Why You May Need a Buy-Sell Agreement for Your Healthcare Practice
What happens to your business partners’ ownership interests if they die or leave the practice? A buy-sell agreement can help you control the possibilities.
Do you share ownership interest in your company with others? If one of your fellow owners died or decided to leave, what would happen to their interest? Would you want to prevent their interest in the company from transferring to someone you don’t know or trust?
Many scenarios could lead an owner to leave a company, voluntarily or otherwise. In anticipation of such an event, the business partners may want to restrict future transfers of ownership interest. They may also want to lay the foundation for the company’s succession plan well beyond the original owners’ lifetimes. Enter the buy-sell agreement.
A buy-sell agreement is an umbrella term for agreements to transfer members’, shareholders’, or entity ownership interests in an LLC or corporation. You may also hear people refer to such agreements as “buyout agreements” or “put-call arrangements.” Note, however, that while some use the terms “buy-sell agreement” and “put-call arrangement” interchangeably, there are some important differences that we will discuss later.
When to Enact a Buy-Sell Agreement
Ideally, business partners create buy-sell agreements early in the formation process, before any conflicts arise or the partners develop their own personal interests within the company. As a result, you’ll often find buy-sell agreements in governance documents, such as the operating agreements for LLCs or PLLCs. As with any provision in these documents, it’s important to include mechanisms for changing the terms of the buy-sell agreement as the business matures and its needs evolve.
How Does a Buy-Sell Agreement Work?
A traditional buy-sell agreement stipulates what happens to an owner’s interest in the company if they die, leave, or are otherwise no longer on board. It creates the “options” the company or remaining owners can exercise when the departing owner sells their interest. It also specifies how to calculate the value of that interest.
Some buy-sell agreements require that the company redeem the interest for the calculated value. Other agreements stipulate that the remaining owners must buy out the departing owner. Finally, buy-sell agreements can be a hybrid of these two models, requiring that either the company or the remaining owners purchase the departing owner’s interest and prescribing the order in which the two options occur. For example, the remaining owners, in their individual capacities, might have the first option, while the company must purchase the interests if all the owners decline.
Put-Call Arrangements
Put-call arrangements are provisions that sometimes appear within buy-sell agreements. They seek to ensure fairness if a member or shareholder tries to buy out another’s interest. Put-call arrangements can create further avenues of resolution for companies whose owners struggle to cooperate or agree.
The “put” option is an owner’s offer to sell their interest to the remaining owners. The “call” option represents an offer to buy another owner’s (or owners’) interest.
Under a put-call arrangement, an owner can offer to buy another owner’s interest for a given price. The owner making the offer becomes the “offeror,” and the owner receiving the offer is the “offeree.” If the offeree accepts the offer, the offeror buys out the ownership interest. However, if the offeree rejects the offer, the put-call option allows the offeree to turn around and purchase the offeror’s ownership interest at the same price.
What makes a put-call arrangement different from a traditional buy-sell agreement is the opportunity for the seller to become the buyer. Some experts refer to put-call arrangements as “Russian Roulette” because an owner does not know whether they will be the buyer or the seller when making the offer.
The “I Cut, You Choose” Method
Here’s a helpful analogy for how put-call arrangements work. Many people know what it’s like to have siblings. What happens when Mom and Dad bring home a delicious cake? Each sibling wants the biggest and best piece. A parent could act as a neutral third party by cutting and distributing the slices. But let’s say that a neutral third party isn’t an option. How can the siblings ensure fairness? People have used the “I cut, you choose” method since ancient times.
If John cuts the cake and takes the piece he wants, he will make his slice much larger than Mike’s. However, if John cuts the cake knowing that Mike has the first choice of slices, John will have a strong motivation to cut two equal pieces.
Put-call options work just the same. The owner making the offer is cutting the cake. The owner receiving the offer chooses the outcome (the slice of cake). If the offeror undervalues the offeree’s interest, the offeree could reject that offer and buy the offeror’s interest for the same lowball price. The offeror would lose out because they acted unfairly.
Uses of Put-Call Arrangements
A put-call arrangement can specify what must occur for an owner to be able to make a put-call tender or what happens when an offeree fails to accept or reject an offer. For example, the stipulations could include a put-call trigger when owners cannot agree on a proposal or when one owner no longer cooperates well with the others. In this way, exercising put or call options can break a deadlock in critical decision-making.
Note that a put-call arrangement can function as a force-out provision. There’s no requirement to wait for an owner to be terminated, to die, or otherwise become unable to continue as a member or shareholder. However, an owner who makes an offer could, in turn, find themselves forced out.
Get Legal Support
New practice or business partners typically focus exclusively on the tasks involved in building a successful and compliant enterprise, with less concern about how the business relationship might end. Fortunately, an experienced healthcare attorney can support your formation and launch while anticipating the challenges that arise as businesses grow, change, become acquisition targets, or dissolve.
Contact us to ensure that your contracts and governance documents address these potential challenges. You can schedule a free consultation if we have licensed attorneys in the state where you operate.
This blog is made for educational purposes and is not intended to be specific legal advice to any particular person. It does not create an attorney-client relationship between our firm and the reader. It should not be used as a substitute for competent legal advice from a licensed attorney in your jurisdiction.