New Associate Compensation and
Buy-in Structure

Let's say that you waltz into your  practice (bright and chipper) on a Monday morning with your Starbucks cappuccino, a triple-berry six-grain scone, and you are also riding the secure feeling that comes with owning a mature, fully booked optometric practice.  In addition, no staff member has called in sick today, which is nice.  However, a special excitement is in the air today because you have decided to bring on an associate.  Yes, you have done the research and determined that your practice can support at least a part-time associate and this promises to be your primary future avenue for growth (and best bet for a day off).  You are confident in the decision because you've used your expert consulting partnership to make certain that it will work financially (yes, that is a shameless plug, but for guidance regarding whether an associate is right for you, click here. 

To get to this point you evaluated resumes, checked references, conducted phone interviews, and so today you are meeting with the associate that you feel best fits your practice style.  Later, as the caffeine slowly recedes from your synapses, this cheery feeling gives way to the thought that you have no idea how to answer the questions that this potential associate is certain to ask:

• When will I be making $100,000 per year?

• When will I be able to buy in as a partner?

The answers to these questions will vary widely based on the specific situation.  However, in this article I have outlined a few of the common threads that tend to run through this process of compensating an associate and eventually structuring a buy-in.

Dating versus Marriage
The contrast between associate-ships and partnerships is analogous to the contrast between dating and marriage.  When you first decided you were ready for a lifelong commitment to a spouse, you almost certainly did not go out, talk to a few likely candidates in one night, and then choose the person that would be your partner for life in a legally binding relationship (unless you were in Las Vegas).  If you did do this, then the risk of divorce is extremely high.  The divorce rate in the United States (as reported by the U.S. Census Bureau) states that nearly 50% of all marriages will end in divorce in less than 15 years.  Interestingly, enough optometric partnerships closely mirror this statistic.  In my tenure as a consultant I estimate that many practice-owning optometrists go through 2 to 3 associates before they find the one that will succeed as a partner.  To bring in our analogy again this is not unlike someone dating many different people before finding the one person they know they want to marry.

Here are some various issues to consider before and during the process of bringing in a new associate:

• A part time associate starts to make financial sense for a solo practitioner when he or she reaches approximately $700k per year in revenue.  That is a ballpark figure that indicates an optometrist is fully booked and has little room for growth based on volume without significant changes in technology or building layout.

• The average starting salary for young OD’s just out of school and practicing fulltime in a private practice, is approximately $80,000 (depending on area of US and depending on benefits like AOA dues, insurance, 401k, continuing education expenses, etc.).

• Example:   The associate’s salary is $67K and the package with other benefits is $13K (AOA dues, health and malpractice insurance, continuing education stipend).

• The new OD should practice for a minimum of one year before the potential for purchasing part of the practice is available.  (You must date before you marry!)

• Make certain the new associate will have all licenses completed well before joining the practice.  Make all agreements conditional on the completion of licensing requirements.

• The key to positioning the transfer of some patients to the new associate is by marketing the concept that, "We have always stayed on the forefront of optometry and in keeping with that the new doctor has all of the latest skills while maintaining the personal attention that the practice has always been famous for." 

If the above concepts seem to work for you, then it is time to decide how to pay your associate.  Associate compensation is based on a guaranteed salary, production-based salary, or some combination of the two.  The final structure of the compensation is negotiable and can take many different forms.  Here are the three most common associate compensation structures that I discuss with my clients:

Example 1:
If the average associate out of school can earn $80,000 per year working full-time, then working 20 doctor days per month 12 months per year equates to a rate of approximately $335 per day.  It is rare that the first time you bring in associate you will be able to provide them with five fully booked days in your practice.  Therefore, one common scenario is that you will pay your associate that daily rate for one to three days in your practice and then they may have to seek another day or two outside of your practice to bring them up to full time.  Since this is guaranteed salary, you must pay it even if the new OD does not see any patients.

Example 2:
You can pay your associate strictly based on production.  This incentive based compensation encourages the new OD to see as many patients as possible.  The more exams he or she performs, the more he or she is paid.  15% to 18% of the associate’s production is a very fair rate of compensation.  If you pay them a higher percentage than this, it is likely that part of their compensation will be coming out of the overall net profitability of the practice (The owning doctor’s pocket).  In order to make $80,000 a year by taking 18% of their overall production (collected receipts) based on 20 doctor days per month the associate would have to produce $444,000.  That is a little less than seven full exams a day at a revenue per patient of $275.

Example 3:
Many practices combine the above examples by paying a lower daily rate and then giving incentives if the associate hits a higher average monthly production target.  The associate may earn a guaranteed rate of around $250 per day and that would cover any production up to about $1250 per day.  At the end of the month, the associate would receive an extra $50 per day for every $250 increment they averaged over that base of $1250.  For example, if the associate averages a collected receipts rate of $2000 per doctor day, then their compensation rate for the month increases up to $250 plus $50 plus $50 plus $50 (or a total of $400 per day).

The amount of production that the associate will need to generate in order to cover his or her salary will vary depending on the resources you must commit for the associate to see patients in your practice.  For example, if you already have ample staff, two fully equipped exam lanes per doctor, and adequate miscellaneous resources necessary to support additional production, then the associate will have to produce $700-$1000 per day to cover his or her salary.  On the other hand, if you must remodel and add space to your existing building, hire more staff, and take on the debt load associated with additional equipment, then the associate will need to produce closer to $2000 per day in order to pay for those additional resources as well as their compensation. 

Congratulations!  You have successfully located, hired, and integrated your new associate into the practice.  If everything is going well after a year, then the associate is likely considering the option to begin the buy in process.  What do you do now?

My colleague, Bill Nolan, is the Vice President of Client Services at the Williams Group.  He is an expert in many areas of practice management but especially when it comes to establishing the value of a practice, structuring partnerships, and determining fair compensation among partners.  When discussing the buy-in process to clients, Bill uses the analogy that the initial partnership process is much like a three-legged stool.  All three legs have to be solid or the stool will tip over.  I utilize his analogy all the time in my discussions with clients as well.

The first leg is the value of the practice.  Someone must establish this (typically a third-party).  Practice values are established via many methodologies; however, establishing this value is a priority over anything else in this process.  This is similar to the discussion between a couple getting married regarding the issue of having children.  You and your new associate may be compatible and agree on everything while practicing optometry together but if you disagree on the basic value of the practice, it will be the point that would tear things apart later.  So, the value of the practice must be determined early in the relationship with the associate before that value becomes cloudy from the practice building efforts of the new OD. 

Clients commonly ask, “Where do you allocate the value for the associate and what goodwill they built on their own?”  Keep in mind that what the associate is buying is goodwill (the expectation of earnings based on benevolence of the previous owner).  Yes, you can make an argument that if an associate is there long enough that they have created goodwill.  If the associate waits 10 years before buying into the practice, then they created some good will and should receive some credit for that.  If they have practiced with you three years or less then there is typically no adjustment for creation of goodwill during that time.  During that first one to three years, they were compensated very well to work the existing goodwill of the practice but likely built very little goodwill in addition to what existed.  Here are some final thoughts on establishing practice value:

• A practice value appraisal is the value of the business at a moment in time based on historical information. 

• An appraiser typically uses the last 3 years of financial data to appraise the practice.  Those years can be weighted if some major practice change took place like a new building.

• Practice appraisals are not an exact science.  If the seller thinks the appraisal is too low and the buyer thinks it is too high then it is usually right on the money.  The practice value as set by a third-party appraisal is merely the beginning point for negotiations.  This is similar to buying or selling a used car.  Just because the nationally established blue book value of the car is $10,000, this doesn't mean that the owner must sell the car for $10,000.  She can set the price higher or lower but that blue book value gives both parties a common basis for initiating negotiations in good faith.

The second leg of the stool is the terms and conditions under which the partners can do business.  How much is for sale?  Who is going to finance the buy-in?  How will the doctors compensate themselves? What is the nature of the partnership going to look like?  Can you still run a country club membership, car payment or cell phone through the business? 

Partnerships are legally binding entities and there are approximately 20 issues to work through before signing on the dotted line.  A solid partnership contract is necessary to define the terms and conditions clearly to all involved parties.  The contract defines the timetable and structure of the buy-in as well as all of these other miscellaneous issues. 

Let’s focus on just one of those terms and conditions issues that I am constantly asked about: the covenant not to compete.  This covenant is put in place to lessen the concern that a young associate or partner will practice for a short time and then move across the street to start a brand-new practice.  Historically these covenants have been very difficult to enforce legally.  Recently, I have seen more of them structured as a “covenant to compete” rather than a “covenant not to compete.”  What this means is that the contract stipulates what will happen if the associate or partner does leave to open up a new practice in your geographic trading area.  However, the covenant has to be reasonable and so in addition to a geographic restriction, a dollar value is set to the covenant based on potential practice earnings from that OD.  The model of a covenant to compete is generally as follows:

1. Determine what the associate generated in volume for the year (for this example let’s say $225K in collected cash).

2. Determine the net of your practice (for this example say 25%).  So, if the associate is producing $225K this year and then leaving, that means that $62K (25% of 225) in net profits will potentially be going with him or her.

3. Not every patient will follow that associate but potentially 70% to 75% will.  Therefore, $62K X 70%  =  $43.4K that he or she must pay to replace the loss in good will for that year.

Let’s say this happens at year 3:

Year one doctor produces $70K x 25% net x 70%  = $12.25K paid to owner for year one of contract.

Year two doctor produces $150K x 25% net x 70% = $26.25K paid to owner for year two of contract.

Year three doc produces $225K x 25% net x 70% = $39.37K paid to owner for year three of contract

Total paid for covenant to compete = $77.87K.
Most practices cap this covenant at 4 years.

The final leg of the partnership stool is compensation. This can be the trickiest of the three.  In most cases I recommend a partnership compensation structure that splits the net profits of the practice into two categories, percentage of ownership (equity) in the practice and doctor production.  Commonly I see the net profits split between these two areas in one of the following three ratios, 50% production/50% equity, 60% production/40% equity, and 70% production/30% equity.  The ratio chosen depends upon the individual circumstances and the size of the practice. 

The equity side of the equation is what the new partner is buying and the income from that amount will typically cash flow the debt load associated with the practice purchase.  This leaves the new partner with the production side of the equation to live off of until the 7-10 year buy-in period is complete.  An example of such a split (with the 70/30 ratio) is as follows:

Assume that the cash amount of the Net Profit in some period of time = $100,000

ENLARGE

All of the issues discussed in this newsletter are but a small number of all the considerations and complexities that must be planned well if one is to have the best long-term experience in an optometric practice partnership.  Making decisions and creating these plans based on sound financial data and industry expertise will give any fledgling partnership the best chance for success. 

Remember that excited (if not over caffeinated) optometrist at the beginning of this article?  If that describes you and your situation, perhaps now you can interview the potential associate and feel a little better armed to handle the questions and concerns that they express to you.  It might even be the last associate “date” you ever need to go on.  Good luck!

Take this month's brief survey on compensation and buy-in structure.

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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