Assessing the Health of Your Business
The health care industry faces continuing increases in competition and costs. This climate challenges practices to keep up with the times. This article discusses a few simple questions to ask when assessing whether, from a business perspective, your practice is monitoring and maintaining its health.
Is the practice organized to maximize liability concerns and reduce costs?
The choice of entity analysis is discussed ad nauseam by business attorneys. That is because the entity chosen is critical for a business to operate effectively and efficiently. Generally, professional practices providing health care services in Pennsylvania are either organized as a type of limited liability company known as a restricted professional company or incorporated as a professional corporation. Although from a liability protection standpoint the differences between the two may be negligible, there are certain differences from a tax standpoint that require a professional analysis of the type of entity to be used. If the business is a corporation, it is taxed for income tax purposes under the Internal Revenue Code as a C corporation, resulting in two layers of tax on the same funds received for services rendered – first, the corporation is subject to income tax at corporate income tax rates and second, that same income is again taxed to the shareholders when it is distributed to them as dividends. An alternative is available to some corporations to avoid this setback. A corporation can file an election with the IRS called an “S election,” which is an election to essentially receive “pass through” tax status. Thus, profits and losses are passed through to the shareholders in this corporation, called an S corporation and only one layer of tax is recognized by those shareholders. The same is true in a restricted professional company. The profits and losses of that entity flow through to the members of the company so that the federal income tax consequences are realized by the members only (and not the company). Although it would seem that in every case a corporation that qualifies should file an S election, there are nonetheless valid reasons for a corporation to forgo the election and remain a C corporation. It is much simpler for a C corporation to deduct its fringe benefits as a corporate expense. By contrast, fringe benefits to a shareholder/employee of an S corporation who owns more than 2 percent of the corporation are often nondeductible.
Has the business maintained sufficient company records?
Maintaining records is unfortunately one task that is often overlooked by practices. However, this is critical for several reasons. First, as good governance, keeping an up to date stock ledger and minute book ensures that there is a properly documented history of business transactions. Any transfers of ownership in the practice must be documented in the stock ledger. Action taken by the board of directors, shareholders, members, managers, etc., must be documented in the minutes. Second, there may be instances where third parties need to see these documents, such as lenders in financing transactions or taxing authorities in an audit. Third, observing corporate formalities diminishes the likelihood that creditors will be able to reach the personal assets of the owners to satisfy debts of the practice.
Are the relationships among owners, employees, and company properly memorialized in writing?
Because it is rarely the case that all owners of a business will always operate the business in harmony and without discord, memorializing the relationships among the owners, employees, and the company, such as through buy-sell agreements or employment agreements, is critical to avoid a breakdown in those relationships. Buy-sell agreements are written agreements between the owners of the business entity which establish the procedures for the transfer of ownership interests in the company (or, to put it more accurately, restrictions on the transfer of ownership) Buy-sells set forth the various “triggering events” requiring an owner to sell his or her ownership interest in the entity, to whom, and at what price. The price can be set at a fixed number, determined by a stated calculation or formula, or determined by a professional appraisal.
Retaining and attracting good practitioners is always a concern for practices. Clearly, there are a number of factors involved in having good employees at the practice – competitive compensation and benefits, good working conditions, etc. However, the relationship between employee and employer will likely undergo changes, whether it is an employee’s buy-in to the practice or the termination of that employee. Without an employment agreement to set forth a written understanding between employee and employer, the parties are typically left to common law principles which, in Pennsylvania, usually means that an employer can terminate an employee at will. In addition, many practices want to protect their practice through the use of a covenant not to compete, which must be set forth in a written contract. The covenant not to compete is a binding promise of an employee to refrain from taking subsequent employment with a competing practice. Courts generally uphold these covenants so long as the duration, distance and scope in the covenant are reasonable.
Do we need to have an attorney review contracts with third parties?
The question is often presented – can this contract be terminated? The answer in response is often “the devil is in the details.” Many contractors that provide services to practices present lengthy boilerplate agreements and expect a busy practice to review and negotiate the entire contract. Without careful legal review of these contracts, there is an increased risk that certain terms may be agreed upon that will result in an unwelcome surprise later in the contract term. “You mean to tell me that if we terminate this contract we have to actually pay them a penalty?” “We had no idea that this contract automatically renewed last year for another five-year term.” Unfortunately, the power lies with the pen and it is usually the case that contractors that draft their own contracts will want the terms to sway heavily in their favor. An ounce of prevention is worth a pound of cure. Reduce the risk of surprise in your contracts by relying on the review and advice of your attorney.