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A 50 percent partnership may be worth less than you think

Here’s a scenario: You’ve been in private practice for 30 years and would like to bring in a co-owner (i.e., partner) to share the workload, liquidate a portion of the equity to you now and have someone to acquire the other half of the practice at some future date. You don’t want just an employee; you want someone who’ll share your owner’s attitude about the business.

You hire a competent medical practice specialist appraiser to assess the value of your practice, who finds that – primarily because you have two mid-level providers (a.k.a. non-physician providers or “NPPs”) and some in-office ancillary services upon which you profit – your practice has a Fair Market Value of $500,000, including $400,000 in intangible (i.e., goodwill) value above the $100,000 fair market value of the tangible furniture, furnishings, instrumentation and supplies.

You’re probably thinking, “Great! If the whole practice has a value of $500,000, I can sell half for a price of $250,000.” But that might or might not be true.

“Price” is the result of negotiation between two specific individuals, each with their own unique situation. Businesses (and all assets) often sell at a price different from the appraised value. It’s just like a seller accepting a lower price, or a buyer paying a higher price, for a used car than Kelly Blue Book says is its value. The final price is the result of specific negotiation. So you might get a price of $250,000, or you might not.

“Value” is a theory based on a set of facts, and three assumptions, including (1) a hypothetical buyer who is (2) in possession of all the facts and (3) under no undue influence to act. “In possession of all the facts” presumes the buyer also has good, expert counsel. If so, that expert counsel should explain to them the concept of Discount For Lack of Control. “DLOC” refers to the well-supported assumption that if you own something that someone else controls, it’s worth less to you.

Here’s a classic example of DLOC from appraisal school: A buyer meets a seller who owns a piece of bare land, free and clear, with no improvements on it, with an inarguable value of $1,000,000. The seller owns the land through her corporation, and is offering to sell the buyer 49 percent of the shares in her corporation for $300,000. It sounds like a good deal to get $490,000 in value for a price of $300,000. BUT, the buyer is not buying a share of the land; they are buying a share in the entity that owns the land. In that entity, the seller still has a 51 percent interest, which results in 100 percent of the control of the corporation. Forty-nine percent ownership has zero control.

The buyer finds out the seller used to have nine more of these pieces of land, which she lost gambling in Las Vegas. Her intent is to take the buyer’s $300,000, return to Vegas, and win back the other nine pieces of land. Since the buyer is a minority shareholder, there is (almost) nothing the buyer can do to stop the seller. So now, when in possession of all the facts, what’s the value of the 49 percent interest in the corporation that has 100 percent of control of the land and cash?

DLOC is applied to factor in the lessened ability of a shareholder with 50 percent or less ownership of the company. When a shareholder has a 50 percent interest, they can block the action of the other shareholder(s), but cannot force an action with the voting rights of their shares. When a shareholder has less than a 50 percent interest, the other majority shareholder(s) owning more than 50 percent can force their will upon the minority shareholder. Decisions subject to control include: compensation for individual physicians, employment and pay-scale of family or others, electing directors and officers, appointing management and the powers of management, acquisition or sale of assets, relocation, payment or allocation of profits and dividends, incurring debt, and even sale of the company.

Other factors having an impact on value are commonly described as Senior Doctor Rights (SDR). For example, a seller transferring 50 percent ownership to an associate might stipulate that the seller retains the practice lease and phone number in event of dissolution; retains all the practice medical records; retains a job for the seller's spouse as manager; requires a non-competition agreement of the buyer; doesn't have to take call; or has a tie-breaker vote or veto. The ability to have control over SDR is of monetary value, whereas the inability to have control reduces monetary value. This is the basis for the DLOC. The most important issue in regard to the value of the ownership is the control of profit or dividends. The larger the number of shareholders – and the more equitable the language in physician employment and governance contracts – the less likely a DLOC is appropriate because control is limited contractually. So DLOC is more visible, and often of less importance, in a 50-doctor group than in a two-doctor group.

If you are considering buying a minority interest in a business/practice, review the seller’s appraisal carefully to make sure it is of the appropriate, specified equity interest.

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