As professional accountants specialising in the medical space, we are regularly entertaining conversations that include all or part of what we go through below.
This information is what we are happy to share with the masses – but consider all of these points before proceeding.
A young GP will often ask what should I do? Buy a home or buy a practice?
Our answer is “buy a practice first. And then use the extra cash flow to buy a better home.”
The best investments for GPs are almost always their practices and their homes, in that order.
Most GPs who become wealthy do so by owning practices. They work on the practice and turn it into a business.
They spend less than they earn, save the difference, then invest in other areas, first the home and then other assets, to build up a significant and diversified asset base.
Ultimately the investments become the major source of cash, income and wealth. But the practice is the engine room: this is where it all starts. The practice deserves special prominence in any discussion about GPs’ investments.
The medical practice as an investment
The practice produces the best returns with the lowest risk. Goodwill values are low and this means returns are high. It is not unusual to see rates of return of more than 50%, and even 100% or more in some cases.
If a GP borrows $100,000 against the security of their home and starts to earn an extra $50,000 a year profit, above their time reward, that is a 50% return on the GP’s investment. It is very low risk. Most owner GPs earn at least an extra $100,000 a year profit and net cash flow every year.
After two decades this compounds out to a very large difference, millions of dollars of difference in the net wealth position of owner GPs compared to non-owner GPs.
Most GPs, no matter what their age and circumstances, should consider owning their own practice. The only real exception is GPs who, for whatever reason, are not able to work full-time. A good example is older GPs downsizing into retirement. Common sense says they work for someone else. Another good example is female GPs contemplating kids and family. Most expect to be the primary caregiver and many are happy to put owning a practice on the back burner for a year or ten until circumstances change. Of course, some male GPs are in this category as well.
The medical practice as a business
There are numerous ways to set up a practice, and what suits one practice may not suit another.
Some practices bulk-bill and still have good profitability. This is achieved through high patient numbers and fiercely controlled costs. Other practices privately bill patients, work on a strict appointment system, perhaps even closing their patient lists, and deliberately spend more on staff and other costs to improve efficiency and profits.
Some practices are ideally located in prime real estate next to large shopping centres, where the pedestrian traffic generates a constant supply of potential patients. Other practices are in industrial areas or CBD business areas, providing occupational health services to nearby industrial and office complexes and relying only on reputation for patients to come in.
Good GPs usually make good profits. So what features distinguish profitable practices?
Anecdotally, more GPs are moving from bulk billing to private billing. It is really just a change in emphasis since most will still bulk-bill some patients.
We encourage this, and our usual advice is to not bulk-bill patients unless they are genuinely in need. Patients are only in genuine need if there is no income earner in the household and they do not own a home – they could not come to the doctor if they were not bulk-billed.
A patient, even a pensioner, is not in genuine financial need if they own their home, drive a car, smoke or have a job, and many doctors eventually agree that they should be billed as such. If this means the patient does not come back to the practice, then so be it. They will find a doctor somewhere. Ultimately, it just means that they do not value the GP’s services. Price is a filter that sifts out the patients who really do not want to be there.
Price rises rarely lead to a drop in patient numbers.
Most GPs are good at controlling costs. Some control them too well and do not spend enough on their practices.
Don’t be shy about spending money to improve patient services.
Carefully calculate the effect on profit of the proposed cost and, if it will go up, proceed.
A simple example is constructing a new consulting room. The new room costs $150,000. If it generates an extra $3,000 a month in net management fees, this translates to a 24% pa return on investment. This is more than the 5% pa interest charge, so the decision is usually “proceed” (and perhaps to ask what happens if two extra rooms are added).
Other examples abound. Fresh water dispensers, children’s play areas, up-to-date magazines, pleasant music, health information and quality reception staff all cost a bit extra but help bring in patients and encourage patients to pay a little more to see you.
With the shortage of GPs it’s too simplistic to say ’employ more GPs’. Nevertheless, the more profitable practices tend to have two or more non-owner GPs. Registrars are good too. Billings are higher and fixed costs are spread over more GPs, so the extra GP contributes to profit.
Extra GPs are the most profitable additions to a practice. But if this is not possible consider other health professionals too. Make sure they pay an appropriate management fee to be part of your patient ecosystem.
The nicest profit is one made for you by someone else.
The practice’s tax profile will improve. Tax-efficient business and investment structures following the ATO rulings and guidelines will pave the way for more investment and faster debt reduction, since more pre-tax profit is available as after-tax cash.
The most profitable practices are in areas where there is less competition.
There is less competition in less fashionable areas, particularly rural and semi-rural areas. Obviously, family and social preferences are important, but a GP starting a practice should at least consider these low or no competition areas.
Less fashionable areas have lower wages and rent costs. Profits will be good and should be redirected from the practice structure to investment trusts and companies to other new investments, which will in turn generate more profit and net cash flow, leading to even more investments. Higher profit diverted to wealth-creating investments is worth more than any lost goodwill.
Buying an established medical practice
Buying a practice should be the best investment for a GP.
A mark of a good practice is a demonstrable ability to produce an above-average return for its owners. Prospective buyers will be prepared to pay a premium over the value of the practice’s tangible assets to receive that above-average rate of return.
This premium is called “goodwill”. Goodwill is an intangible asset: it does not have a physical presence and will differ in amount and nature from practice to practice.
Starting a new practice can seem daunting.
It takes time and creates stress. It has the advantage of not having to pay for goodwill and location, staff and premises are an open book, allowing decisions to be made autonomously.
Buying a medical practice has more certainty.
It allows GPs to be confident that the patients will be there. This lowers risk and ensures there is a good income from day one. Often the GP will work in the practice before buying and will be familiar with it. They may have actively contributed to the growth of the practice, which may be reflected in negotiations of a discounted buy-in price. This is the best due diligence: real hands-on experience in the practice. Know the patients, the other GPs and the staff. You learn what makes it tick and can be confident it will be there for you once you own it.
There is no definite right or wrong: some GPs are better off starting their own practice, and some are better off buying an established practice.
Our advice tends to be “buy if at all possible”. Starting a practice from scratch in a brand new location can be done, but will incur higher risks than purchasing a perfectly good practice down the road. It can take months for a new practice to get up and running, and the months will drag into years if town planning permissions are involved.
The advantages of buying an established medical practice include:
- Immediately busy;
- No long lead time setting up;
- Time saving relating to acquiring new assets;
- No need to hire a new team of staff members;
- There is an established customer base i.e. patients;
- There are reduced marketing requirements;
- There is an established reputation; and
- There is no need to launch extensive new opening campaigns.
The disadvantages include:
- The reputation may not be as positive as you would like it to be; and
- The staff may have work habits you do not like.
The phrase “buying a practice” includes buying part of an existing practice. This can be an associate buying a right to practice, a partner buying a share of a partnership’s assets, or a shareholder buying shares in a practice company. It assumes the buyer will take over any rights to provide management services to the practice, which are commonly owned by a separate service trust, and this is included in the assets being sold with the practice.
What assets are being purchased?
First, consider what assets are being bought. Typically they include:
- The practice’s goodwill. This includes patient lists and records, the benefit of expected repeat business, reputation, and the relationships established by the practice with patients over the years;
- Medical supplies and other supplies.
- The practice’s plant and equipment. A detailed schedule of plant and equipment should be available. The vendor should confirm a clear title to these items and if an encumbrance exists, the vendor should be asked to arrange for it to be lifted as a condition of the sale proceeding.
Care needs to be taken with leased equipment. When buying leased equipment it is necessary to ensure either:
- Part of your purchase price should be forwarded directly to the leaser as payment of the amount owed on the lease; or
- The amount of the purchase price should be reduced by the amount of the lease liability responsibility is being assumed for.
Staff contracts and provisions
The buyer takes over the staff contracts. Normally staff liabilities, including sick leave, annual leave or long service leave, are deducted from the sale price on settlement.
A buyer should keep staff. They can be the real goodwill of the practice, and staff continuity is important for practice systems and patient relationships.
If you do plan to let some staff go, the question of which staff to keep is an important one that should not be answered before buying the practice. Err on the side of caution and do not let staff go until you have a real handle on how the practice is performing.
Buyers need to know about any employee liabilities, such as annual leave, sick leave, and long service leave. If they exist the purchase price needs to be adjusted. For example, an employee who has thirteen years of employment will probably become entitled to three months long service leave in two years time. The purchase price should be adjusted on a pro-rata basis for long service entitlements.
Is the price right?
Negotiations are a dynamic, and backing intuition is usually the best thing to do. It is a good idea to engage someone else to double-check the reasoning and perhaps prepare a valuation report on your behalf. This helps ensure decisions are not rushed. At the end of the day the buyer must be satisfied on the matter of price. It is perfectly acceptable to ask for time to think things through. Alternatively, where confidence is lacking, someone else could be appointed to negotiate the deal. Emotional indifference can be a wonderful asset in a negotiation and can throw an objective perspective over the whole proposal.
Once a price is agreed upon, it should then be set aside. Negotiations are difficult, and in most cases it will never be known whether a better price could have been reached. Once the price is agreed, it is time to begin making the practice work. Don’t look back. No regrets.
Financing the medical practice
Medical specialist lenders will lend GPs money to buy practices at normal goodwill values. GPs should demand the best possible interest rates: this will usually be at lower rates than usual commercial business lending. Believe us, loan delinquency rates suggest that GPs are very good ‘bets’ for a lender. Make sure your lender treats you like the sure thing you almost certainly are.
Council zoning permissions
A failure to check zoning permissions is a common mistake in the sale-of-business transaction.
Do not assume a practice is permitted on the site just because a practice is there now. Confirmation from the vendor and the council is strongly advised.
It won’t really matter, down the track, if you try to tell the Council that you assumed the practice was permitted.
This should be a standard part of the due diligence process taken by any solicitor acting for the buyer GP.
Preparation of the sale of practice agreement
The vendor’s solicitor will prepare the sale of practice agreement.
The buyer’s solicitor checks the sale of practice agreement and related documents and advises the buyer whether they are in order to sign, or what changes are needed.
The solicitor’s role is not to “do the deal”. This is done by the GPs, perhaps with some backroom coaching from the solicitor. The solicitor’s role is to document the deal agreed to by the GPs, and make sure the sale transaction proceeds smoothly in accordance with the deal.
It’s not a good idea to buy shares in an existing company. The reason is simple: there may be undisclosed debts and the buyer will end up being at least partly responsible for these debts, or the debts may even be so large the company becomes insolvent.
This happens more often than you might think: just last year we watched an accounting practice buy shares in another accounting practice. Seven months later there was still no profit, and on investigating it was found the vendor, a chartered accountant, had faked five years of financial reports, not disclosed $400,000 of liabilities, and had not lodged tax returns for five years to boot.
The rule is “do not buy shares in a private company”.
It can be a good idea to transfer the assets from the old company to a new company, and then subscribe for fresh shares in the new company. Provided certain rules are observed the transfer is ignored for tax purposes. This prevents the shares being tainted by any latent liabilities not appearing on the balance sheet, or that current shareholders are not aware of.
Specialist tax advice is essential.
Sometimes the buyer assumes responsibility for certain vendor debts. For example, the practice may be one year into a five-year lease on computers that cost $30,000. The lease is at a competitive interest rate and is with a reputable financier. Taking over the lease can be a smart way to part pay for the practice. The sale price is reduced by the amount of the liability. Here this means $24,000, ie 4/5ths of $30,000, will be taken off the purchase price.
Restraint of trade clauses
A restraint of trade clause is an essential part of any agreement to purchase a practice. It helps make sure the patients stay and the buyers get what they paid for.
If there is no restraint clause the seller GP can re-appear a month later almost literally next door. The seller GP may not be able to directly approach the patients; however, word would soon spread and the buyer GP will not get what they paid for.
The restraint clause should place a reasonable restriction on the vendor for each of:
- The type of activity restricted (i.e. medicine and, perhaps, health care generally), whether as a principal, a partner, an associate, an employee or otherwise;
- The geographic area restricted. A reasonable geographic restriction is usually not more than, say, between 2 and 3 kilometres from the practice premises; and
- The time period restricted. A reasonable time restriction is usually three years. This period could be longer if an unusually large amount is paid for the practice.
Deferring part of the purchase price is a good way to add business efficacy to restraint of trade clauses. It gives the buyer GP bargaining power should anything go wrong.
The right to use the premises, whether as an owner or as a tenant, is a critical part of the purchase agreement. It would be a disaster to buy a practice only to find the landlord will not renew the lease, and there are no other suitable premises available.
Tenure can be provided to a buyer in a number of ways. These include:
- If the vendor leases the premises, transferring the vendor’s tenant rights to the buyer. The landlord’s consent is usually given without too much trouble; or
- If the vendor owns the premises, arranging for a fresh lease to be granted to the buyer for, say, five years with options to extend the lease, as
We recommend buyers retain an experienced solicitor to check the lease carefully before proceeding too far with buying the practice.
Warranties and Guarantees
It is a good idea for a buyer to obtain third party guarantees from the vendor. For example, if the vendor is a practice company, a director’s guarantee is appropriate.
One common warranty says the vendor has disclosed all known relevant matters. If the vendor won’t agree to this clause, the buyer should probably walk away.
Notice to Patients
Appropriate written notice should be given to patients and this notice should stress the skills, experience and other attributes of the incoming GP.
If the new GP is buying into a partnership it can be a good idea for the retiring GP’s patients to be invited to see the remaining partners as well as the new GP. This should improve the retention rate for the partnership as a whole.
For a solo practice managing the patients is even more important. The buyer should insist on a phase-in phase-out arrangement where the vendor fades out of the practice over time. If this is done properly, the patients may virtually not notice the change.
Potential of the practice
The potential of the practice should be given a great deal of thought. A new face can be a breath of fresh air in a medical practice. A new coat of paint can help too. Many potential new patients may come once to see what it is like. Word of mouth is a strong form of advertising. Positive first impressions cannot be underestimated.
Valuing goodwill in an established practice
Goodwill exists if the practice has a maintainable competitive advantage that generates above-average profits that can be passed on to a new owner.
Goodwill values vary from practice to practice. In recent business transactions acting for vendors and purchasers, we’ve seen anything from a nominal value paid for a practice with very little or no goodwill to values up to 4-6 times average EBITDA. Such transactions are purchasers ranging from individuals to corporate health practices.
It’s difficult comparing one practice to another as you’re not comparing apples for apples. Some practices generate a reasonable amount of passive income. i.e. income generated by non-owner doctors and health professionals, practice grants and incentives and sub-lease arrangements with specialists, pathology, etc. Other practices may be set up on a smaller scale and produce a small amount of passive income, but average EBITDA may still be similar to that of a larger enterprise. Therefore, it’s important to review each practice on its own merit. Ultimately, goodwill value is recognised when a practice receives passive income from other sources and the owners of the practice have the advantage of taking home an amount over and above what they would otherwise take home as a non-owner paying a market management fee to a practice.
There are many instances where it is difficult to justify any goodwill value in a practice. Various reasons include:
- The increasing gender-balanced nature of the medical workforce – the traditional age at which a person might undertake general practice ownership often conflicts with the first years of parenthood;
- An increasing preparedness for younger GPs to prefer lifestyle over extra work, and a perception that owner GPs work too hard. Many younger GPs do not see proprietor status as being relevant to their professional status, and many see it as a negative, reducing future location options and lifestyle flexibility;
- A tendency for younger GPs to marry/partner other GPs, or high-income earners, thereby reducing the financial need to own their own practice;
- The shortage of non-owner GPs, the engagement of whom is the key to increasing maintainable practice profits and hence creating goodwill value; and
- The large number of patients and the small number of GPs, which means virtually any GP will have an instantly busy workload if they decide to set up on their own. The low cost of setting up a solo practice, which can be as little as $80,000, limits the value of an established practice.
Selling practices in rural areas and the less fashionable metropolitan suburbs can prove to be difficult at times.
GPs just do not want to work in these locations. Normally these practices cannot even be given away (although, perhaps paradoxically, this makes them excellent options for younger GPs setting up their own practices, particularly if the older vendor stays on as a part-time assistant). This creates a substitution effect across the market and reduces the goodwill values in these areas. Excellent practices have changed hands for virtually token goodwill just so to ensure the practice continues its survival of servicing the patients in these areas.
How are practices valued?
Market value is the price a willing but not anxious buyer, and a willing but not anxious seller, will agree on. This definition assumes the buyer and the seller each have the same information regarding the asset, and each of them have other alternatives that they may pursue if the sale is not completed. That is, it assumes both the buyer and the seller come to the table with equal knowledge and bargaining power.
Goodwill exists when the expected future profits from a practice exceed the amount the GP can otherwise earn. Here a willing but not anxious buyer will be prepared to pay a premium to acquire a right to receive or to share in the practice’s profits. Typically this is where the practice has a special quality that cannot be easily replicated, which is not personal to the owner, and can be passed to a buyer with a reasonable level of certainty.
There is no complete list of the qualities that create goodwill, but they include:
- Efficient support staff that enjoy a friendly rapport with patients;
- Clean modern premises that are easily accessible, have adequate car parking space and, preferably, a play area for children, with some form of entertainment for adults, so patients find the ambient surroundings comfortable;
- Stable and personable assistants and associates, who have their own lists of patients, and who are able to operate at a maximum capacity, with minimal supervision and control (and who do not intend to, or who are contractually prevented from, setting up an opposition practice in the same locality);
- Established relationships with allied health care professionals, such as physiotherapists, pathologists and chemists, ensuring the practice can provide a broad range of medical and health services to its existing patients;
- Increasingly, a market niche or practice specialty that attracts a particular type of patient, as well as the general practice. Examples of this include skin cancer, geriatrics, sports medicine, language expertise, and women’s medicine;
- Good location, both within a particular suburb and as to the choice of suburb or region itself, and the related issue of a practice’s physical presentation; and
- In some cases, specialist equipment, that has a high cost or market interest, creates a barrier to entry for a particular type of procedure or treatment, thus bringing patients to this particular clinic.
Capital gains tax and goodwill
The Government has created special concessions to reduce tax on capital gains on the sale of a business. The rationale is that small and medium business are the engine room of the Australian economy, employing more staff than each of the big business sectors and the government sectors, and generating more wealth for the economy.
Small and medium-sized business operators need incentives to encourage their efforts, and exempting capital gains on the sale of a business (provided certain conditions are met) is one way of encouraging entrepreneurial efforts and energies.
The bottom line is most capital gains on the sale of a practice are not taxed, provided certain concessions are applied, but specific advice should be sought regarding each individual case.
Engaging Non-Owner GP’s
Most GPs are not employees.
The industry standard is for a non-owner GP to run their own individual practice, bill their own patients, and pay a management fee to a host practice. The fee covers the services the GP needs to run the practice such as space, staff, reception and other common areas, gas and electricity, stationery, computers and so on. It does not cover personal costs, such as professional indemnity insurances, cars, registrations, training, memberships and similar costs. These are paid personally by the GP.
The management fee normally ranges between 30% and 40% of billings.
The management fee includes collecting cash from patients and insurers. There are a number of ways of doing this, and most commonly the host practice collects the cash, deducts its agreed management fee, plus 10% GST, and then hands the balance to the GP. This sometimes looks like the host practice is paying the GP. But they are not: the GP is technically paying the host practice, and the host practice is not paying the GP.
This is an important point and means:
- the host practice is (probably) not liable for the GP’s negligence;
- the host practice does not insure the GP, under the Workcover rules or the professional indemnity insurance rules;
- the host practice does not deduct pay as you go withholdings from the net payments to the GP since no salaries are paid;
- the host practice does not pay super contributions for the GP; and
- the host practice does not pay payroll tax on the net payments to the GP.
Variations are encountered. For example, in some practices the non-owner GPs bank patient income into their own bank accounts and then pay the management fee to the host practice. In other practices the host practice banks all income into a special trust account, and then pays each non-owner GPs billings over, without adjustment, and the non-owner GPs then pay the management fee to the host practice.
But the approach depicted above is the simplest and the most common presentation, and the one usually recommended to clients.
In each case the tax results are the same. That is:
- the GP includes all billings in his or her own tax return (or the tax return of a company or trust set up for these purposes);
- the GP claims a deduction for the management fee paid to the host practice;
- the GP claims a GST credit in the quarterly Business Activity Statement; and
- the host practice includes the management fee in its tax return and shows it as a creditable supply in its quarterly Business Activity
Are there any exceptions to the industry standard?
There can be exceptions to the industry standard.
Some GPs are engaged as employees and paid a salary for their work. GP Registrars in their earlier years of practice, Government employees (e.g. military GPs), hospital GPs, community health GPs and locums are often employees.
The employee GP’s salary is usually calculated as a percentage of their billings, or it may be a set hourly or sessional rate (a session normally runs for between three and four hours). Sometimes the salary is calculated as an annual amount, although this is unusual outside hospitals or government institutions, such as the defence force.
Sample engagement contract
Some practices use complex legal documents to engage non-owner GPs and to record the understanding between the parties regarding matters, such as:
- the range of services provided;
- the calculation of the service fee;
- the minimum hours each week and the minimum weeks each year;
- common professional standards;
- the notice period for termination by either party;
- ownership of, and access to, medical records;
- contact with staff and patients post-termination, and any other similar matters.
Draft tax invoices
Australian tax law requires a service provider to provide the GP with a tax invoice showing the service provider’s name, Australian Business Number, the pre-GST value of the services, the GST and the post GST amount payable.
Co-ownership with other GP’s
Most practices involve some form of co-ownership, and the frequency of co-owned practices is increasing as practices become larger.
The owners may be the GPs themselves, or trusts or companies controlled by the GPs. The practices may be set up as partnerships, associateships, companies or trusts (unit trusts or hybrid trusts). With so many variables in the ownership equation, the number of possible outcomes is almost unlimited.
The range is demonstrated in this matrix:
The co-ownership agreement will be a partnership agreement, an associateship agreement, a shareholders’ agreement or a unitholders’ agreement depending on the form of ownership.
Hybrids are possible. For example, in a three GP partnership one partner may be an individual, one partner may be a trust and one partner may be a company. The position is complicated further if there is a service entity. The service entity may be a service partnership, a service company or a service trust, and the partners, shareholders or unitholders may be individuals, spouses, trusts or a company. The complications compound further again if there is a property entity.
Some practices are quite complex. One of the most complex structures we have seen involved four GPs in an associateship, with a service company and a property trust, with a mix of individuals, trusts, spouses and companies owning each entity.
There are no legal restrictions on the type of co-ownership structure. The ATO’s public rulings and similar public statements need to be observed: the main message here is personal services income must be ultimately derived by the GP who generated it. Practices receiving tax free grants, such as super-clinics and similarly large practices, may find they have to use a company structure, and have no choice: no company means no grant.
Co-owned practices need co-ownership agreements.
A co-ownership agreement is a legally binding agreement controlling the practice owners’ relationship. It is in writing, and may vary from a simple 2 page letter, to a 50 page legal masterpiece, bound nicely and signed and witnessed by all concerned.
Co-ownership agreements protect minority interests and create rights and entitlements that may not otherwise be in place. The agreement reduces the scope for dispute in the practice by setting out processes for dealing with potentially contentious matters. The co-ownership agreement can be varied by consent, so the owners are not locked into the agreement: if they can think of something better there is no reason why they cannot do it. The co-ownership agreement provides a fallback document for guidance while other options are not apparent.
Partners will be surprised to hear they are deemed to a partnership agreement if they do not have a separate written agreement. The various state Partnership Acts provide a statutory agreement that applies to any partnership that does not have a written agreement. The deemed contract provides for equal profit share: this may be completely inappropriate and against the wishes of the partners. But if there is no written partnership agreement then the law says profits are distributed equally.
Whatever its form, an effective co-ownership agreement will include rules for
- profit-share arrangements;
- cash distributions (cash being different to profit);
- decision-making processes, including tie-breaker clauses;
- employment of staff and the engagement of other individuals;
- expulsion for inappropriate behaviour or poor performance;
- hours spent in the practice;
- absence from the practice due to leave or illness;
- restrictive covenants on leaving the practice;
- the process for an owner leaving the practice;
- the process for a new owner joining the practice;
- mediation and possibly arbitration processes;
- capital expenditure provisions; and
- owners’ meetings and decision making.
The precise form of the co-ownership agreement depends on the precise form of the practice’s ownership. The options are set out in the attached table:
|Legal structure||Type of co-ownership agreement|
|Unit Trust or Hybrid Trust||Unit-holders’ agreement|
Some practices will need more than one agreement. For example, in a four-owner practice where the individuals are partners and use a unit trust as a service trust, the individuals will need a partnership agreement and the unit-holders will need a unit-holders agreement.
Features of a co-ownership agreement
The following table describes the main clauses in a co-ownership agreement:
|The parties||The parties will differ in each case and will usually be the GP or their companies or trusts.If a party is not the GP consider whether the GP should be asked to guarantee the performance of the party, or be a second party to the contract.|
Each party or guarantor should sign the agreement.
|Recitals or Preamble||These clauses briefly describe the history of the matter and include background materials to help explain the document.|
|Nature of the relationship||This clause confirms that the relationship is one of associate or partnership, as the case may be. It may go on to exclude other types of arrangements (e.g. “…This is a partnership and is not an associateship…”)|
|Profit share rules||These clauses include a technical description of how profit and cash are to be distributed to the owners. It’s a good idea to include a worked example based on a real month, so that everyone knows exactly what the arrangements are.Common combinations include:|
|Decision-making processes||These are rules for meetings and decision making, for example, on a 50% majority, or perhaps a 75% majority for serious decisions. Smaller decisions may be delegated to an individual GP for expediency’s sake. Consider who will sign cheques.|
Consider if a “managing partner” or a management committee is needed.
|Employment of staff||Smaller practices will tend to have a 100% rule for hiring or firing decisions so that any one GP can block a decision. Larger practices may need a smaller % to make the process more efficient.|
|Expulsion of owners||These rules include requirements to maintain professional standards/qualifications/licences, and subjective criteria regarding professional deportment and presentation.|
|Hours spent in the practice||It’s a good idea to include minimum hours, and even a proposed roster (perhaps in a schedule) so that all are aware of what is expected. Some practices will have a cap on maximum hours.|
|Absence from practice due to recreational leave||We recommend a minimum of four weeks. Many practices will have six weeks. Some will have more. Some practices forfeit unused weeks (intended as an incentive to take a break and freshen up!). Some practices will allow for longer leave, with the individual taking the longer leave subsidising costs while absent from the practice. Some practices allow older partners to take more leave. Timing of leave? Who gets school holidays? Does unused leave lapse or accumulate?|
Can unused leave be sold?
|Sabbatical leave||Quite common to allow, say, one month after five years of continuous service|
|Sick leave, parental leave||Varies between practices. We counsel generosity but often observe stinginess. Does a sick/injured/disabled GP have to leave after a period of absence?|
|Process for leaving the practice not on retirement or death||Normally a notice period of between one and six months (may be reduced by consent, and often is).Need to set out what payments will be made, if any, to a departing partner.|
Often includes a process for offering the ex-owner’s interest to the remaining owners, or for the remaining owners to OK the buyer (ie their new co-owner).
|Process for leaving the practice on retirement or death||Consider whether there should be a compulsory retirement age (and whether the retiree can continue at the practice in a difference capacity).Consider whether a small amount of life insurance is needed to cover payments to a deceased owner’s estate on premature death, for goodwill.|
|Process for expelling an owner||Needed in case of serious professional misconduct and possibly serious personal misconduct or financial malfeasance (e.g. bankruptcy)|
|Restrictive covenant||These are enforceable, provided they are reasonable and in the public interest. What is reasonable differs from practice to practice. More likely to be reasonable when goodwill is greater. What geographic area? How many years?|
|Process for a new owner joining the practice||Consider whether a trial period or a “view” period is appropriate. Consider what majority decision is needed. Consider what payment, if any, a new owner should make. Consider whether a new owner should assume a % responsibility for liabilities, and what form the contract should take.|
|Mediation and arbitration processes||Should be mandatory. Should include a mandatory preliminary process involving face-to-face meetings to settle matters of concern. If external mediation is necessary it is likely someone should be leaving. Alternative dispute resolution processes are encouraged over court based processes.|
|Capital expenditure||We suggest a majority is needed for any costs exceeding, say, $5,000 in a year.|
|Amendment||Normally the agreement can be amended by a further deed, if all owners or the required percentage of owners agree in writing to do so.|
|Other details||Which bank? Which account? Which accountant? Which accounting system? What about owners’ personal deductible costs? How formal should decision making processes be? Professional indemnity insurance? Other insurances? Monthly accounts Employment of a practice manager?|
Ending co-ownership agreements
It is often said that practices partnerships are like marriages. We do not agree. Marriages are forever and are intensely personal (or should be) while practices are by their nature not forever and are not intensely personal (or at least should not be).
Don’t be too emotional about the practice. It’s just a practice.
It was not meant to last forever, and was only going to work while it suited all concerned. It is not “until death do us part”. Its more like “until something better comes along”. That something could be anything: retirement, travel, seachange, etc. There should be no trauma in ending a co-ownership agreement.
This does not mean co-owners should go into a practice flippantly, without a sense of purpose, or with the right attitude to co-owners. Obviously, levity and gravity are essential: practices are real and important. But never lose perspective. They are not marriages and are not meant to last forever.
Normally a deed of termination will be prepared by a solicitor to record the formal end of the co-ownership relationship. In some cases, typically cases where there is no tension or stress, this deed can be skipped and the end of the co-ownership relationship can be recorded in simple minutes. For example, the partners would meet on say 30 June and discuss business including their decision to end the partnership as at 30 June, and authorise the chairperson to do all things necessary to give effect to this decision including signing documents on the former partners’ behalf.
The common law defines a partnership as “a combination of persons carrying on a business with a view to profit. Each of the states’ Partnership Acts defines “partnership” in similar terms. For example, the NSW PARTNERSHIP ACT defines a partnership as “the relationship which exists between persons carrying on a business in common with a view to profit”.
It follows that a medical partnership involves two or more GPs combining in a business to provide medical services to patients for a profit. Each partner is both the principal and agent of each other partner and has the authority to bind the other partners in respect of the partnership’s business.
Each partner has a duty of trust, confidence and utmost good faith to each other partner: this is the highest duty imposed by the law. It means each partner must put the interests of the other partners ahead of his or her own interests.
A partnership is not a separate legal entity. Each partner deals with patients on both their own account, and the account of their partners. Each partner is equally responsible for the actions of the other partners. This responsibility is joint and several, which means a patient who complains about the actions of a partner may take action against any one or all of the Individuals in the partnership.
Each GP partner is responsible for the actions of each other GP partner.
Up to fifty Individuals can be partners in a medical practice partnership (compared to only 20 in a non-professional partnership). But normally there are only three or four. We do not know of any medical partnerships even getting close to fifty partners.
Partnerships are not a separate taxable entity for tax purposes. A tax return has to be lodged, and this return will show the share of net partnership income derived by each partner, who will include that amount in their own tax return.
The Partnership Act deems partners to have adopted a standard partnership agreement if they do not have a written agreement. This standard partnership agreement may not be the agreement the partners would choose for themselves. This is a very good reason to have a written partnership agreement that reflects the preferences of the Individuals who own the practice and not the preferences of a statutory draftsman.
Most partnership agreements will provide rules concerning the following matters:
- procedures for sharing profits and losses;
- procedures for admitting new partners (normally all partners must agree);
- procedures for partners to retire;
- procedures for changing the profit share proportions (normally all partners must agree);
- procedures for changing the partnership agreement;
- procedures for ending the partnership;
- procedures for the death or serious illness of a partner;
- procedures for owning business names and similar assets;
- restrictive covenants;
- bankruptcy of a partner;
- practice management and borrowings;
- dispute resolution and valuation procedures;
- interest on partners’ capital and current accounts.
The concept of an “associateship” is not defined at law. Associateships are strange legal relationships that are only encountered in the health profession context, principally medicine and dentistry, but sometimes in allied health professions too.
The NSW AMA defines an associateship as follows:
“An Associateship exists where there are two or more medical individuals sharing expenses such as those associated with the premises, staff and equipment. The medical practice of each GP remains autonomous, in that individuals keep their own patients and do not share their income with each other.”
The Queensland AMA defines an associateship as follows:
“An associateship is an industry specific term for a business relationship where two or more individuals operate their medical practices from a single site and agree to share the costs of their practices, for example, staff, rent, utilities etc.”
Associates run their own practices, derive their own fees and pay their own costs. These costs include a management fee, probably between 40% and 45% of billings, payable to a service entity that is beneficially owned by the associateships, via their family trusts.
Unlike partners, associates are not joint and severally liable for each others’ negligent acts or omissions, and normally are only liable for their own individual negligent acts or omissions. (We say “normally” because litigation is a complex area and it is possible for individuals who believe they were not joint and severally liable for each other’s negligent acts or omissions, to in effect be so liable. For example, doctors might be deemed to be associates because they have both seen the same patient or even because the court believes they are partners even though they believed they are not.)
Both associateships and partnerships are easy to set up, although complex capital gains issues can arise where one wishes to vary a partnership.
Associates run their own practices and do not combine with other GPs in a business.
Associates share the cost of services and facilities, such as rent, receptionists, telephones and so on, and co-operate professionally. But they do not run a business together. Associates do not owe each other a legal duty of trust, confidence and utmost good faith. Associates are not jointly and severally liable for each other’s actions, whether with patients or otherwise.
Most associates regulate their relationship with a written agreement. These agreements tend to look like partnership agreements except the word “associate” is used in lieu of the word “partner”. The matters discussed are essentially the same as those listed at (i) to (xiii) above. There is normally a provision saying the GPs are not partners, are not jointly and severally responsible for each other and can’t bind each other in any way.
Most associate agreements mimic partnership agreements, with the nomenclature changed to avoid creating a partnership. The associates then act as if they are partners. As a result it is often hard to see what the real difference is between an associateship and a partnership.
Partnerships and associates compared
|Bank account||Shared bank account||Separate individual bank accounts (not strictly needed)|
|Profit-sharing||Share profit, rather than costs.||Keep income and only share costs|
|Loss sharing||Share losses||No loss sharing|
|Fiduciary relationship||Yes. Partners owe each other a duty of utmost good faith||No|
|Joint and severally liable||Yes||No, but take great care here|
|Documents||Partnership agreement needed||Associateship agreement needed|
|Can they sell their practice?||No. Can only sell their fractional interest in the partnership’s assets, which include the practice||Yes|
|Do they individually own goodwill?||No. They only own a fractional share of the goodwill||Yes|
|Right of access to partnership accounts and||Yes||No. There is no correlating right unless specifically created by contract records|
|Notice at reception||Not needed||Explanatory notice needed at reception|
|Stationery||Group stationery may be used||Group stationery should state that the individuals are not partners and run separate practices|
|Right of indemnity||Yes||correlating right unless specifically created by contract|
|Partner’s liability||Unlimited||No correlating concept|
|Joint and several liability||Yes||No correlating concept|
|Liable for debts by the practice||Yes||No (except incurred by the associate personally)|
|Consumer protection laws||Low risk (ACCC takes the view that a legal partnership comprised of individuals is not subject to competition laws)||High risk. Associates cannot cooperate on prices and may breach collective bargaining rules and other ACCC competition laws|
|Business name||Yes. Possible||Yes. Possible|
|Tax returns||Partnership tax return required.||No tax return required. Associates lodge their own returns|
|Assignment||Must be in writing||May be oral. But normally in writing.|
Is it a partnership or an associateship?
GPs are sometimes concerned that the structure set up as an associateship is in fact a partnership, and that they may unwillingly and possibly unwittingly be jointly and severally liable for each others’ negligent acts or omissions.
Our practice has an association with McMasters’ a leading provider of financial and legal services to the medical profession. McMasters report that, over the years they have briefed Counsel (senior barristers) as to whether a particular practice was a partnership or an associateship. Each time they were concerned that a practice that called itself an associateship was in truth a partnership, with the consequences that the GPs were jointly and severally liable for each others’ negligent acts or omissions. In each case Counsel advised these concerns are unfounded. The determining factor for Counsel seemed to be how the GPs actually see themselves, and what their intention was at the time the practice started and whether this has changed since.
Nevertheless, we think it is a good idea for the practice’s patient paperwork and signage to make it clear that the GPs are associates and not partners. For example, if the paperwork includes a footer showing the names of each GP, add in a sentence like “The GPs are not partners and each GP runs their own practice” and to make sure the correct names are used, for example, if Dr Smith owns her interest through a company the correct name is “Dr Smith Medical Pty Ltd” not “Dr Sahara Smith”. Its also a good idea to have a sign at reception and on the website saying something like:
“The GPs are associates and are not partners. They run their own medical practices and are not jointly and severally liable for each other’s patient consultations and procedures.”
Income tax returns
A partnership lodges a tax return each year but normally does not pay tax itself. Instead, each partner includes a share of net partnership income (or loss) in the partner’s own taxable income computation. The amount of tax paid depends on the partner’s overall tax profile.
A partnership is required to pay GST as if it is a separate entity.
An associateship does not lodge a tax return. Instead each associate lodges their own tax return, showing gross income, including their medical practice income, as assessable income, and claiming deductions including their share of practice costs.
Is the ATO concerned about whether a practice is an associateship or a partnership?
Occasionally concerns are raised as to whether the ATO will treat a particular practice as an associateship or a partnership.
We do not share these concerns. In practical terms, there is little difference between associateships and partnerships. We are not aware of the ATO ever questioning the status of a particular practice as an associateship or a partnership. It has no influence on the amount of tax paid and therefore is of no real interest to the ATO.
GPs invent an infinite number of ways to share profits. These can be complex and sometimes a High Court judge, or even a spreadsheet expert, is needed to understand how each way works (although somehow the GPs never miss a cent!).
Despite the complexity and diversity, two basic concepts can be identified. These are:
- fixed profit sharing, ie, each GP gets a fixed percentage of profit. If there are two GPs they get half each, and so on; and at the other end of the spectrum
- variable cost-sharing, ie, each GP keeps his own fees and pays a share of This may be a fixed percentage (e.g. 50% if there are two GPs) or a variable percentage, calculated by taking each GP’s gross fees as a % of all fees and multiplying this % by total costs.
A simple example shows how each method works. Assume Dr Smith bills $450,000, and Dr Jones bills $550,000. Costs are $300,000, and net profit is $700,000.
|Fixed profit sharing||Variable cost sharing|
|Billings: Dr Smith||$450,000 (45%)||$450,000 (45%)|
|Billings: Dr Jones||$550,000 (55%)||$550,000 (55%)|
|Dr Smith’s profit share||$350,000||$315,000|
|Dr Jone’s profit share||$350,000||$385,000|
- How to treat income other than patient fees?
- How to treat management fees from non-owner GPs and other practitioners?
- How to treat practice nurse income?
- How to treat costs that are more connected to a particular GP?
- How to treat after-hours income?
- How to treat expensive equipment used more by one GP?
- How to treat costs when total sessions are not equal?
Whatever method, formula or spreadsheet is used the agreement should specify how profit share works and provide a diagram and a worked example of a profit share computation in an appendix. Technical accounting terms mean little to most GPs, in the same way a technical medical explanation means little to most accountants. A diagram plus a worked example of a sample month, showing how a given profit will be allocated to the owners is worth 100 pages of words.
Which is better, associateship or partnership?
There is no easy answer to this question. It depends on the circumstances of each case and the GPs’ preferences. Of course, in many cases the die is cast, and it can be hard to change. Certainly, advice should be sought before changing from one to the other.
Names are not important: it’s how the practice runs.
GPs who call themselves associates, may be partners if they hold out they are in business together. Associates should take care with signage, stationery, accounts, banking and advertising, to avoid creating an impression of partnership.
Some GPs believe partners can be jointly and severally liable for non-partnership matters such as a property investment loan. This is not right. The partners are only jointly and severally liable for partnership matters. This is a basic common law principle and is reinforced by the Partnership Act of each state. Partners are not liable for each other’s private debts or other non-partnership matters.
Can partners shield themselves from joint and several liability?
We are often asked whether a company can shield a partner from joint and several liability?
The answer is yes, it can. It can shield a GP from the negligent act or omission of other GPs with whom the GP works, ie the other partners, but not from his or her own negligent act or omission – the GP will always be personally liable for that.
This applies to companies acting as the trustees of trusts, as well as acting on their own account.
Take an example of a four GP partnership, with each GP using a company to own their interest in the partnership. If one GP is negligent that GP and his or her company may be the object of a legal action. The other partners, ie the companies, may be joined to the action under the doctrine of joint and several liability. But the GPs are not personally partners, and therefore normally cannot be personally joined to the action.
This assumes that the other GPs were not personally involved in the negligent act or omission. We qualify our comments by using the word “normally”. Litigation is a strange beast and unexpected things happen. Who can say for sure what a court will decide, or what insurers may agree to?
But, assuming normality, using companies as partners has reduced patient litigation risk by up to 75%, all things being equal, compared to the position where the individual GPs are the partners.
We are constantly reminding GPs that professional indemnity insurance is effective and no GP has lost his or her home, or other significant assets, in a patient litigation. So keep a sensible perspective. Nevertheless, it makes sense to take simple steps to reduce risk wherever possible, and using a company to own your interest in a partnership cannot hurt, ie there is no significant disadvantage, and is usually recommended.
The capital gains tax rules contain special provisions known as “rollovers” which allow a GP to transfer an interest in a partnership to a 100% owned company without triggering a taxable capital gain. The transfer will usually be recorded by a deed of transfer, or a deed of assignment of an interest in a partnership.