Protection for a younger partner

[Dr Oli]

I am partners with a much older physician in a single specialty practice. Even though he is over 70 he is not considering retirement for at least 5 years. We desperately needed more office space and so recently went in together (50/50) in forming a separate LLC to build our new office. We couldn't be happier at present and although he says he'd like to pay off our new building before he retires, my worry is that life will happen and he won't make it to that point.

How should I protect myself in this situation. I've heard this is best done with life insurance that we both would purchase individually that would pay to the LLC in the event one of us passed away. Obviously however this policy would be much more expensive for him to purchase than me.

Has anyone else faced a similar situation? Would welcome suggestions.

[jfoxcpacfp]

I realize this is going to sound like a dumb question, but what are you trying to protect in the event of his death? For example:

• Loss of income to the practice?


• Inability to pay off debt of the practice?


• Problems with heirs who would inherit his half of the building?


• Something else?

First consideration I see is what does your partnership agreement say happens in the event of his death? How will his surviving spouse be compensated for her loss of income at his death? Do you have first right of refusal to buy his half of the building? Does the LLC agreement provide for how to value the building? How does your state address non-professionals having ownership of a professional practice?

You are correct that buy-sell agreements are most often funded with life insurance, and also that the premiums on him would be prohibitive. How this works is that, in a cross-purchase, each partner is named as beneficiary on life insurance of the other partner. The surviving partner uses the proceeds to buy out the widow(er)'s share so both survivors end up with what they need. This would have been a good plan years ago when the insurance was affordable. Might be possible now, if that's the best alternative.

Quite frankly, it appears to me that his spouse (assuming that is pertinent) should be more concerned. I think once you identify your priorities and where your weaknesses lie, it will be easier to come up with a plan to resolve them.

[Dr Oli]

Thanks for the detailed reply. In our state (Texas), I don't believe a non-professional can have ownership of a practice.

On the bright side, I looked back at our contract and there is a first right of refusal in the event of death.

I guess my main concern would be how would the "half" of the monthly payment on the building that is his responsibility be structured in the event of his death. Currently we've got a triple net lease structure whereby the practice "pays" the LLC monthly an amount that covers the building payment. This works very well since we're 50/50 partners in our practice (an S corp). However, in the event of his death I would be required by contract to buy out his half of the medical practice. I'm assuming at that point that the practice would pay half of the monthly payment to the LLC and his estate would be responsible for half as well? This is where I guess it would be more a concern for his heirs to ensure that they could cover these payments?

I have a first right of refusal on the building as well but don't think I'd want to buy the other half right away, since I'd already be looking at significantly decreased practice revenue until I can recruit a replacement physician for my partner.

Make sense? Maybe then in our case, it is more important to ensure against lost practice income in the event of his death?

[jfoxcpacfp]

Dr Oli wrote:

I have a first right of refusal on the building as well but don’t think I’d want to buy the other half right away, since I’d already be looking at significantly decreased practice revenue until I can recruit a replacement physician for my partner. Make sense? Maybe then in our case, it is more important to ensure against lost practice income in the event of his death?

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The question is how much would the net revenue decrease after the expenses of your deceased partner are deducted (in particular, his salary)? Would you be able to recruit a replacement doctor who would cost less than the current partner? Rent out 1/2 the building? My guess is that you would pick up a lot of his patients until you could bring in a replacement and you might be better off than you expect.

I wouldn't not want to buy out the building. Would be very apprehensive about having a non-doctor partner (his heirs) and having to deal with that.

Dr Oli wrote:

Currently we’ve got a triple net lease structure whereby the practice “pays” the LLC monthly an amount that covers the building payment.

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You shouldn't make the rent payment equal to the building payment. Need to have an arms'-length lease determined by the rental value of the property, not the amount you have borrowed.

Dr Oli wrote:

However, in the event of his death I would be required by contract to buy out his half of the medical practice.

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Do you have a valuation calculation in your partnership agreement? This could get very dicey and should be agreed upon now, not after his death when his heirs are all arguing about who gets what and what it's worth. Same for you - you could drop dead and your spouse could be left to haggle with your partner. All sides will be arguing about who was more valuable to the practice and so on.

[Dr Oli]

Again, thanks for the detailed reply and you've already given me a lot of useful information. To answer some of your questions above, I misspoke when I said that the practice is paying only the exact amount of the note each month...indeed we are paying a "rent" that is not too close to the monthly note payments.

Yes, we already have a valuation calculation in writing of the exact amount each of us would pay to buy out the deceased partner's share in the practice itself, so this is not an issue.

Although, in regards to the building, he has already stated that he'd like to pass down his "share" of the building to his heirs as an inheritance. I think he has not saved up much to leave them otherwise. In other words, I have first right of purchase but his half may not be for sale upon his death. Since I know this now, is there any way to minimize the potential headaches that may arise? And that also speaks to the legal issue of his heirs being non-physicians, but since we're talking about ownership of the building and not the practice I guess there wouldn't be any legal impediments to this...

[jfoxcpacfp]

Dr Oli wrote:

Although, in regards to the building, he has already stated that he’d like to pass down his “share” of the building to his heirs as an inheritance. I think he has not saved up much to leave them otherwise. In other words, I have first right of purchase but his half may not be for sale upon his death. Since I know this now, is there any way to minimize the potential headaches that may arise? And that also speaks to the legal issue of his heirs being non-physicians, but since we’re talking about ownership of the building and not the practice I guess there wouldn’t be any legal impediments to this…

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No issue on building ownership, it doesn't matter what profession your partners are in if you do not have a "professional" partnership.

imo, you should go ahead and start that conversation. His heirs would probably prefer liquidity to ownership of a building - as long as you pay a fair price, they are still receiving a fair inheritance. Plus, if you are 50:50 owners with the heirs, they are going to want the rent to go up but you are not and you could easily reach gridlock. Plus, what if one of them filed for bankruptcy or got divorced - you would have no control over who future partners could be.

I would approach this from the viewpoint of trying to do what's best for his heirs, because that is a legitimate concern.