business advisor

Partnership Analysis: Control

You don't need to own 51% of a practice to maintain control.

JERRY HAYES, O.D.

True story: Two O.D.s practicing in the same community for a number of years developed a friendship and decided to merge their offices on an equal basis. An attorney inexperienced in partnership agreements advised them to choose a majority owner, and, against their wishes, split their equity 51/49. His reasoning: "You never want to have 50/50 ownership in case of a disagreement."

Dispelling the myth

Let's explode one myth about partnerships right now. You do not have to own 51% equity in a business or practice to have authority regarding key management decisions. A legal document can spell out conditions that allow a minority or equal stockholder to have complete authority or veto power over virtually any management area of the practice.

For example; your attorney might use this language: "It is mutually agreed that while Dr. Seer and Dr. Tester are equal partners financially, Dr. Seer will have final authority on all equipment purchases of more than $1,000, and Dr. Tester will be responsible for decisions involving the office space and location of the practice (make your own list here).

In another case, two O.D.s in a 60/40 equity split were ready to offer their employed associate a third partnership. The plan was for Dr. Oldy to sell 33% of his share and Dr. Middel to sell 25% of her share resulting in a 40/30/30 split with the associate, Dr. Newby.

Everything was on go until Dr. Oldy realized that his partners would have a 60% controlling interest if they decided to gang up on him.

Again, the three partners could address Dr. Oldy's concern with a clause in the contract that gave him final veto power over the issues he felt were critical for him to manage, such as the approval to switch major suppliers or terminate long-term employees. This control could be for life, set to expire at a fixed time in the future, or based on Dr. Oldy meeting certain production levels each year. Use your own imagination.

Better to own than sell

In my column which appeared in OM's April 2008 issue, I made the case that an optometric practice with $500,000 in gross-collected revenues should produce a pre-tax profit of approximately 30% or $150,000. By comparison, the selling price for that same practice is usually in the range of two to three times its pre-tax profits, or $300,000 to $450,000.

Because the market price for an optometric practice is a relatively low multiple of annual earnings, I feel that a profitable practice is worth more to the owner for the long-term income stream it can generate than for the equity you might realize when you sell.

For that reason, out of the three I.C.E. (income, control, equity) elements of a partnership agreement, I think income and control are more important than the percentage of equity you own.

You get what you negotiate

The fact is, it's very simplistic to base control on who has the majority ownership. You can be a minority owner and have control in specified areas if you build that into your partnership agreement. My recommendation is: Just be sure to get an experienced attorney to help you do it. OM

Disclaimer: The content of this article is for general information only and is not intended to substitute for or serve as legal, financial or management advice.