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Why You Are Risking Millions of Dollars by Not Having a Well Drafted Associate Agreement

Imagine this scenario: you are 65 years old and listing your practice for sale. For 30 years, you’ve lived and breathed this office. Everything you did incorporated thoughts of growth and improvement. You read countless books on practice ownership, attended seminars, engaged a practice consultant to learn effective leadership skills, taken your team on yearly retreats, navigated a few bad apples (staff and patients), and ultimately found your rhythm as you clocked in day in and day out. You have gone through a roller coaster adventure and are ready to set your sights on retirement. You obtain a practice valuation of $2 million. Wow, what a great way to retire. You find a strong successor/buyer who is motivated to employ your staff and keep your practice’s momentum going. You are set to close at the end of the month.

Within 2 weeks of getting a bank approval and during the buyer’s due diligence, she asks for copies of the associate contract that you have with your star associate who is generating 40% of your revenues. You have tried to groom your associate to take over since she has been with you for five years, but she does not seem interested in buying your practice. You provide your buyer with copies of everything that you have. A few days later, your buyer gives you formal notice that either you have to reduce the price or she will walk. What happened?

Unfortunately, we have seen this scenario and numerous nuances of this scenario time and time again. Here are three common issues that you can avoid today:

  1. You have an employee agreement in place with a restrictive covenant (promise not to compete, promise not to solicit, etc.) that will not assign to the buyer. How does this happen?

a. Poor drafting strategy. We often see this when there are too many modifications to the contract which the parties don’t do correctly to incorporate the previous documents. For example: employee is hired with a robust employment agreement and fairly standard-place restrictive covenant. However, the parties amend the document the following year to make changes to the compensation plan. The third year, the parties provide another amendment to make another change to job description and compensation (again). The fourth year, the parties make a slight modification to the non-compete provision. The fifth year, the parties changed hours and compensation (again), but did not state that the other contracts are valid. All contracts are titled “Employee Agreement”. There is substantial legal ambiguity over how each of these documents should be read. Are they all separate contracts that override one another or are they amendments that build on top of one another? Without clear language, either side’s attorney can argue a different point. How could this have been avoided? The seller/employer should have hired a contract attorney to review the changes.

b. The contract is missing a clear assignable rights provision to the seller/employer’s benefit. This means that once the seller entity sells, the contract stays with the seller entity. The buyer will not automatically inherit those rights and will have to start fresh with the employee. A potential way around this is to have the associate sign an assignability of rights provision to the buyer as a closing requirement but that could prompt another unique issue (see #3). Another potential way around this is for the buyer to buy the seller’s stock but that generally carries some level of risk requiring more due diligence and reflects a discounted purchase price because of the potential risk. How could this have been avoided? The seller/employer should have hired a contract attorney to make sure that the contract has an assignability of rights clause.

2. You have a contract with your associate but you classified your associate as a contractor in a state that penalizes misclassification of employees. So, even if the contract is assignable to the buyer and has no ambiguous language, is the classification itself valid to allow for the associates’ contractual promises to also be valid? Consider this, too: did the seller/employer set a bad or unrealistic precedent? Will the associate agree to be hired as buyer’s employee since he/she will no longer be able to claim that they are their own “business” for purposes of writing off deductions? How could this have been avoided? Make sure you have a well-written associate agreement that properly classifies your employee as an employee, unless they qualify as a contractor per IRS and state rules. Remember, misclassification as an independent contractor (those that receive a Form 1099 to outline payments made as opposed to a W-2) is far too common in the world of healthcare especially when there can be some ambiguity especially where traveling specialists are common. Make sure to understand the rules to avoid going down this potentially unpleasant road.

3. You never bothered to write an associate agreement and it never seemed to be an issue until now. Can a seller/employer cure this before Closing? Maybe. What consideration would the associate have in return for signing a non-compete/non-solicitation agreement when you have no long-term employment to offer? Are you willing to pay additional compensation to incentivise signing? Will the associate feel like your compensation offer will sufficiently incentivize her when she realizes that she has free rein to walk away and potentially take patients with her without having to pay your hefty $2 million price tag?

If you purchased a practice with the goal of building equity that will sustain your future retirement goals, don’t overlook this fairly small but critical task. Make sure to meet with your CPA and practice attorney before hiring an associate to ensure that you are properly classifying this person and then make sure that you work with your attorney to create a fair employee agreement to outline key terms to protect your future sale.


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