Thinking about adding a new partner into your medical practice? How are you going to split profits?
Depending on your entity status you probably have been taking your salary/draw in a tax efficient way. Also, many of you have been using the practice as your personal check book in an effort to lower your taxes. By running your car lease and family vacations through the practice you will reduce your tax burden, but you are distorting the profitability of the practice. You will need to stop the majority of this behavior when you bring on a partner.
Before you add a partner, you need to think of your salary as a competitive salary rather than just minimizing taxes. Imagine that you and your partner were not doctors; instead you were both investors that are going to go out and hire two new doctors with your qualifications and experience. How much would you be willing to pay those doctors to do your job? Wouldn’t you expect something in return for investing in the practice and managing these two employees and the practice?
Split Profits: 50-50
Let’s start with the easiest method, to split profits right down the middle. What if we do the same amount of clinical work, but I am always the go to person when it comes to staff issues? What if I do all of the free work for friends and family? Or, if I am the one who is bringing all of the new business through the door? What if I am the one that spends all weekend going through the books and paying the bills? How about if my partner decides that he or she will be going on a 3-month vacation, how happy will I be to cut a check for my partner’s share of the profits during that time? What if my partner decides that he or she is only willing to work one day per week?
As one can see, this method has some serious draw backs, but in an ideal situation it can work great. For example, let’s say that I am great at bringing in new business and my partner is great at the office management aspects. I may do a bit more production on the clinical side but recognize that my partner’s office management tasks free me up to do more production and marketing. To use this method both partners need to feel equal value for their partner’s contributions to the practice. That feeling is hard to put in a legal document so these partnerships can experience problems.
If we were to set up a deal with a 50-50 split, we would probably want to put in a clause in our partnership agreement that would reevaluate our profit sharing agreement every couple of years in case some of the balance is no longer possible. I tend to see this method after problems arise and partners are going through messy partnership disputes.
Split Profits: Pro-Rata
This method looks at the production that you do vs. what your partner does. In this method, let’s assume the following income and expense for a general dentistry practice:
- Dr. 1: $400,000 in collections
- Dr. 2: $200,000 in collections
Hygiene department $200,000 in collections
Wages for the team (no salary or draw for the two doctors) all other bills: $480,000
This leaves us with a profit margin of 40% before paying the doctors.
In this method, Dr. 1 and Dr. 2 are in a direct competition for clinical production. In this case, the total amount of doctor collections is $600,000. Dr. 1 did 2/3 of the production so Dr. 1 will take 2/3 of the profit ($213,000) and Dr. 2 will take the remaining 1/3 ($107,000) sounds fair, right?
What if I changed a couple of facts? What if Dr. 1 tells the front desk that he gets all of the new patients? What if Dr. 1 has more chairs? Do we really want the staff to take sides on where the patients go? If I am busy managing the practice doesn’t that mean that you are working out of your chair doing more production than I am? If I spend a day out of the office and bring in ten new clients, but you do the work on them am I not hurting myself? As one can see this leads to fighting over patients and an anti-motivational method for managing and promoting the business.
For fun, imagine what happens if we hire three associates and pay them a salary of 35% of their collections. The numbers now look like this.
- Dr. 1: $1,000
- Dr. 2: $500
- Total Associate Production $1,500,000 (3 X $500,000)
- Hygiene: $200,000
Let’s leave the expenses the same and now include a salary for the associates of $525,000 or 35% of $1.5M
This gives us revenue of $1,701,500 and expenses of $1,095,000. That leaves Dr. 1 and Dr. 2 a profit of $606,500 to split between the two of them.
In this method, they are in competition against each other not their associates. Dr. 1 and Dr. 2 have been able to bring in other people to do the work for them while they sit back and manage/invest in the practice. This method would have Dr. 1 take 2/3 of the profits or $404,333, while Dr. 2 would take only 1/3 or $202,167. This is an extreme example, but it highlights the point that this method is a little quirky. It should only be attempted if the doctors feast on competition. Consequently, multiple highly competitive clinicians can make this system flourish.
Corporate Split Method
In this method, each owner will be given two hats to wear. The first we will call their clinical hat, and the second their investor hat. What we are going to do is pay each other a salary based on a percentage of each doctor’s clinical work (typically between 35%-40%). We are going to pool all of the revenue (even from hygiene) pay both doctors their salaries and then pay off all of the bills. All of the remaining profit will then be split 50-50.
In this case, the better producer is going to get a higher salary, but what about the management/investment incentives? If we both know that bringing in new business or taking care of that staff issue before it gets out of hand will increase the profitability. Both of us have incentive to grow the practice profit as we are splitting it 50-50, after our salary of course.
If the production is the same amount wouldn’t we be able to just split everything 50-50? Yes, if you and your partner were equal producers you would probably be indifferent between this method and the first method we looked at. However, keep in mind that this method will protect each doctor during times of vacation or short time illness. The partner who is in the office will be compensated for the work that they will do. Both partners will still be splitting the profits with the person who is out. Both parties will see a drop off in profits and that month’s split of profits, but each will have a consistent flow of cash coming from the practice. It is important to put in expectations for each partner duties when doing the contracts. These expectations would balance the management/marketing duties and ensure a minimum amount of clinical participation.
Which Method Should You Choose to Split Profits?
I tend to find that the Corporate Split method tends to work for most deals that I touch. This is due to having dual incentives to keep the partners in check.
I tend to not recommend people use the equal split of profits method. On occasion, I’ll run into an all for one practice that can thrive, but it is pretty rare. Unfortunately, I mainly see the equal profit split method when they are in the process of breaking up the partnership.
I don’t think that Pro-Rata split of profits is flawed, but it takes highly motivated partners to make it work. Therefore, I rarely encourage people to go with it.