Signing a Covenant Not To Compete When Selling a Medical Practice
Successfully selling or buying a medical practice is one of the more challenging and complicated business transactions.
When everything aligns and the seller and buyer are able to agree on the basics of the transaction, there is generally a detailed due diligence period as there are many items to review. This includes making sure the doctor buying the practice can get privileges at the nearby hospital, qualifying for the insurances and government programs of the practice and being patient while all this is obtained.
The list of items where the seller and buyer have to come together can be lengthy. In a transaction I’m currently brokering, the buyer has a checklist of items they wish to review as part of their due diligence and the list has 158 items. It’s extensive and exhausting working through their list in such detail. It’s also intimidating as an employee of the seller has to spend countless hours on it and its unknown if the buyer will then agree to close the sale.
Covenant Not To Compete and Selling a Medical Practice
An interesting item that has come up that’s important to both the buyer and seller is the Covenant Not To Compete.
A Covenant Not To Compete is normally an agreement that the seller will sell the medical practice and for a period of time, agree not to practice medicine in the immediate vicinity or geographic location of the practice.
The reason for doing this is so the buyer of the practice is not disadvantaged by losing patient business. Without a Covenant Not To Compete, there is little to no incentive for the buyer to acquire the practice and take the risk the patients will stay with the practice.
Covenant Not To Compete and geographic limitations
A Covenant Not To Compete has different complexities. It has the legal complexity as noted above in that it defines what the seller can and cannot do. In California it’s a little more complicated as the courts have recognized that a person has the right to work and be paid for their labor. However, the courts have decided that it’s also not right for the seller of a business to enter into a contract and receive compensation as part of a Covenant Not To Compete and then disregard it.
In the case of this transaction I’m working, it came up in a totally unexpected way as the sellers were part of an independent association. As they were planning to sell the practice they needed to resign from the association. The association however said the sellers could not go and work for another practice as it could have a negative effect on the association and therefore they were enforcing a Covenant Not To Compete; against the sellers.
Covenant Not To Compete and Goodwill
Another complexity with Covenant Not To Compete is the tax issue.
With the sale of the practice there is a need for tax purposes for the seller and buyer to agree on a Purchase Price Allocation.
The Purchase Price Allocation breaks down the total purchase price of the transaction for tax purposes to comply with IRS Form 8594.
This agreement lets the seller handle the treatment of his assets and the subsequent tax consequences with the IRS and likewise, going forward, the buyer can handle their tax responsibilities with the IRS.
Professional practices including medical practices may bump into a real tax issue when it comes to the Covenant Not To Compete and the Purchase Price Allocation as there may be a sizeable tax benefit to the seller to not treat the goodwill at the corporate level but at the personal level.
Almost all medical practices in California operate as a Corporation. If the practice operates as a C Corporation the seller will be taxed for goodwill at the corporate level and then again at the personal level. There are therefore considerable tax benefits not to have the goodwill allocated at the corporate level but at the personal level.
A Covenant Not To Compete and goodwill are complex pieces when selling a medical practice. The issues require the help from a legal and/or tax professional. My suggestion is to get good legal and tax advice early on in the transaction so the seller and buyer can come to an agreement rather than leave it to later in the transaction when deal fatigue can set in jeopardizing the ability of the sale to close.
Are you thinking about selling your medical practice and move to the next phase in your life? Would you like to know the value of your practice? If you would like more information please visit my website Sell a Medical Practice.
For more immediate help, send an email to Andrew Rogerson or give me a call on 916 570-2674.
