AFTCO

Ambiguity is Not Benign

Drs. A1 and A2 had practiced together for 25 years in relative harmony. Dr. A1 was age 61 and Dr. A2 was 50. They each owned their own professional corporation and owned their own general dental practice. They shared the office space and had formed a corporation that was owned 50/50 and was used as an operating entity for both practices.

Unfortunately for them, they did not have a detailed operating agreement that addressed issues such as adding associates, cross purchase obligations in case of death or disability, ownership transfer and many other issues that just did not seem important to them. They were good friends and neither had any intentions of doing harm to the other so neither felt the need to address these issues.

Over the years both practices grew and then the doctors decided that they would like to make some long-term plans for eventual retirement. They decided that they would bring in an associate who would eventually buy into the practice and become a third partner in their shared corporation. This would require both doctors to give up some patients over time to the associate (“Dr. B”), but the more productive the associate was, the greater amount of money Drs. A1 and A2 would be paid for Dr. B’s buy-in.

They located a Dr. B and he worked in the practice for a period of 4 years (with no written agreement that spelled out the terms of the buy-in, of course). Eventually Dr. B’s production reached $600,000 per year, and that meant Dr. B would pay $480,000 for his purchase price to become a 1/3 stockholder. That came to $240,000 each to Drs. A1 and A2, which represented a nice little nest egg for both doctors and they looked forward to Dr. B’s eventual buy-in.

However, Dr. A1 was now ready to retire and wanted to sell his practice, so he came up with his own plan. Dr. A1 offered to sell his practice and 50% ownership in the operating corporation to Dr. B. By doing this, Dr. B could become a 50% owner instead of a 33 1/3% owner… and Dr. B would not have to buy and pay for the practice that he had built over the last four years. This means that Dr. B could get the $600,000 practice that he had build… for free!

However, Dr. A1 valued his practice for a price that included his share of the $240,000 that he would have been paid when Dr. B was scheduled to buy-in. Dr. B did not object because that price still saved him $240,000 (that would have been paid to Dr. A2) so he was ready to buy. When they got all of the contracts done and financing ready, Dr. A1 then went to Dr. A2 and told him of his plans to sell to Dr. B. Dr. A1 gave Dr. A2 twenty-four hours to purchase Dr. A1’s practice for the same price and terms that were offered to Dr. B.

There was no way Dr. A2 could agree to those terms and arrange financing in 24 hours so he declined the offer. Dr. A2 had spent the last four years helping build Dr. B’s practice by referring patients to him, and Dr. A2 was looking forward to being paid that $240,000 for that help. Now Dr. A2 would be paid nothing and Dr. B was going to be his new equal partner. To make matters worse, Dr. B’s practice was now much bigger than Dr. A2’s because it was comprised of Dr. A1’s practice and the $600,000 practice built by Dr. B.

Dr. A1 left the practice as happy as can be because he was paid in full for his practice plus the value of the buy-in that would have been paid by Dr. B (if he had exercised his buy-in). Dr. B was happy because he was now a 50% partner instead of a 1/3 partner and his practice was twice the size of Dr. A2’s (without having to pay for its full value). In addition and because of the ambiguous contract that existed for the operating corporation, Dr. B was aware that no one else would want to buy Dr. A2’s practice when he wanted to retire in the future (a purchaser candidate would worry that Dr. A2’s patients would go to Dr. B instead of the new purchaser), so Dr. B could plan on owning Dr. A2’s practice someday and not have to pay anything for it!

Dr. A2 was stunned. He now had a new, younger equal partner whose practice was twice the size of his, and he lost that $240,000 that he thought was going to be paid to him by Dr. B. Worse yet, because of the bad economy Dr. A2’s practice had slowed down and Dr. A2 needed more work, and he was told by Dr. B that he was searching for a new associate to work in Dr. B’s practice because he was so busy with all those patients (many of which were referred to Dr. B by Dr. A2).

Dr. A2 learned a tough lesson… the hard way. Just remember, when you put two nice people together in business, one person always ends up being a little nicer than the other. The not-quite-so-nice person will always come up with a reason to take advantage of the other if the opportunity presents itself in the future. When ambiguity rules the day, the nicer person rues the day. Don’t wait until it is too late to discover that you might be the nicer person in a practice relationship. Give AFTCO a call and see how having the right program will provide you with the protection you need, now and in the future.

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