For most medical practices in Australia, the ongoing success of the medical practice depends heavily on its key people. These key people can be doctors, senior partners or practice managers. However, once a key person exits the practice, this can have devastating effects.

An exit may be voluntary, such as retirement, or involuntary, such as death or total and permanent disability. Without a plan in place to contemplate an exit by a key person, the consequences can be devastating for the business and patient continuity.

There can be disputes between surviving owners and family members, confusion about decision-making, financial strain, and sometimes even the collapse of the practice. This is where legal planning essentials, particularly a well-drafted Buy/Sell Agreement, come into play.

In this article, we explore:

why planning for death and incapacity is critical;
the role of Buy/Sell Agreements (and how they differ from a Shareholders’ Agreement); and
practical steps medical practices can take to safeguard their future.

Why planning ahead matters for your medical practice

Medical practices are not like other businesses. A medical practice provides services, but those services are wrapped up in patient care delivered by skilled professionals. That means your doctors, nurse practitioners, partners, and key managers are irreplaceable in the short term without impacting patient continuity.

When a key person retires, dies or suffers a permanent disability, your medical practice may face:

disruption to patient care with reduced capacity and loss of patient trust;
uncertainty about ownership of the medical practice due to shares automatically transferring to a spouse, children, or an estate;
financial pressure if a deceased or incapacitated owner’s family want to be bought out quickly; and
disputes between owners, beneficiaries of an estate and insurers.

There are a number of scenarios that can impact the operation of your medical practice, namely retirement, death or total and permanent incapacity of a key person, termination of employment, bankruptcy or loss of registration, whether that be temporary, permanent or a restriction on practice.

In all cases, clarity and pre-agreed mechanisms to determine value and buy out are vital.

That’s where a Buy/Sell Agreement comes in.

What is a Buy/Sell agreement for medical practices?

A Buy/Sell Agreement (sometimes also called a Business Succession Agreement) is a legally binding contract between the owners of a medical practice that sets out what happens if one of them exits the practice by retiring, dying or becoming totally and permanently incapacitated.

A Buy/Sell Agreement for a medical practice typically provides for:

Events that will trigger its operation (Trigger Events) such as retirement, death and permanent disability for example;
An exit mechanism for the departing owner (Exit Mechanism) where the departing owner is required to sell their interest and the remaining owners or the medical practice is required to buy it.
A way to value the practice on a Trigger Event (Valuation Method). This is usually a clear formula or process for determining the value of the exiting parties interest.
A way to fund the buy out (Funding Mechanism). This is commonly achieved through life insurance and total & permanent disability insurance (TPD insurance).

A shareholders agreement and a Buy/Sell Agreement are not the same thing

Many medical practice owners believe their Shareholders Agreement already covers these issues, but this is not the case, and there are critical differences:

Shareholders’ Agreements cover governance, voting rights, dividend policies, transfer restrictions, and dispute resolution; and
Buy/Sell Agreements deal specifically with succession planning and exit mechanisms triggered by death or incapacity.

It is important to have both documents in place, as they deal with very different and specific issues.

How insurance funds supports Buy/Sell agreements in medical practices

One of the most common problems in buyouts is affordability. Medical practices may have strong cash flow but often there is a lack the liquidity to pay out a departing owner’s estate at short notice. That’s why insurance is key and many Buy/Sell Agreements use insurance policies as their lynchpin noting it is common in Buy/Sell Agreements for medical practices to have provisions that provide each partner or key person has:

a life insurance policy with a lump sum if an owner dies; and
a total permanent disability (TPD) policy with a payout if an owner becomes totally and permanently incapacitated and is unable to work.

Insurance policies can be structured so that the payout is used specifically to fund the buyout under the Buy/Sell Agreement.

Valuing a medical practice in a Buy/Sell agreement

Arranging insurance is a key part to be able to fund a buy-out but working out what the buy-out should be is one of the most contentious issues in business succession planning. For that reason, Buy/Sell Agreements commonly set out the way medical practices can be valued and what will happen if any of the Trigger Events we referred to above in this article happen.

There is no one size fits all formula for valuations and it is important to get accounting and financial advice to make sure you are taking the right approach. However, common approaches used by medical practices include:

Valuation by an agreed formula such as a multiple of Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA) or a percentage of gross fees;
Appointment of an independent valuer to conduct an independent valuation, noting this can often be a medical practice accountant; or
A process where the owners agree on an annual valuation each year and document it, so this figure is used if one of the Trigger Events occurs.

Practical examples

It can be hard to conceptualise these matters and it might help to consider a real-life example.

Consider a medical practice in the leafy north shore of Sydney with 3 founding Doctor partners. The 3 partners Dr Bob, Dr Ann and Dr Barbara had a Buy/Sell Agreement in place.

One partner, Dr Bob, tragically dies in a boating accident. Not only is that disruptive to the practice but Dr Bob is Dr Barbara’s husband and she is struggling to attend work and function too. This leaves Dr Ann, the patients and staff in a bind.

Fortunately, there was a Buy/Sell Agreement in place with cross-insured life policies which:

provided an insurance payout to purchase Dr Bob’s equity;
Dr Barbara and her family received the agreed value promptly and fairly; and
the practice continued to function while Dr Barbara decided what the future held.

For medical practices, the death or incapacity of a key person is often not a question of if, but when. The consequences of failing to plan can be catastrophic, both in operational and financial terms.

A Buy/Sell Agreement, backed by appropriate insurance and fair valuation mechanisms, provides certainty, fairness, and continuity. It protects the practice, the surviving owners, and the families of those who pass away or can no longer work.

If you’re a practice manager or doctor owner in a medical practice, the time to act is now. Review your current agreements, speak with your advisers, and put in place the legal and financial structures to secure the future of your practice. These should be regularly updated to keep pace with inflation and changes in your practice, such as retirement of partners or new partners.

Need Expert Advice?

At You Legal, we specialise in advising medical practices on succession planning. Whether you need a Buy/Sell Agreement, an update to your Shareholders Agreement, or guidance on valuing your practice, our team can help. To discuss your needs, contact our team here, and we will put you in touch with the best professional for your needs.

Why a Buy/Sell Agreement is essential for medical practice succession planning