 partners, buying out a single withdrawing partner is generally very affordable for the nine remaining partners. But, what happens if four partners in the same group withdraw in the same year? Depending upon the buy-out structure, the smaller remaining partnership may not be able to afford (or even secure financing for) such simultaneous buy-outs.
To avert this, practices often apply a “governor” on the payout rate. Here is a simple example applied to the 10-partner practice. For practical reasons, annual payouts made to all four withdrawing partners might be limited to 5% or 7% of annual practice revenue for the overall practice. Under this approach the eventual total payment to each withdrawing partner need not be reduced, but for practical reasons lower payments will flow to them for a longer time frame, making the transaction more affordable for the remaining six doctors.
6. MINIMUM WORK LEVELS AND MAXIMUM TIME OFF FOR PARTNERS
This can be a controversial area for partners. In some practices, the operating agreement is silent as to minimum work hours, maximum time off or minimum collections necessary to achieve and retain one’s partnership status. But in smart practices, reasonable boundaries are established.
Here are some examples:
- Each partner may take up to 8 weeks of combined vacation, CE and sick leave annually. A penalty of $5,000/day will be paid for exceeding this limit.
- To achieve and retain partnership, an anterior segment specialist must perform surgery and achieve not less than $800k in net revenue each year.
- To remain a partner, a doctor must achieve net revenue in excess of 70% of the average net revenue of the other partners.
7. GENERAL CODE OF CONDUCT
In times gone by, brusque doctor behavior was overlooked. But not anymore. Small practices and major health systems alike have found it necessary to apply an evolving set of common- sense guidelines for doctors to follow. As with most rules, it is the 5% of misbehavers who oblige us to lay down the law in the first place. Your practice’s operating agreement, as well as each individual’s provider employment agreement, should reference a code of conduct (and the potential consequences) covering such items as:
- Attendance
- Staff and patient interaction
- Charting
- Compliance
- Adherence to agreed care pathways
8. MANAGING PARTNER SELECTIONS AND DUTIES
Confusion abounds about managing partners in general. In some practices, they are absent (because none of the partners wants to have a boss). At the other extreme, the managing partner, for better or worse, is granted fiat control over all practice decisions.
The best approach is to operate between these extremes, which includes the following terms:
- The managing partner reports to the board, not the other way around
- A written position description that includes responsibilities and authority limits
- A 2-year term of office
- No term limits — talented individuals can be voted to receive additional terms
- A modest honorarium ($1500 to $5000 is the typical range, depending on practice size)
- The position is not rotated from doctor to doctor in an effort for fairness; instead, the group picks the person who is the most capable, available and interested in the job.
9. ANNUAL BUDGET PREPARATION AND APPROVAL
This is very much related to practice scale and ambition. Smaller, steady state practices without any concerns about their financial performance trending can reasonably forgo formal budgeting at the start of each new year. However, for larger, more dynamic practices (and practices of any size in need of applying the brakes to spending), the importance of having a disciplined budgeting process necessitates that it be written into the operating agreement as an operational mandate.
10. PARTNER FACILITY COMMITMENTS AND PRACTICE BUSINESS COMMITMENTS
Sometimes, it is sensible for practice business partners to go in together on significant office building projects. These can be highly leveraged and oblige the partners of a practice to have considerable individual debt obligations.
For example, imagine three doctors with a successful group practice who take out a $10 million loan for a new office and ASC building. Even if just one partner withdraws, the remaining partners can be left with an out-sized debt burden. Such a group will want to consider inserting language obliging the withdrawing partner to remain on the building note at least until the remaining two partners can secure another building partner.
11. LIFE AND DISABILITY BUY-OUT INSURANCE
In most practice settings, the operating agreement should spell out insurance coverage that the practice (or partners) must purchase to facilitate the buy-out of a disabled or deceased partner. The unanticipated loss of a partner is traumatic and costly enough without having to scramble for buy-out funding or negotiate affordable payout terms with heirs.
12. LONG-RANGE BUSINESS PLAN PREPARATION, APPROVAL AND UPDATING
Like the mandate for annual budgeting, a formal institutional mandate for business planning should be applied in the context of each organization’s scale and ambitions. Whether the practice is large or small, we find that the absence of a long-term strategic plan leads to the absence of partner alignment and a lack of tactical priorities by management staff. All of this improves when a practice writes down and annually updates its objectives in such areas as:
- Service area
- Scope of services
- Desired growth rate
- Provider mix
- Succession planning
For a modest, boutique practice, this document may only run a page or two; in larger, multi-location, multi-specialty practices operating in a competitive market, it may run to 50 pages or more.
13. PARTNER WITHDRAWAL MINIMUM NOTICE
In all but the largest practices, each partner represents a significant percentage of practice cash flow. When a partner leaves voluntarily but abruptly, with short notice, the practice must often scramble to find a new provider or to trim expenses to align with lower revenue. Obviously, in most cases, a partner’s disability or death comes with little warning. But in cases of retirement or simply resignation, it’s beneficial for the leaving partner to provide a one-year advance notice or longer.
Also, it is common and appropriate for practices to apply a buy-out payment penalty reduction to partners who retire or otherwise withdraw with insufficient notice. This penalty can take many forms, including an overall percentile reduction, loss of accounts receivable or reduction in tangibles buy-out.
14. PRACTICE REPORTING FREQUENCY AND CONTENT
You might think of this area of practice management like the instrument panels of various kinds of airplanes. The instrument panel for a little Cessna is far less complex than the instrumentation of a jumbo jet. And thus, it is with your practice.
If your practice is large, complex and moves fast, you will want to deeply and frequently monitor performance each month, which includes monthly financial statements, weekly revenue cycle reports, trends for dozens of benchmarks and individual doctor performance statistics. In contrast, a slow-changing, high-profit, low-ambition practice might be perfectly well served with high-level quarterly reports.
15. SETTING AND ADJUSTING PARTNER COMPENSATION METHODOLOGY
It is easy for something as important as partner compensation to not be addressed in the partner’s operating agreement; however, there is perhaps no dimension of practice management more important than how the partners pay themselves. Because money discussions can be sensitive, it is common for partners to set up a compensation methodology and then run with it for many years, over which time the payment formula becomes progressively less fair.
There are hundreds of possible compensation methodologies. Your operating agreement need not designate the specific methodology, but it should lay out the ground rules for keeping the formula fair and relevant in a changing practice. Any given formula can shift from being fair to unfair depending on several factors, including individual doctor productivity, practice costs, entry into new services lines and payer fee adjustments.
Your operations agreement should spell out the review frequency and a few philosophical hallmarks for partner compensation methodology. Some practices prefer a pure “eat what you kill approach,” while other practices prefer more equality. In larger practices, we set up a standing compensation committee, including partners and outside advisors, to conduct a formal annual fairness review. Such a committee allows each partner a safe place to register questions and concerns about how the current compensation model applies to them.
CONCLUSION
A few last points about operating agreements:
- Individual shareholder employment agreements should align and agree with the corporate operations agreement.
- One of the most common oversights we observe in client practices is the too infrequent review and updating of your operating agreement. Just as you probably audit your billing and accounting practices from time to time, it’s good business hygiene to have your practice’s general legal counsel review your documents every few years to assure they still align with your scale, complexity, and contemporary legal practice.
- Every partner and administrator should closely re-read their key agreements annually. Your refreshed understanding of your agreements will lead to more appropriate board decisions and reduce potential conflicts. OM
