Creating Stability Through Minority Partnerships
All of us who endeavor to build a group practice have some different aspect of how we define success. For some, it may be a transaction. For others, it may be a level of consistent income. For all, however, we want a level of stability.
And “stability” typically means minimal turnover of key people – most notably associates.
Pay rates and compensation can address certain aspects of this situation, but ultimately the best way to solve it is through some sort of partnership model. Those models typically involve some level of either buy-in or earn-in (or a hybrid of both) by the Associate.
Well, that sounds good for the Associate(s), but what about for you? You’re the one who took the risk. You’re the one who personally guaranteed all of the debt. You’re the one who initially that created all of this opportunity. And you probably developed most of the systems, processes, and “secret sauce” that helped replicate early successes.
How much is that stability truly “worth” to both you and your Associates? As you would well imagine, there are multiple ways to answer that question…
Maintaining Control of Your Business
Before you start the process of bringing on any partners, you should work with a consultant and an attorney to understand the different control provisions in a business. Most are directly (or indirectly) found in the Operating Agreement, so you want to think through the way that document allows for minority ownership while maintaining the governing control you desire.
Ownership can have different “rights and privileges” tied to equity. One of those is voting rights. Certain classes of shares can be “non-voting” and have only equity and/or distribution rights. Structuring shares as “non-voting” can have a negative connotation to your Associates who earn them because it makes them feel like they don’t have a voice or a say in the direction of the business – which is basically true.
If you elect to have all shares designated as “voting,” then it’s important to understand how voting happens, what’s actually voted upon; and what the outcome of the vote means.
The Basics of Corporate Governance
Just because all shares have voting rights doesn’t mean we have to vote on everything to get something done. There are “day-to-day” decisions that need to be made to keep the business moving in the right direction, and these are entrusted to the “manager” (or “managing member” or “managing partner”). This is going to be you (most likely). The responsibilities of the manager are outlined in the Operating Agreement, and usually there is a threshold of a dollar amount up to which he or she has the ability to make a unilateral decision. Decisions with a financial impact that exceed that “day-to-day” threshold do require a simple majority vote.
Of course, there are larger decisions of greater magnitude and significance that typically require larger levels of financial commitment. These often require a “super majority” vote. For example, acquiring another practice for $800,000 or amending the Operating Agreement itself would all require super-majority approval. The voting threshold for super-majority is defined in the Operating Agreement and typically falls in the 65-80% range.
Occasionally we see some Operating Agreements with criteria requiring a unanimous vote (100%). We heavily advise against this because it creates what’s known as a “poison pill” in the Operating Agreement where a sole holdout can break a deal (typically in the event of a potential sale of the business), so it’s important to avoid this scenario.
Minority Partners Create Stability
Now that you have a very basic understanding of governance, let’s talk about your potential Associate partners. Whether you decide to allow your Associates to actually buy-in to the business or you opt for an earn-in model, it’s important for you to play from a point of strength, which means an accurate valuation of the business.
If your business currently values too low, you’re going to end up selling a large percentage with too little of a dollar payoff. Earn-ins work better if the business is valued low in the beginning because the earn-in is incremental over each year of time and (hopefully) the business will continue to improve in valuation along the way.
On the other hand, if your business values very highly, then you may elect to sell a small percentage to each Associate because that may equate to a large dollar amount for them and for you.
You could also elect for a hybrid model whereby the Associate buys a nominal amount upfront to get started, then earns in over a longer timeframe (typically around 10 years). This could be the best of both worlds for them and for you.
Solving for Multiple Outcomes Concurrently
If we go back to our part about governance and “voting control,” your ultimate goal is to maintain an ownership stake that meets or exceeds that supermajority level of voting control. This level would ensure that no one would ever be able to preclude you from doing what you want to do with the business you took the risk to found.
There may be practical matters at hand if you want to sell the business, but your 10 Associates vote against it.
Do you have the votes to do it? Yes. Can they stop you? No.
But if they refuse to sign employment contracts with the buyer, then you don’t have much to sell.
“Governance” can mean a lot more than what the outcome of the vote is, so it’s important for you to be mindful of both.
And from the perspective of your Associate, what you’re trying to solve for is ultimately some economic outcome that would meet or exceed what they could achieve on their own, if they decided to take on the risk to do it.
If the outcome is likely greater and the risks are less with you, why would they leave and do it on their own? If you can solve for that, then you’re on your way to building a great business with significantly less turnover than other groups of your peers.