A milestone for the solo professional practitioner is the growth of the practice into a partnership. Two common scenarios are: Your client makes a staff member a junior partner, or a colleague joins your client to create a two-partner firm. What should you consider when advising a client making this transition? Similar considerations apply to your practice and succession plans.
What are the specific reasons your client wants to make a partner or merge his or her practice? Be certain that the structure of the transaction reflects and meets those goals. Be certain that recital clauses — sometimes called "Whereas" clauses — at the beginning of the legal documentation for the transaction spell out those goals. If they are not clear to you, they are not satisfactory. These should provide the guidelines for the deal now and a clear explanation to a court if a problem arises in the future.
Balance of Power
Be certain that your client understands the dynamics of the situation. If your client is promoting an employee to partner, the employee has limited negotiation power, and more steps should be taken to protect and favor your client. If your client is merging with a colleague owning a comparable solo practice, the dynamic will be different. Although these considerations are obvious to the outside adviser, the practitioner in the midst of the process often misunderstands the overall dynamic.
Weighing Appropriate Disclosure
Due diligence and disclosure are always necessary, but the level should be appropriate to the relationship of the parties. If a longtime employee is being promoted to junior partner, he or she may know the practice well; however, he or she may not know the finances (debt) and perquisites. To make the transition work, even a longtime boss must permit reasonable disclosures. In many instances, counsel to one of the parties will use boilerplate disclosure provisions, which may be either excessive or inadequate to the circumstances; endeavor to tailor those before costs are incurred or antagonism results. The practice CPA as perhaps the most neutral of the advisers may be in the best position to address this.
Regardless of the knowledge and familiarity with the practice the new partner may have, representations in the documents addressing the transaction should always be included to provide some level of protection. Lien and judgment searches, a good standing certificate for the entity and credit checks on the individuals and the practice should be done regardless. Even the most honest and careful of practitioners may have issues of which they were unaware. The time to address this is prior to the consummation of the transaction.
Old Practice Documents
If the practice is organized as an entity, be certain minutes and governing documents are current and accurate prior to the transaction and that revised documents are executed to reflect the results of the transaction. Too often, only new documents are executed, and the informalities of the former solo practice remain gaps.
Type of Entity
Consider what type of entity should be used for the post-transaction partnership. If your client had operated as a sole proprietorship, an entity should be formed. If a professional corporation is used for the new partnership, and there is a lawsuit for malpractice for an act the new partner committed as a partner, and your client was not involved in the matter, then the new partner and the corporation will be held liable, not your client.
Many state statutes permit the formation of a special form of general partnership, or in some instances, a limited partnership known as an LLP. LLPs also are called registered limited liability partnerships and are recognized in many but not all states. This form of practice entity offers greater protection than a general partnership form of operation; the degree of additional protection will vary depending on the provisions of state law. In most instances, the protection an LLP provides is significant but limited. The protection is that you should not automatically be held liable for the professional malpractice acts of another partner. Professional Limited Liability Company (PLLC) provided in many state statutes include special provisions governing professional service LLCs.
New Practice Documents
Practice documents should address issues critical to the relationship of your client and the new partner, including detailed parameters for how the practice will be managed and the anticipated contributions of each professional involved. Management and control issues are vital to deal with while both you and your new partner are cordial and optimistic. Compensation arrangements, allocation of client workload and administrative responsibilities should be specified. Even if specific details cannot be agreed to, a general framework can prove useful in the event of a dispute. It should be a comprehensive agreement addressing vacation, termination (with and without cause), disability, death, divorce, retirement, future succession planning, insurance planning, buy-sell and other planning.
If your client's goal is retention of a key employee, the agreement should have incentives for duration of the employee/new partner's continuation with the practice and penalties for an early departure (e.g., a buyout on departure could reflect a substantial penalty that diminishes with each year with the practice). Incorporate into the arrangements a bonus arrangement, or kicker, based on years the new partner continues with the practice.
If the end goal is for the current practice owner to retire, does the current deal reflect that goal? Too often, practitioners have sold some equity to a younger partner without an assured strategy for the remaining equity. This could make it difficult for the senior partner to eventually sell out and retire. If complete succession is a future goal, at minimum, confirm it in the documentation and include a mechanism to achieve it.
Binding the Partnership
The appearance of the practice following the transaction will be that the new partner has the authority of a partner. If the new partner is not an equal colleague, then the intent may be that the former solo practitioner retain certain controls. The documentation should carefully restrict the actions of the new junior partner and protect your client's decision making and control. Be wary, however, a designated partner may create liabilities for your client's practice if third parties had no knowledge of the restrictions on the junior partner's authority.
Be a nitpicker in a positive, not a negative way. Too often, the parties in the deal are so focused on the big, economic issues that important administrative issues which later create considerable friction are overlooked. Are there any expectations by either party as to participation in the ownership of the building housing the practice or liability on the practice office lease?
Control issues are often the most contentious issues. Their resolution will vary depending on the relationship and clout of each party. Some junior partners are partners in name only, with the senior partner continuing to control key practice decisions. If the new junior partner is joining the practice with the expectation of becoming a full partner, then the governing documents could include a mechanism for gradually increasing the junior partner's involvement, authority and control position.
Income and equity issues need to be clarified for your client's new partner. The new partner may only be a non-equity contract partner with limited contract rights created under the practice's governing agreement, but not full participatory partnership. This may be offered to a valued employee who does not possess all the skills for becoming a full partner but is vital to the practice. This type of arrangement could be structured by using a two-member LLC naming your client as manager and a member and the junior partner as a member with you. The LLC would be taxed as a partnership. Profits and other benefits could be allocated in any manner consistent with tax requirements (e.g., Code Section 704(b) substantial economic effect). This arrangement could be structured as a corporation with a voting and non-voting class of stock. Your client could retain all the voting stock, and the junior partner can own non-voting stock.
Coordinate and plan the results of the practice changes with your client's personal financial planning. The new practice partnership agreement disability provisions should be evaluated in light of your client's disability planning. For example, if your client has a disability policy with a 90-day waiting period, continuation of some compensation and benefits in the practice for 90 days of disability absence may be advantageous. Your client's interest in his or her professional practice may be one of the largest assets in his or her estate, and the primary factor affecting key financial planning milestones are death, disability or retirement. So, coordinate practice decisions on practice retirement plans with personal savings goals, life insurance, etc.