As the D.I.Y. movement grows, we are seeing more and more risky areas. In this episode, Michael and Brad share a cautionary tale of a surgeon client who decided to build his own exit plan that was doomed from the start. Tune in as we dive into the details of understanding the financial health, legal health and operational health of a medical practice.
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Intro: [00:00:00] Welcome to Legal 123s with ByrdAdatto. Legal issues, simplified through real client stories and real world experiences. Creating simplicity in three, two, one.
Brad: Welcome back to another episode of Legal 123s with ByrdAdatto I’m your host Brad Adatto with my cohost Michael Byrd.
Michael: Thanks Brad. As a business in healthcare law firm, a client call is usually a request for help. The problem lies with the client’s timing on when they ask for help. Sometimes they ask for help long after they made a decision that was set to doom an opportunity from the start.
Brad: Yes, Michael timing is key. It makes a big difference, both on the size of the problem and eventually the outcome. And sometimes timing is something that we just can’t fix. Often we’ve heard if those of you have heard other episodes you have heard us talk about the 5/50 rule where you either pay us $5 up front to do it in the right or $50 in the back end, or as one of our clients call it the 5,000/50,000 [00:01:00] rule. But either way it’s a painful discovery.
Michael: Yes, for sure. Brad, are you familiar with the DIY movement that we have seen across all aspects of our lives in recent years?
Brad: Yes. The DIY do it yourself. Yes and why?
Michael: YouTube can make you a so-called expert on anything. Brad, do you have any home improvement projects or other DIY projects where you were doomed to fail from the start?
Brad: I can say I’ve absolutely made my mistakes over the years, especially with DIY home improvement moments. When I first bought my first house, I did paint every single room in the house. So I felt pretty sufficient. And then when it came to the caulking of a bathroom, not so bueno, and then I started getting more complex renovations, it got worse. So I quickly learned that I actually had a really good skill set with my DIY, which is picking up the phone and calling someone else and paying them to do it. [00:02:00] How about you?
Michael: Yeah. I am like that as well. Well, I’m going to share something with you, Brad that is just between us so don’t tell anyone.
Brad: I won’t tell them. Don’t worry, no one’s listening.
Michael: Okay, good. Actually you probably will remember the story. My biggest fail happened in advance of my wedding in 2013. And as you know, our family’s story is complicated, we’re a blended adoptive family. So my daughters needed to be measured for bridesmaid’s dresses and my wife, Stephanie gave me the sheet that needed to be filled out for their measurements so that she could order their dresses.
Brad: Seems normal.
Michael: That night I looked at the sheet and thought yeah, I don’t need to go to a tailor to get that measured. I can just do it myself. I didn’t have a tape measure though. Oh, But I did have a ruler. So I found as any good DIY person would a solution. I found a piece of [00:03:00] string and I took the measurements with the string of both of my daughters. And then of course measured the string with the ruler. So I can actually get the results. I didn’t tell my at the time, future wife how I took the measurements because I didn’t even think twice about it was all logical. A few weeks before the wedding, both dresses came back and they were way too small. And I don’t mean like my oh, wow that was just a size too small. I mean, like for my daughter who was in high school probably would have fit her when she was about eight or nine years old, they were unusable. And so I explained to my wife what I had done because I couldn’t understand why they were so off. And as you might imagine, she was horrified. We ended up having to pay double to put a rush on two brand new dresses, just a few weeks out [00:04:00] from our wedding. We laugh about it now, but it was definitely not funny at the time.
Brad: Yeah first, I absolutely remember this story. Great epic fail, Michael. Congratulations. And it’s actually a perfect example of the 5/50 rule. Um, second we’re all still surprised that Stephanie decided to marry you anyway. So your DIY solution was doomed from the start it sounds like.
Michael: Yes. For sure. I gained some serious wisdom towards the solution we both have identified, which is having someone else help and stay away from the DIY. As we’ve seen this movement grow, probably because of YouTube, we’re now seeing it go into more risky areas. I know you and I have talked about these websites where you can buy Botox and other medical products online and then do it yourself at home.
Brad: Yeah that sounds like a great idea, you know, sticking a needle in your face with no medical [00:05:00] training. That’s like saying here, hold my beer while I juggle some chain saws.
Michael: Exactly. Well, that brings us to today’s story. We had a surgeon client who decided to build his own exit plan and was doomed from the start.
Brad: Michael, our first vocabulary word of the day exit plan in the context of what we’re referencing with medical practices or other small businesses. The exit plan is the strategy to eventually sell the business that the owner has built. And I think we’ll discuss a lot of that in detail in the story.
Michael: Yeah, so several years ago, we were hired to help a surgeon make his associate a partner in his practice. This was another step in selling the practice to his colleague that had joined our client out of fellowship training. Several years previous, our client is one of the most giving people we’ve worked with and a quality that is just reiterated by anyone that knows him and loves him. [00:06:00] We’ll call our client for the story, Dr. Generous.
Brad: Good name. There’s nothing unusual about this in the story that you’re about to give. In fact, we have several of these types of projects that are ongoing at any given time.
Michael: Yeah. There was nothing that stood out. I remember you and I talking about it right afterwards and, you know, Doctor that joins the practice out of the school, has been there and is going to become a partner. Business as usual. Something we deal with all the time, they all have their different obstacles, but it just seemed like no big deal.
Brad: Yeah maybe this is the point where we should ask Rob, our podcast engineer. Maybe he should start queuing the foreboding music, I feel like something like that’s about to happen.
Michael: Well, that’s probably fair since it made it into a story about when to ask for help. But yeah, there were several factors at play [00:07:00] that created obstacles to this transaction. And we talked about those things, but ultimately there was one fatal DIY mistake that doomed the relationship from the start and really, you and I didn’t even talk about that doom factor at the beginning because you couldn’t see it yet. It was kind of hidden, it was hidden in plain sight, but it was not until you really got into it that you realized that it really was dooming the entire deal.
Brad: I like this. So we have a mystery with some scary music playing in the background. So let’s break down these obstacles and touch on the very first one. So as you said, we worked on this one together and we both know one of the biggest obstacles was the actual value of this particular practice.
Michael: Yeah. I mean, if you’re going to sell a practice, you have to know what the value is. And there’s a lot to unpack there, but here, Dr. Generous is a famous surgeon. His practice was what [00:08:00] we call an outlier practice with extremely high revenues and a lot of factors that yielded a really high valuation by a third-party valuation company. And this actually posed a challenge because the practice was worth so much and we had to figure out a way to structure it so that this associate could afford it, to buy into it. So as we introduced the associate into the story, we’ll call him Dr. Nervous.
Brad: All right. So we have Dr. Generous, and now we have Dr. Nervous, but you know, you and I have dealt with this type of issue many times where the founder has built such a valuable business. It’s difficult to determine how to bring on that new owner. And I know we’ll discuss some creative solutions as we go throughout today, but for our audience, why the name Dr. Nervous?
Michael: Well, this was actually the second [00:09:00] obstacle that we faced. Dr. Nervous suffered from analysis paralysis. So we had an ongoing challenge from the discussions screeching to a halt whenever Dr. Nervous got stuck. So think about as you remember, Brad, we would come to an obstacle, come up with some ideas on how to be creative. Share that with Dr. Nervous and his attorney who’s still a good friend of ours. And things would just go to a screeching halt because he couldn’t figure out what to do with it.
Brad: Yeah, that was challenging, but not insurmountable. So obstacle one valuable practice check, obstacle two analysis by paralysis check. Michael, do we have a third obstacle?
Michael: Yes. Dr. Nervous had been an employee for seven years at the time of the discussions. Because Dr. [00:10:00] Nervous had contributed as a surgeon to the practice for so many years, the waters start getting muddied as to what value Dr. Nervous had created himself for the practice. And this is a long time for an associate to be an employee under this DIY model that Dr. Generous had created, so it was an obstacle to deal with. The problem posed by Dr. Nervous of why am I going to pay for something I created.
Brad: Yep, and we’re going to get more into the model. I think we should save that to after our break, but let’s focus on why this particular DIY exit plan was doomed from the start.
Michael: And this is the one that was hidden in plain sight. We often see that people’s greatest gifts can also be their greatest weakness. Dr. Generous was way too generous in what he paid Dr. [00:11:00] Nervous as an associate over the seven-year period.
Brad: Yeah. And what we remember, is that Dr. Nervous, I guess you said he had been there for seven years and was a high producer. He made a lot of money, but he also made a lot of money as an employed physician.
Michael: Yeah. And Dr. Generous allowed Dr. Nervous to benefit from the ancillary revenues created by the practice.
Brad: Michael, second vocabulary word of the day is ancillary revenue. So again, that’s a term that’s used a lot by attorneys, but it’s used in the medical industry, but this references other revenue generated by a particular medical practice, not connected to the actual work performed by the physician. So this can include fees generated in the operating room by the facility itself, sometimes called facility fees, or even based on revenues generated by the physician assistants, nurse practitioners, or nurses when they’re performing. Hey Michael, you like this word noninvasive services. And in this case, Dr. Nervous, again, a non-owner [00:12:00] was receiving a lot of these benefits.
Michael: Yeah. And the instrumental challenge was that there was no way to structure the buy-in to the practice without Dr. Nervous taking a huge pay cut for several years. So think about obstacle one, we have an outlier practice that’s worth a ton, and then you combine that with this doomed obstacle, which is why would I buy into something when I’m making so much money as an employee.
Brad: Yep. This problem was amplified by the other obstacles that we’ll discuss, but let’s go into commercial, Michael. And on the other side, we’ll talk about how things could have turned out differently for Dr. Generous, had he not tried the DIY and if he had known when to actually ask for help.
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Brad: Welcome back to Legal 123s with ByrdAdatto. I’m your host, Brad Adatto with my cohost Michael Byrd. Michael, the season theme is when should I ask for help. There’s a lot to unpack from the Dr. Generous story and the doomed DIY plan when he developed this, when he hired his own associate to buy in his practice. And we’ve mentioned a lot of things about Dr. Generous and his implementation, but let’s talk a little bit about what was doomed about this DIY plan and what he did to make this DIY plan.
Michael: Yeah. So, you know, the idea of bringing an [00:14:00] associate in with a goal to buy into the practice is a common model. And so doctors commonly follow this model, and it’s not YouTube videos, but it’s, you know, colleagues that they see at conferences or in the locker room at the hospital and they hear, oh, well, this is how I brought my associate in. And so I’m just going to do that. And there’s really no strategy beyond just adopting how someone else did it.
Brad: And so you’re saying that there’s a trick that there are other strategies to hiring other associates. I think what’s important in this particular story is when they’re hiring and there’s other strategies that they can come up with.
Michael: Yeah and the key word you use, Brad is strategy. I mean, it is not a strategy to simply adopt what someone [00:15:00] else did. Well, it is a strategy, but it may not be a good one. Dr. Generous knew why he wanted to hire Dr. Nervous, but he didn’t know how to design the plan so that it fit both with his goals and with the practice. And we actually, when we give these lectures at medical conferences where we talk about different exit plans and this plan is common enough that we have our kind of term of art that we call it, we call it the sensei plan.
Brad: Yes. I love that plan. And the idea for the audiences, that sensei plan is you are the founder of the entity. In this case, the physician. So you’re the sensei and you bring on this associate the grasshopper and you want to train them about how to be a great doctor and integrate them into your practice and eventually transition and train them on how to be a great partner with the idea of selling them some or all of your practice.
Michael: Yeah. And this model [00:16:00] tends to work best with a shorter employment period of one to three years and then buy-in. The strategy is to allow enough time for the associate to become busy and self-sufficient with his or her practice and then move to the buyer.
Brad: Yeah. And ideally you want to design the compensation model so that there is an upward trajectory in the compensation even during the buy-in period.
Michael: Yeah. And when you’re designing it, there’s other factors at play. I mean, you need to design or offer a competitive compensation at the beginning so that you can recruit them. And there’s things Dr. Generous could have done even offering a competitive comp that would have improved his chances. He could have shortened the employment period. As we just mentioned it and done the buy-in after about year three and there wouldn’t have been this huge, [00:17:00] reliance on this compensation that Dr. Nervous had been making and this obstacle of his contribution or perceived contribution to the practice. And then another thing is just not to offer compensation on ancillary revenues in the employment offer to Dr. Nervous.
Brad: Yeah. And the ancillary revenues are typically the fruit to be enjoyed only by the owners of a practice. And oftentimes there are a massive number of regulatory reasons why an associate can’t even participate or be allowed to participate in the actual ancillary revenues. And we’ve talked about these regulations in some of our past episodes but on a very high level it’s based on a lot of federal and state rules often call the anti-referral law or sometimes going to stark laws known as an anti-stark and anti-kickback laws. Whenever a medical provider receives payment for referring a patient to another service, this can trigger these laws [00:18:00] and you’re basically paying someone for the volume or the value of their patient referral and the provider who’s actually not performing the services wouldn’t have to meet some type of applicable exception. And Michael, I could probably spend the next 45 minutes discussing all these exceptions and even my family members who are the only loyal listeners we have, all three of them, they would actually probably stop listening if I went through all these details. So let’s get back a little bit to where we are with today’s story.
Michael: Well, first let me acknowledge and agree that yes, it’s super boring to get into that level and it ends up protecting these laws, protect our clients from making this exact mistake because they can’t do it often. But here, fortunately for Dr. Generous, it was actually in a state where what he did was compliant and the structure of his practice made it compliant. But that was just dumb luck because he did it himself. Yep. And we don’t [00:19:00] know if Dr. Nervous’s analysis paralysis would have prevented even a well-constructed plan from working. Brad, when should Dr. Generous have asked for help?
Brad: You know, ideally the quick answer is that he should have asked for help prior to hiring Dr. Nervous. Beyond the when to ask for help, let’s really talk a bit more about what he could have done actually at the beginning of this.
Michael: Totally agree. I mean, we always start with the idea of starting with a practice assessment before you can embark on a strategy to transition your practice. You have to know what you have. You have to lift up the hood and take a look.
Brad: Yeah. And you need to understand certain aspects of your practice. What is your financial health? What is your legal health? We were just talking about the ancillary piece with operational health, and then I always see all that plays into the overall valuation of the practice, which typically is once you understand that really is the first major [00:20:00] step.
Michael: Yeah. I mean, just taking financial health as a category. I mean, you want to look at your different revenue streams and your overhead. Many practices have overhead creep over the years and particularly when it comes to staff, their loyal staff has been there forever. And so that impacts your strategy to have an exit plan. When you have these kind of warts to your business that just naturally accumulate over the years.
Brad: And your legal health is really looking at your legal structure and identifying well, are there any compliance issues that need to be addressed prior to actually bringing someone on.
Michael: Yeah. I mean, we have so many great stories, Brad on the legal health. You mentioned one just, as you said, a couple of times now with the structure of ancillary revenues. And we have so many stories of clients, they’ll say, hey, I’ve got three different business entities. I’ve got my medical practice [00:21:00] and my surgery center and my medical spa. And then you start looking into it and realize they may have formed those entities, but they’re really just running everything through one practice and you’ve got to figure out, okay, what’s the impact of that as you start going towards your plan. The operational health, all of these things are similar but with the operational health you want objective, we look at the practice through the eyes of an outsider. Do you have family on staff that could create an obstacle? We have so many times where spouses are also the office manager or a nurse. And this does create challenges to someone that’s looking to buy in. And I mentioned this before, but if you have a loyal team that’s been with you forever, are they going to buy in to working with a new doctor?
Brad: We we’ve talked about this as ultimately you have to understand what is the idea of trying to find out [00:22:00] what the actual value of your practice is. In this case, Dr. Generous, as we discussed, had an extremely valuable practice and was something to strategize about upfront before he got into this.
Michael: He clearly would have benefited by knowing what the value is, because that would impact trying to create a compensation strategy for Dr. Nervous as an employee. And then, you know, Brad, what you have on your hands. The doctor, in this case, Dr. Generous needs to identify his late career goals. It’s hard to build a plan if you don’t know where you’re trying to go.
Brad: We’ve talked about before driving or being blindfolded or all these other things. If you don’t know where you’re going, it becomes a problem. It’s much harder than it sounds, we’ve helped many doctors over the years to exit a practice. And from the professional financial, emotional variables that come to [00:23:00] play. It gets very difficult. Ultimately, Michael, this is something they built and so it’s their baby and they have to figure out how to let go sometimes. Well, Michael, let’s tell the audience how this worked out for Dr. Generous.
Michael: Well, things did not work out with Dr. Nervous and he eventually left the practice. That was in fact the comp issue did doom it from the start. Thankfully, Dr. Generous was still young and had an amazing practice. We worked with him to build his exit plan and built a plan that fit his goals and it leveraged all of his great qualities and particularly his generosity.
Brad: Yeah. We were talking about the sensei plan earlier, but when he decided that he wanted to go with a different path and he just wanted to employ the physicians without their ability to actually have ownership. But Dr. Generous was able to continue to be generous on how he paid them. He created a win-win [00:24:00] for the practice to make money, but also hold onto his equity. And Dr. Generous was also able to maintain more importantly to him, the control of the practice, even in his late years at the practice. So, Michael, any final thoughts?
Michael: Yeah, this season we talk about when to ask for help. And inevitably the answer is earlier than when the problem arose, but what it comes down to is if you have a strategy, no matter what the situation is, in this particular case, we’re talking about an exit plan, but having a strategy sets you up for success than just jumping in feet first and then seeing how it works out.
Brad: Yes. And as we know, we have a good friend that told us once before hope is not a plan.
Brad: Join us next Wednesday when we have blind spot partnering with a friend. And again, we have a special guest joining us.
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