Why Healthcare Practice Owners Should Pay Attention to Their Buy-Sell Agreements

Healthcare practices, whether physician groups, dental partnerships, veterinary clinics, or home health agencies, face heightened ownership-transition risk when an owner retires, becomes disabled, or passes away. Many of these practices represent the largest single asset in an owner’s portfolio, yet the documents meant to govern an eventual exit are often signed at formation and rarely revisited. Layered on top of the usual challenges are industry-specific considerations that can complicate a transition and, if overlooked, lead to disputes among owners or unexpected financial and tax consequences at the worst possible time. A poorly drafted or outdated buy-sell agreement only magnifies these risks, turning what should be an orderly succession into a source of conflict. The article below offers a framework for business owners and their advisors to evaluate the valuation provisions in their buy-sell agreements, so that a planned transition does not become an expensive crisis.

Buy-Sell Agreements: Getting the Valuation Right Before It Matters

What Is a Buy-Sell Agreement?

A buy-sell agreement is, in essence, a pre-negotiated plan for what happens to an ownership interest when an owner exits the business, whether through retirement, disability, death, termination, divorce, or voluntary withdrawal. Think of it as a prenuptial agreement for business partners.

A well-designed agreement accomplishes several objectives: it creates a market for ownership interests that would otherwise be illiquid, it establishes a price and terms so that future transactions occur in an orderly fashion, it provides for funding (such as life insurance or seller financing) to support the buyout, and it helps manage expectations among owners long before emotions run high.

When buy-sell agreements work, they are invisible, the transition occurs smoothly and predictably. When they fail, the consequences can include costly litigation, fractured relationships, and unintended tax exposure.

Where Things Go Wrong: Common Valuation Mechanisms and Their Pitfalls

Most buy-sell agreements rely on one of the following approaches to set a price for ownership interests, and each carries structural risks that owners and their advisors should understand.

Fixed-Price Agreements. A fixed-price provision sets a specific dollar value agreed upon by the owners. The appeal is simplicity. In practice, however, these prices are rarely updated. As the business evolves, the fixed price may become materially understated or overstated, creating misaligned incentives. An unrealistically low price benefits the remaining owners; an inflated price benefits the departing owner. These distortions typically surface only after a triggering event, when renegotiation is least likely to succeed.

Formula-Price Agreements. Formula provisions, such as a multiple of EBITDA, a percentage of revenue, or book value, appear to adjust automatically with financial performance. However, the perceived precision is often illusory. Changes in the business model, capital structure, accounting practices, or economic conditions can render a once-reasonable formula obsolete. Book value, for example, rarely reflects the economic value of a going concern. Formula agreements also typically fail to account for non-operating assets (e.g., excess cash, real estate, life insurance) or to distinguish between enterprise value and equity value, a critical distinction when debt is involved.

Valuation Process Agreements. These agreements defer the determination of price to a professional appraiser at the time of a triggering event. While this approach has the advantage of producing a current, market-based valuation, the details matter enormously. A multiple-appraiser process, where each side selects its own appraiser and a third is appointed if the two cannot agree, can be expensive, adversarial, and time-consuming. A single-appraiser process is generally more efficient, but its effectiveness depends on careful advance planning and precise drafting.

A Better Approach: Plan Now, Not Later

Drawing on industry best practices, we recommend a framework built on three principles:

1. Select and Retain an Appraiser Now. Rather than waiting for a triggering event to find and engage an appraiser, retain a qualified business appraiser at the outset. An initial valuation transforms abstract agreement language into a concrete, reviewable report. It reveals ambiguities in the agreement, clarifies expectations, and allows revisions to be made while no party yet knows whether they will ultimately be a buyer or a seller.
2. Update the Valuation Periodically. A static valuation mechanism does not work in a dynamic business environment. Annual or periodic updates align expectations and reduce the likelihood of surprise or dissatisfaction when a triggering event occurs. In practice, disputes are more often driven by unmet expectations than by the absolute level of value.
3. Draft Precise Valuation Language. Even the best valuation process can fail if the agreement lacks clarity. At a minimum, the agreement should address:

• Standard of value — e.g., fair market value vs. fair value (these are not the same).
• Level of value — enterprise vs. equity; whether valuation discounts (e.g., lack of control, lack of marketability) apply.
• Valuation date — typically tied to the triggering event.
• Appraiser qualifications — credentials such as CPA/ABV or ASA, which require adherence to professional appraisal standards.
• Treatment of non-operating items — life insurance proceeds, excess cash, real estate, and similar assets.
• Funding mechanism and payment terms — how the buyout will be financed and over what period.

Don’t Forget the Tax Implications

Buy-sell agreements also intersect with estate and gift tax planning. Under IRC §2703, the IRS evaluates whether a buy-sell agreement’s pricing is binding for transfer tax purposes based on several factors, including whether the agreement restricts lifetime and testamentary transfers, whether it reflects a bona fide business arrangement, and whether the price was adequate and fair when the agreement was executed.

The U.S. Supreme Court’s 2024 decision in Connelly v. Internal Revenue Service further underscored the importance of careful planning. The Court held that life insurance proceeds received by a corporation to fund a stock redemption increased the corporation’s value for estate tax purposes, resulting in a significantly higher estate tax liability than the decedent’s family had anticipated. The lesson is clear: the interaction between life insurance funding, redemption obligations, and valuation must be carefully coordinated with qualified tax and valuation advisors.

Conclusion

Buy-sell agreements fail not because valuation is inherently subjective, but because valuation provisions are often left ambiguous, untested, or static. As Benjamin Franklin is credited with saying, “If you fail to plan, you are planning to fail.”

The time to stress-test your buy-sell agreement is now, before a triggering event forces the issue. By selecting a qualified appraiser in advance, updating valuations periodically, and ensuring that your agreement contains precise valuation language, you can dramatically improve the likelihood that a transition will be fair, predictable, and orderly for all parties involved.

Does your buy-sell agreement need a check-up? Our Valuation team can help evaluate your existing agreement’s valuation provisions and identify potential gaps before they become costly disputes. gsaunders@keitercpa.com | 804.474.7925