A partnership is a formal arrangement between two or more parties to manage and operate a business and share in its profits. For many single-owner small businesses, adding a partner is the first step towards transition, and ultimately, exit. Preparing your optometry practice for partnership demands careful attention to a variety of functions to ensure equitable benefit to all stakeholders. Here are the necessary considerations practice owners should take to prepare their practice for partnership across the financial, legal, and operational aspects.
Financial due diligence is conducted to evaluate the financial health of an investment. Applied to the process of adding a partner to your practice, the analyses ensure the practice provides enough revenue to cover expenses and debt service requirements and provide desired income to both parties. Evaluating the financial stability of your practice includes:
- Financial Performance: Prior to adding a partner to your practice, gain a clear understanding of the cash flows and profitability of the practice. Careful review of financial statements and reporting including federal and state tax returns, financial and bank statements, accountant-prepared profit-and-loss statement, and collections reported in accounting and practice management software provide a glimpse of the big picture. (Pro Tip: “Common-size” financial statements allow for benchmarking to your practice and industry standards, uncovering myriad opportunities to improve profitability.)
- Pro Forma. Financial pro forma provides a multi-year financial snapshot of your business based on historical revenues and expenses and your applied projections. Your forecast shall include detailed modeling of practice economics reflecting the vision for future milestones, such as expanding scope of care, renovating or re-locating the practice, adding locations or associates, and anything else you and your prospective partner may be considering. Also, be sure to include appropriate cost ratios across the time horizon and applicable debt service terms when determining financial viability. (Pro Tip: Construct financial pro forma over a minimum three-year forecasting period, including production benchmarks, adjustments to cost structure, and necessary capital expenditure to maintain operations.)
- Adjusted EBITDA. Earnings Before Interest Taxes Depreciation and Amortization identifies the true economic benefit of the practice. The measure is calculated by adding non-cash expenses to net income and adjusting for owner-operator replacement compensation to provide a true measure of economic output of the enterprise. There may be a plethora of items included in the calculation, most notably including: salary and retirement plan contributions for the owner, interest, taxes, depreciation and amortization expenses, as well as expenses personal to you that will not be incurred by your prospective partner. (Pro Tip: Pending how you compensate yourself as the owner, it may be necessary to adjust your salary to market rate so as to not over-inflate the calculation.)
- Balance Sheet. It is critical you as the owner have a clear view of the full picture of your practice’s financial health, beyond day-to-day operations and profitability. The balance sheet provides a compilation of assets, liabilities, and your equity in the business. Assets are the business’ resources of economic value such as cash, equipment, inventory, accounts receivable, and real estate, among other items. Liabilities are financial obligations of the practice such as debts, employee compensation earned not yet paid, and services paid for but not yet delivered.
- Revenue Channels. When preparing your practice for partnership, it’s vital for owners to understand revenue sources, especially those of managed care reimbursements. Conduct a payor audit utilizing your EHR to report net collections by service or product area for each payor the practice is credentialed with. If your new partner intends to be credentialed with the medical insurance and vision care plans currently accepted in the practice, conduct a local managed care audit to identify opportunities to grow the practice with those carriers. (Pro Tip: Consider attracting a partner practicing a robust, modern scope of care or a specialty not currently offered in the practice to diversify sources of practice revenue.)
- Valuation. A valuation of your practice will provide the starting point for negotiations and developing the strategic plan for an optimal partnership. There are three common approaches to valuing a business: asset approach focuses on tangible assets and goodwill; income approach evaluates profitability of the business; and market approach compares practice performance to benchmarks. Valuation provides transparency for all stakeholders to facilitate an equitable arrangement. (Pro Tip: The valuation approach, or combination of approaches, as well as the premiums and discount applied to the analysis, will depend on the exact details of your deal.)
- Executive Compensation. When a business comes to have more than one owner, establishing an executive compensation structure is necessary. Equitable executive compensation for the modern practice is composed of three parts: clinical compensation based on production; profit share based on percent of ownership; and executive compensation which is a function of executive duties of each partner. (Pro Tip: To protect all parties, include details of the executive compensation plan in the Operating Agreement.)
When preparing your practice to add a partner, it is imperative to ensure the business is in good legal standing with all federal and state governing bodies and regulatory agencies. Additionally, there are numerous points of consideration and documents critically important for the protection of all parties. Some items of particular importance include:
- Legal Documents. Evaluate all legal documents relevant to the practice including articles of incorporation, lease agreements, and any other contractual arrangements such as marketing services, utilities contracts, and vendor agreements. Also, if there are associates employed in the practice, all parties should understand the employment contracts and consider re-negotiation.
- Real Estate Agreements. Prior to adding a partner to your practice, it is vital to understand the current and future real estate needs of the business. Review all commercial lease agreements, noting general lease terms, renewal options and rates, and demolition and relocation terms, among others. If there will be a real estate purchase involved, be sure to assess title, license, and insurance documents.
- Bill of Sale. Compile a list of all assets and liabilities of the practice such that all parties know exactly what the partnership entails. Some examples of assets include: equipment, inventory, intellectual property, and real estate. Liabilities may include: employee benefits and bonuses, licensing fees, bank loans, and lawsuits. If adding a partner to your practice is the first step in your exit strategy, the Bill of Sale shall outline transition terms including sale price, time horizon, and percentage of ownership to be transferred throughout transition schedule. (Pro Tip: If the partnership is that of a phased buy-in/buy-out, the Bill of Sale should identify the valuation methods to be utilized across the transition time schedule.)
- Operating Agreement. An operating agreement is a legal document that outlines ownership, organizational structure, and how a company is to be managed. Additionally, the operating agreement addresses a variety of situations the business could find itself in and lays out proper action to be taken on occasions such as death or disability of a partner, decision-making for the business, adding additional partners, and options to sellout. In the case of partnership, the operating agreement serves as a binding contract between members. (Pro Tip: Including executive compensation and detailed documentation of executive duties ensure equitable economic benefit for all owners.)
Any strategic decision that will impact day-to-day operations of the practice shall include thorough evaluation of current standard operating procedures, personnel requirements, and the patient experience across the clinical and optical journey. Identifying operational constraints and opportunities will provide the foundations to develop sustainable strategy that serves all stakeholders. When preparing to add a partner to your practice, perform practice management due diligence:
- Practice Management. Practice management due diligence offers a behind-the-scenes view of operations, as well as an opportunity to engage with staff and assess the overall physical condition of the office, equipment, and inventories. Also, access employee handbook and HR materials, procedures, training manuals, and any additional materials documenting functions across the practice. (Pro Tip: If any of these assets are outdated, now is the ideal time to update and enforce them to align operations and provide necessary HR protection for the business. If any are missing, now is the ideal time to create and implement!)
- Analyze the Business. A key element of operations due diligence is analysis of past performance to identify the KPIs that are generating results across the practice. Modern EHR and practice management systems organize data, allowing for powerful insights across the practice ranging from identifying growth drivers and bottlenecks, to benchmarking and opportunities for improvement across the practice. Assessing the business by patient segments – new versus returning, patient type, goods and services provided, demographic reporting, etc.— provides a foundation for future strategic decisions across the practice, including scope of care, marketing, and exit planning.
- “Bandwidth for Change.” Adaptability of the existing practice will be a key determinant of the rate at which sustainable changes can be implemented upon adding a partner to your practice. Review all relevant procedures and training manuals, HR assets, and standard operating procedures across each department to gain a clear understanding of day-to-day operations, carefully noting competencies and opportunities for improvement. Additionally, documenting organizational structure, reporting guidelines, training functions and expectations, and employee development and accountability standards establishes the structure to facilitate positive change in the practice.
- Equipment and Inventory. A thorough inspection of equipment and inventory is warranted to determine usability and future sale opportunities. Tour the office one room at a time, creating an itemized list of all equipment and inventory, assessing each item to ensure it is in good working condition, and inventories are in suitable sale condition. This is also a great opportunity to evaluate arrangements that may be in place with equipment suppliers and the in-office processes for maintaining equipment and ordering supplies and inventory. (Pro Tip: Be realistic about equipment lifecycles and future usability, and what’s possible to sell, such that you can include sufficient capital expenditures in the financial pro forma.)
Partnership offers many benefits to established and emerging practice owners, and the communities they serve. Preparing various financial, legal, and operational aspects of the practice for partnership positions all stakeholders for equitable, timely benefit.