By Eric George, Senior Consultant, Williams
Group
Our consulting team is commonly asked about the pros and cons of forming a shared overhead expense arrangement. Many doctors look at this as a way to defray the expense load and even share some of the practice management burden without giving up some practice control in a full partnership. Here are some common questions and issues to consider before going down this path.
For the purposes of this discussion let’s assume the following:
- Doctor EstablishedGuy owns an existing location that Doctor NewGal is now going bring her practice into.
- Dr. NewGal currently generates $325K as a solo practitioner
- Dr. NewGal is bringing 2 staff and some equipment into Dr. EstablishedGuy’s building as they enter into an overhead sharing arrangement.
When first researching a possible shared expense situation you will need:
- The incoming practice’s revenue on an annualized basis.
- The incoming practice’s Cost of Goods (COGs) on an annualized basis.
- The incoming practice’s percentage of net profit on an annualized basis.
- Make certain to get 3 years worth of numbers but weight the most recent year heavily.
- Realize that in all shared expense cases, each doctor pays their own COGs as this cost is directly related to production and is easy to track separately.
Realization for the Dr. NewGal, joining the existing practice: For every dollar Dr. NewGal generates now (before the overhead sharing situation), $X goes to expenses to run her solo practice. So (for example), if she nets 25% as a solo practitioner on $325K then $80k is at the bottom line, the rest goes to expenses. Then when she joins Dr. EstablishedGuy’s office, Dr. NewGal has reduced or eliminated all of her fixed and variable costs.
Now, out of every dollar Dr. NewGal generates in Dr. EstablishedGuy’s office (assuming there is no change in overhead for Dr. EstablishedGuy), Dr. NewGal will pay her cost of goods. This much is for certain. However, at this point, all of the fun begins. How do these two figure out how to equitably share all of the other costs in the practice? Read on!
Question:
How much of the fixed expenses and overhead load does Dr. NewGal pay to Dr. EstablishedGuy now?
Answer:
Start with the expense percentages Dr. NewGal was experiencing as a solo practitioner. In her old practice of $325K yearly revenue, her overhead was 45% (COG’s plus Net Profit = 55% so Operating Expenses are the remaining 45%). Dr. EstablishedGuy could ask her to pay her own COG’s and 45% of her collected revenue and she still would net 25% of her production with no management headaches. Using the 45% of $325K figure means that Dr. EstablishedGuy receives $12K per month from Dr. NewGal so she can be in his practice using his space, staff and resources. The advantage to Dr. EstablishedGuy is that he now can put $12K toward his overhead that he couldn’t before. So they are truly sharing in the overhead now but not the revenue.
Question:
Should Dr. EstablishedGuy receive some additional return (beyond expenses) if Dr. NewGal just sees patients with has no management responsibilities)? In other words, if Dr. NewGal does not want any management responsibilities, should she make the same amount of money in this arrangement that she would have done if she ran her own practice?
Answer:
In this case, there could be some split of her net profit to compensate for the practice management responsibilities shouldered by Dr. EstablishedGuy. So, Dr. NewGal would net 15-18% of her revenue instead of 25%. This would compensate Dr. EstablishedGuy more and more as the practice revenues grow along with the headaches created by such growth.
Question:
What happens if Dr. NewGal is bringing 2 staff people with her?
Answer A:
First, Dr. NewGal should provide 3 years of tax returns so we can determine what makes up her expenses as a solo practitioner. Then, Dr. EstablishedGuy could lump all of those expenses into his. So now he will pay it all and part of that $12K he receives from Dr. NewGal (from the previous example) will go to pay those additional staff and other expenses in the new arrangement. In essence, Dr. EstablishedGuy will now pay all of the practice expenses but will still probably end up paying less than he did as a solo practitioner.
Answer B:
Dr. NewGal could pay her own COGs and her 2 staff people directly.
- 4000 staff hours/year X $12/hour = $48K + 15%(matching taxes, etc.) = $55K/year staff costs for Dr. NewGal).
- That $55k ends up being 17% of $325K she produces. Therefore, out of her 45% expenses, we are saying that 17% is staff cost. So, she would pay Dr. EstablishedGuy 28% (45% overall overhead minus 17% for staff = 28%) and this goes toward his non-staff overhead. With that, Dr. EstablishedGuy can make the argument that he doesn’t have liability for those staff. This scenario prevents Dr. EstablishedGuy and Dr. NewGal from always going back and renegotiating that 45% and Dr. NewGal can make her own staff decisions.
- If Dr. NewGal still wants no practice management involvement, then that 28% becomes 35% for the practice management compensation. (It is fairly standard in the industry to define the compensation for practice management to range between 5% and 7%).
Question:
What if after presenting one of the above scenarios Dr. NewGal asks “What is really in this for me?” and/or “Why don’t we just completely split the overhead?”
Answer A:
Dr. NewGal typically is receiving the advantages of a better facility, more of a unified marketing front in the community against commercial competition, and a decreased practice care load. The scenarios discussed above simply split the costs fairly based on what she is getting from this arrangement.
Answer B:
Let’s pencil out the scenario of just splitting the combined practice overhead down the middle. This may work sometimes, but as the production between the two doctors increasingly differs, the math will not work out. Assume that Dr. EstablishedGuy generates $730K per year. If the combined practice overhead is 45%, then this equals a total of $328.5K per year or $164.25K paid by each doctor for overhead. If Dr. NewGal is producing $325K per year then the math for her half would look like this:
- $325K – (($164K overhead split) + ($97500 for her COGS) + ($55k for 2 staff))
- $325K - $316.5K = $8500 profit for Dr. NewGal. It’s tough to live on that!
Question:
What happens if Dr. EstablishedGuy and Dr. NewGal don’t gel personally or philosophically and one of them wants to terminate the situation?
Answer:
Frankly, Dr. EstablishedGuy has very little risk here because Dr. NewGal is the one who moved everything in and must now move everything out and re-establish her practice. The doctor who takes the biggest risk is always the one who is moving in.
- From the start, both doctors need to agree on a 90 or 120 day “out clause” to be fair to Dr. NewGal and give her time to find another situation.
- A non-compete clause is not an issue because they were set up as competitors before.
- One problem would arise if the practice had purchased equipment while under the shared expense situation. For example, the doctors agree to purchase a retinal camera together but then the shared expense situation is terminated:
- One doctor must buy the other out at fair market value.
- OR if it is a lease situation, one doctor has to buy the lease out from the other in order to take the equipment.
The final step after talking over all of the pros and con’s and compromising on plans to deal with complexities, have an attorney write up an "operating agreement" with the out clause.
A great analogy to this entire situation is the bachelor vs. living together vs. getting married analogy.
- A solo practitioner is like a bachelor or bachelorette has more issues that he or she must confront directly without support. This is more difficult in one sense but can mean more freedom of choice regarding practice decisions.
- A shared expense situation is like living together. There is some “give and take” but they don’t have to give and take as much because they are not married (i.e. full partnership). Remember that technically and legally these practices are separate entities. The trick of getting the shared expense situation to work is being very up front and thorough with complexities like marketing, who gets the new patients, and what happens if one person wants to terminate the relationship.
Finally, usually it is the process of setting up an overhead sharing situation that will reveal the correct answer to the question of whether or not to actually do it.
About the author:
Eric’s educational background is medically focused in the genetics field. However, having run a very successful, multi-doctor optometric practice, he now uses both his scientific knowledge and practice management background to help hundreds of Williams Group ™ clients reach their goals. Eric was a Williams client before becoming a senior consultant and so he identifies with new clients’ concerns regarding change while at the same time he can testify to the results of their efforts. Eric is now responsible for guiding clients through customized implementation of consulting programs, traveling to client offices, public speaking engagements in the US and Canada and many facets of the monthly client training sessions in Lincoln. His specialties include human resource management, budgeting, and marketing.
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