A young GP will often ask what should I do? Buy a home or buy a practice?
The best answer is usually “buy a practice and generate extra cash flow. And then use the extra cash flow to buy a better home.”
The best investments for GPs are their practices and their homes, usually in that order.
Most GPs who become truly wealthy do so by owning practices. They work on the practice and turn it into a business. They spend less then they earn, save the difference, then invest in other areas, first the home and then other assets, to build up a significant and diversified asset base.
Ultimately the investments become the major source of cash, income and wealth. But the practice is the engine room: this is where it all starts. The practice deserves special prominence in any discussion about GPs’ investments. It should be investment number 1.
If a GP borrows $100,000 and starts to earn an extra $50,000 a year profit, above their time reward, that is a 50% return on the GP’s investment. And it is very low risk. The bottom will not fall out of the market. Indeed, if the economy turns down, then a typical GP is likely to become even more busy.
After a few decades this increased cash flow compounds out to a very large difference, millions of dollars of difference in the net wealth position of owner GPs compared to non-owner GPs.
Most GPs, no matter what their age and circumstances, should consider owning their own practice. The only real exception is GPs who, for whatever reason, are not able to work full- time. A good example is older GPs downsizing into retirement. Common sense says they work for someone else. Another good example is (generally) female GPs contemplating kids and family. (Once again, generally) most expect to be the primary care giver and many are happy to put owning a practice on the back burner for a year or ten until circumstances change.
Some practices bulk-bill and still have good profitability. This is achieved through high patient numbers and fiercely controlled costs. Other practices privately bill patients, work on a strict appointment system, perhaps even closing their patient lists, and deliberately spend more on staff and other costs to improve efficiency and profits.
Some practices are ideally located in prime real estate next to large shopping centres, where the pedestrian traffic generates a constant supply of potential patients. Other practices are in industrial areas or CBD business areas, providing occupational health services to nearby industrial and office complexes and relying only on reputation for patients to come in.
Good GPs usually make good profits. So what features distinguish profitable practices?
Anecdotally, more GPs are moving from bulk-billing to private billing. It is really just a change in emphasis since most will still bulk-bill some patients.
Our typical advice is to not bulk-bill patients unless they are genuinely in need. Patients are only in genuine need if there is no income earner in the household and they do not own a home.
A patient, even a pensioner, is not in genuine financial need if they own their home, drive a car, smoke or have a job, and should be billed as such. If this means the patient does not come back to the practice, then so be it. Ultimately, it just means that they do not value the GP’s services. Price is a filter that sifts out the patients who really do not want to be there.
Price rises rarely lead to a drop in patient numbers.
Most GPs are good at controlling costs. Some control them too well and do not spend enough on their practices. Don’t be shy about spending money to improve patient services. Carefully calculate the effect on profit of the proposed cost and, if it will go up, proceed.
A simple example is constructing a new consulting room. The new room costs $150,000. If it generates an extra $3,000 a month in net management fees, this translates to a 24% pa return on investment. This is more than the 5% pa interest charge, so the decision is “proceed” (and perhaps to ask what happens if two extra rooms are added!)
Other examples abound. Fresh water dispensers, children’s play areas, up-to-date magazines, pleasant music, health information and quality reception staff all cost a bit extra, but help bring in patients and encourage patients to pay a little more to see you.
With the shortage of GPs it’s too simplistic to say ’employ more GPs’. Nevertheless, the more profitable practices tend to have two or more non-owner GPs. Registrars are good too. Overall billings are higher and fixed costs are spread over more GPs, so the extra GP contributes to profit.
Extra GPs are the most profitable additions to a practice. But if this is not possible consider other health professionals too. Make sure they pay an appropriate management fee to be part of your patient eco-system.
The nicest profit is one made for you by someone else.
The practice’s tax profile will also improve. A realistic top tax rate is 30% if the practice satisfies the ATO’s views on what is a business. This paves the way for more investment and faster debt reduction, since more pre-tax profit is available as after-tax cash.
The most profitable practices are in areas where there is less competition.
There is less competition in less fashionable areas, particularly rural and semi-rural areas. Obviously, family and social preferences are important, but a GP starting a practice should at least consider these low or no competition areas.
Less fashionable areas have lower wages and rent costs. Goodwill may not be much but goodwill is normally not much anyway. Profits will be good and should be redirected from the practice structure to investment trusts and companies to other new investments, which will in turn generate more profit and net cash flow, leading to even more investments.
A mark of a good practice is a demonstrable ability to produce an above average return for its owners. Prospective buyers will be prepared to pay a premium over the value of the practice’s tangible assets to receive that above average rate of return.
This premium is called “goodwill”. Goodwill is an intangible asset: it does not have a physical presence and will differ in amount and nature from practice to practice.
Goodwill values have been low for years. Low values skew the “to buy or start” decision in favour of “Buy”.
Starting a new practice from scratch is a more daunting option. It takes time and creates stress. It has the advantage of not having to pay for goodwill and location, staff and premises are an open book, allowing decisions to be made autonomously.
Buying a practice has more certainty. It allows GPs to be confident that the patients will be there. This lowers risk and ensures there is a good income from day one. Often the GP will work in the practice before buying and will be familiar with it. They may have actively contributed to the growth of the practice, which may be reflected in negotiations of a discounted buy-in price. This is the best due diligence: real hands on experience in the practice. Know the patients, the other GPs and the staff. You learn what makes it tick, and can be confident it will be there for you once you own it.
There is no definite right or wrong: some GPs are better off starting their own practice, and some are better off buying an established practice.
Our advice tends to be “buy if at all possible”. Starting a practice from scratch in a brand new location can be done, but will incur higher risks than purchasing a perfectly good practice down the road for a minimal cost. It can take months for a new practice to get up and running, and the months will drag into years if town planning permissions are involved.
The advantages of buying an established practice include:
- Immediately busy;
- No long lead time setting up;
- Time saving relating to acquiring new assets;
- No need to hire a new team of staff members;
- There is an established customer base i.e. patients;
- There are reduced marketing requirements;
- There is an established reputation; and
- There is no need to launch extensive new opening campaigns. The disadvantages include:
- The reputation may not be as positive as you would like it to be; and
- The staff may have work habits you do not like.
Staff contracts and provisions
The buyer takes over the staff contracts. Normally staff liabilities, including sick leave, annual leave or long service leave, are deducted from the sale price on settlement.
A buyer should keep staff for the first period after the sale. They can be the real the goodwill of the practice, and staff continuity is important for practice systems and patient relationships.
If you are intending to change staff , the question of which staff to keep is an important one that should not be answered before buying the practice. Err on the side of caution and do not let staff go until you have a real handle on how the practice is performing.
Buyers need to know about any employee liabilities, such as annual leave, sick leave, and long service leave. If they exist the purchase price needs to be adjusted. For example, an employee who has thirteen years’ employment will probably become entitled to three months’ long service leave in two years time. An adjustment should be made on a pro-rata basis for long service entitlements.
Is the price right?
Negotiations are a dynamic, and backing intuition is usually the best thing to do. It is a good idea to get someone else to double-check the reasoning. This helps ensure decisions are not rushed. At the end of the day the buyer must be satisfied on the matter of price. It is perfectly acceptable to ask for time to think things through. Alternatively, where confidence is lacking, someone else could be appointed to negotiate the deal. Emotional indifference can be a wonderful asset in a negotiation, and can throw an objective perspective over the whole proposal.
Once a price is agreed, don’t look back. Negotiations are difficult, and in most cases it will never be known whether a better price could have been reached. Once the price is agreed, it is time to begin making the practice work.
Consider if part of the purchase price can be deferred for, say, a year. If this is done, and for any reason results are not what was expected, the door is open to withhold all or part of the final payment unless an appropriate adjustment is made.
Financing the practice
Medical specialist lenders will lend GPs money to buy practices at normal goodwill values. GPs should demand the best possible interest rates: this will usually be the home loan rate.
Council zoning permissions
A failure to check zoning permissions is a common mistake in a sale of business transaction.
Do not assume a practice is permitted on the site just because a practice is there now. Confirmation from the vendor and the council is strongly advised.
This should be a standard part of the due diligence process taken by any solicitor acting for the buyer GP.
Preparation of the sale of practice agreement
The vendor’s solicitor will prepare the sale of practice agreement.
The buyer’s solicitor checks the sale of practice agreement and related documents and advises the buyer whether they are in order to sign, or what changes are needed.
The solicitor’s role is not to “do the deal”. This is done by the GPs, perhaps with some back room coaching from the solicitor. The solicitor’s role is to document the deal agreed to by the GPs, and make sure the sale transaction proceeds smoothly in accordance with the deal.
It’s not a good idea to buy shares in an existing company. The reason is simple: there may be undisclosed debts and the buyer will end up being at least partly responsible for these debts, or the debts may even be so large the company becomes insolvent.
This happens more often than you might think. And if you buy shares in the company, you buy the company, warts and all.
It can be a good idea to transfer the assets from the old company to a new company, and then subscribe for fresh shares in the new company. Provided certain rules are observed the transfer is ignored for tax purposes. This prevents the shares being tainted by any latent liabilities not appearing on the balance sheet, or that current shareholders are not aware of.
Specialist tax advice is essential.
Sometimes the buyer assumes responsibility for certain vendor debts. For example, the practice may be one year into a five-year lease on computers that cost $30,000. The lease is at a competitive interest rate and is with a reputable financier. Taking over the lease can be a smart way to part pay for the practice. The sale price is reduced by the amount of the liability. Here this means $24,000, ie 4/5ths of $30,000, will be taken off the purchase price.
Restraint of trade clauses
A restraint of trade clause is an essential part of any agreement to purchase a practice. It helps make sure the patients stay and the buyers gets what they paid for.
If there is no restraint clause the seller GP can re-appear a month later almost literally next door. The seller GP may not be able to directly approach the patients; however, word would soon spread and the buyer GP will not get what they paid for.
The restraint clause should place a reasonable restriction on the vendor for each of:
- The type of activity restricted (i.e. medicine and, perhaps, health care generally), whether as a principal, a partner, an associate, an employee or otherwise;
- The geographic area restricted. A reasonable geographic restriction is usually not more than, say, between 2 and 3 kilometres from the practice premises; and
- The time period restricted. A reasonable time restriction is usually three years. This period could be longer if an unusually large amount is paid for goodwill.
Deferring part of the purchase price is a good way to add business efficacy to restraint of trade clauses. It gives the buyer GP bargaining power should anything go wrong.
The right to use the premises, whether as an owner or as a tenant, is a critical part of the purchase agreement. It would be a disaster to buy a practice only to find the landlord will not renew the lease, and there are no other suitable premises available.
Tenure can be provided to a buyer in a number of ways. These include:
- If the vendor leases the premises, transferring the vendor’s tenant rights to the buyer. The landlord’s consent is usually given without too much trouble; or
- If the vendor owns the premises, arranging for a fresh lease to be granted to the buyer for, say, five years with options to extend the lease, as required.
We recommend buyers retain an experienced solicitor to check the lease carefully before proceeding too far with buying the practice.
Warranties and Guarantees
It is a good idea for a buyer to obtain third party guarantees from the vendor. For example, if the vendor is a practice company a director’s guarantee is appropriate. A director’s guarantee means that a director is responsible for the actions of a company.
One common warranty says the vendor has disclosed all known relevant matters. If the vendor won’t agree to this clause, the buyer should probably walk away.
Notice to Patients
Appropriate written notice should be given to patients and this notice should stress the skills, experience and other attributes of the incoming GP.
If the new GP is buying into a partnership it can be a good idea for the retiring GP’s patients to be invited to see the remaining partners as well as the new GP. This should improve the retention rate for the partnership as a whole.
For a solo practice managing the patients is even more important. The buyer should insist on a phase-in phase-out arrangement where the vendor fades out of the practice over time. If this is done properly, the patients may virtually not notice the change.
Potential of the practice
The potential of the practice should be given a great deal of thought. A new face can be a breath of fresh air in a medical practice. A new coat of paint can help too. Many potential new patients may come once to see what it is like. Word of mouth is a strong form of advertising. Positive first impressions cannot be underestimated.
Goodwill exists when the expected future profits from a practice exceed the amount the GP can otherwise earn. Here a willing but not anxious buyer will be prepared to pay a premium to acquire a right to receive or to share in the practice’s profits. Typically this is where the practice has a special quality that cannot be easily replicated, which is not personal to the owner, and can be passed to a buyer with a reasonable level of certainty.
There is no complete list of the qualities that create goodwill, but they include:
- Efficient support staff that enjoy a friendly rapport with patients;
- Clean modern premises that are easily accessible, have adequate car parking space and, preferably, a play area for children, with some form of entertainment for adults, so patients find the ambient surroundings comfortable;
- Stable and personable assistants and associates, who have their own lists of patients, and who are able to operate at a maximum capacity, with minimal supervision and control (and who do not intend to, or who are contractually prevented from, setting up an opposition practice in the same locality);
- Established relationships with allied health care professionals, such as physiotherapists, pathologists and chemists, ensuring the practice can provide a broad range of medical and health services to its existing patients;
- Increasingly, a market niche or practice specialty that attracts a particular type of patient, as well as the general practice patient. Examples of this include skin cancer, geriatrics, sports medicine, a language expertise, and women’s medicine;
- Good location, both within a particular suburb and as to the choice of suburb or region itself, and the related issue of a practice’s physical presentation; and
- In some cases, specialist equipment, that has a high cost or market interest, creates a barrier to entry for a particular type of procedure or service.