EP55 - Medical practices as ESOPs - interview with Richard Glassman - ESOP attorney from Connecticut.

Welcome back. Thank you so much for tuning in. I'm the ESOP guy and we are continuing on this journey to an ESOP. For those that are new to this podcast, this is produced really to provide education to those companies or owners of businesses that are thinking that they might want to use an employee stock ownership plan for an exit or a succession strategy. And today I'm excited to have with us, Richard Glassman, who is an attorney practicing with Shatz Brown and Glassman. Uh, we are gonna do the title of this podcast is going to be ESOPs for Medical Practices and how they apply. Rich's background is with the firm basically includes being a, the, the firm itself includes being a boutique firm that focuses primarily on ESOP work that includes ESOP transaction work, ESOP Consulting, trustee representation, as well as working with banks on other ESOP deals. So they are a an attorney firm that focuses primarily on, on ESOP work. So with that, Rich, thank you so much for joining the podcast today. Uh, Philip, it's, it's my pleasure to be here. Certainly an interesting topic, and I always do enjoy speaking about ESOPs and maybe especially for this little relatively tiny niche in the ESOP world that maybe we can make bigger. So it's my pleasure to be here with you today. Great. So, yeah, I'm excited and I think the real premise behind the on the podcast is education and and opening this up. As the, you know, experienced professional that you are an ESOPs, it's gonna be interesting because um um you have done a lot of different ESOP work over time, but going into how is an ESOP work for a medical practice is going to be the focus of this episode. So with that, can you kind of go over a brief overview of not only your background, but also your firm's background? Um, again, thank you very much, Philip. Uh, as you mentioned, uh, Shatz Brown Glassman, our marketing name is ESO Plus. And we use that as our marketing name because all we do are ESOPs, as you mentioned, we are a boutique firm, as I like to say, we run around the country in doing ESOPs. We enjoy educating people about ESOPs as you do and implementing the an ESOP strategy when and if it is appropriate. So the firm, uh, right now there are 5 of us in the firm. Um, we're actually located around the country, and that's only because that's where we live. So we actually have home or real offices from Spokane, Washington to Connecticut to upper state New York, and again, that's just because that's where we live, but we're happy to go anywhere. In the United States, and as we'll see as we get into a medical practice ESOP transaction that I had the fortune to work on, I really went all the way to Guam, the island of Guam, became an ESOP hotbed for medical practices, meaning we did one out there, and it was very exciting. We'll, of course, get into the details in a few minutes. My own personal background. It brings both a banking background. I spent a little over 20 years in banking as a lawyer and a banker, then had the opportunity to work in private industry as CFO and president of an operating business. So I've been on the on the other side of the table, if you will. where I've had to make payroll and manage people, and I've seen the operation of a family owned business from that side as well as the uh professional counselor side. Um, with that as a background for the last 16 years, um, all I've been doing, as we've just said, um are ESOP transactions and um and advice related to ESOPs. I've been doing them for 16 or 17 years. Some of my partners have been doing ESOPs since the 80s, so they've been doing ESOPs for over 30 years now. I guess maybe some of them are approaching 40 years. So we were pretty good standing in the ESOP community. We're happy to be part of it and certainly happy to be here with you today, talking about ESOPs for medical practices. I'm, I'm excited. You're the only one I, I know that's ever done an ESOP deal in Guam, not alone, and the, the medical side of it. So this is gonna be an interesting episode. Um, Rich, so one of the questions I get from folks is this, this idea like, what is a good industry for an ESOP and as we, as we get this question and we apply it to the medical side. Um, one of the areas, as we've kind of alluded to is you focus on the medical space, you've also done a lot within the professional service business. What, when we talk about this medical space, let's be very clear, like, what exactly does that business model look like, um, in terms of a medical practice that's going to go through the potential ESOP. Yeah, I guess I would start before we specifically get into the medical practice, I would frame the question or frame the the environment in the whole world of professional services, services where the um the the the service being provided to the client. To the patient, whatever it might be that person that is providing the service, or at least much of the service must be provided by licensed professionals. Um, as you mentioned, that could be engineers, could be architects, could be land surveyors. In this particular case, we are talking about doctors. Medical technicians. So in the broad range of professional services, I look at a medical practice as just being one of the specialized areas within the professional service provision of, you know, products and services and meeting the needs of of clients. Within that range, of course, today we are focusing on medical practices. And the 1st, 1st recommendation or the first point that I would emphasize is that as with engineers, architects, lawyers, or CPAs, for example, as with all of these professional service areas, it is a state law issue, meaning the states individually, not the federal government. Even though ESOPs, of course, are controlled by ERISA and federal law, the provision of these professional services, again, doctors or medical technicians, as we're talking about here today, the provision of those services. Um, is regulated by state law. So it really becomes a state by state issue. First, you have to think about the ESOP, and then you, before you get too far down the road, you must look at the state law and see how the state law has requirements regarding ownership and provision of services. Um, I can tell you that we have been successful in doing ESOPs in many, many professional services around the country. And so the ESOP community in general has become, I think, innovative, conservative, right down the middle of the road, all perfectly legal, but we've become innovative in forming the right transaction structure. So that we can do an ESOP for these professional service companies and yet of course fully meet the requirements of the state or states that the professional services company may be operating in. In the particular case that we'll focus on today. It just happened to be on the island of Guam. It just happened to be the first ESOP ever in Guam, and Guam, as your listeners may know, Guam is a territory of the United States. Guam has adopted the US tax code as its tax code. And for those of you who do get involved with ERISA, believe it or not, ERISA right in its preamble says that the requirements in ERISA and the laws contained in ERISA in that particular act do apply to the island of Guam, which is why Guam isn't available. Um, location to do an ESOP. Within that general overview of professional services companies, um, medical practices, practices to me are just one of those opportunities. They did happen to work out for this particular medical practice, uh, like I said, on the island of Guam. And um once you meet the needs of the local requirements, again, the The structural needs of the local laws in Guam in this example, then honestly putting the ESOP together was not much different than creating an ESOP for any other company, certainly not for any other professional services company, which Philip, as you know, there are many, many ESOPs for engineers, architects, land surveyors, etc. Uh, so that's sort of a general overview, and I think some of the things that, that you really need to think about first, um, as you're starting to contemplate, uh, and the implementation of an ESOP for a medical practice. Awesome. Well, first off, congratulations on being the one that had like the first ESOP in Guam is going, you'll go down in history. So I think that's a pretty big, pretty big deal when the history books go back and look at. You know, how they uh ESOPs actually got to Guam. They're gonna see your name, Rich. Um, honestly, it's very exciting and, uh, doing, I, I very much enjoy doing these apps. I, I, I relish the opportunity to meet entrepreneurs from all over the country and now I can say all over the country, including Guam. And it's always fascinating to see how different entrepreneurs have started different businesses. This particular doctor started these medical clinics on the island of Guam, but just as you said, just, just to be able to say that I did the first one on the island of Guam, and it was a long flight, I will tell you to get there, but it was well worth it. Well worth it. lot of fun and I'm glad we can talk about it today. That's great. So let's, can we focus a little bit on the state law issue, um, because we, we, you kind of talked a little bit about that being the requirement of ownership, making sure that the state law would allow for an ESOP, um, for a professional services firm. Can you go into a little more detail on that to um help the listener understand if they have a medical practice, does that mean that Typically, a doctor needed to own the practice and an ESOP can't, or how does that work specifically? Um, yes, no, you, you're exactly on point and moving, uh, moving in the, in the direction of the questions that do need to be looked at. In most locations, and again, I can't speak for every state or every territory, uh, but the general rule is as you. Around the country, a medical practice that's of course, the professional service that we're focusing on today, but same applies for engineers, architects, etc. The professional services company, the medical practice must be owned at least a majority, if not 100%. By licensed professionals in our case here, by licensed medical professionals, whether they be doctors or medical technicians that are licensed under local law. And and that is what we found in Guam, that the medical practice had to be owned by licensed professionals. Um, I, I believe that even although you may see this in other states that you could have minority, a minority interest owned by non-professionals in the island of Guam, at least that the law was when we did this about, which was about 2 years ago, that only licensed professionals to be owners of the business. So what we did there, which is very, very similar to what we do in many states, and like I said, we've done these for other professional services companies, is we do the management company or service company parallel route with the professional services company. So you end up creating a service company that provides services to the medical practice company. The medical practice company, the professional company, the licensed company still provides all of the services to the clients, to the patients in the, in the case of, of my situation in Guam. Uh, and therefore, you're meeting the local, the local requirements, the state law requirements or the territorial requirements in Guam. And then you, in effect, through the contract between the professional services company and the management company, you move the you move the vast majority, roughly 99% of the profits. Of the practice into the services company through a contract through a management services contract between the medical company and the professionals, excuse me, the um through the management company, and the management company employs all of the employees. And it has the profits and you end up doing the ESOP at the management company level. While the professional services company, the medical company, is the one that is providing the services to the patients with the management company doing all the back office work, all of the leasing work, all of the accounting work, all of the billing work, maybe managing real estate, uh, whether it's owned real estate or leased real estate. Um, so you end up with two parallel companies. And of course the ESOP is done at the management company and at that point you are creating an ESOP for a service company like many other service companies. So there is that little extra complexity of setting up a second company of having a management services arrangement between the professional corporation and the service corporation. But like I said, the ESOP community in general, not only have I done a number of them, not only has my firm done a number of them, but, but this is pretty standard operating procedure across the country for the creation of an ESOP at a professional services company or of course, in our case at a medical practice. And I hope through this podcast, we get more and more people thinking about doing ESOs for medical services companies. Yeah, I mean, I think that's probably what what I like about the very beginning of this is that I think that's going to be something that people are thinking immediately. How does this work if the doctor needs to own the actual practice? So I think you explained that really well. Um, for the company that, that the doctors, so you have a service company that then has a contract with this medical entity that's owned by the doctors, and that's kind of like the structure, right? You're kind of walking through. Yes, exactly. So that the medically, the professional services company enters into a service agreement just like they could even today forget their forget an ESOP might be in the discussion, but a doctor's office certainly can subcontract out its billing. It can contract subcontract out its accounting service. It's telephone answering services, it's marketing services, but instead of subcontracting those out to an independent and non-affiliated business, they are in in effect contracting those out to a company that was created by the doctors originally. Um, so that the sole purpose of that management company is to provide services to the medical professional company. Great. And then that professional service company, is it going to have its own malpractice insurance? Is that how it works with the Protecting, so the the malpractice insurance and all the insurances, whether it be ENO, you know, let's say for an architectural firm, medical malpractice, all of that uh insurance um coverage remains at the medical practice just as it was prior to doing an ESOP, because the The contract company, the services company, is only providing back office services. It is not offering medical advice. It is not selling medical advice or providing medical services. It's just like any other management services company, like I said, providing back off. Services to any business, whether it be a medical practice or something different. Great. Now I think that's awesome and I know we, we, um, you know, there's probably more nuances to it, but I think that's a good overview of the of the structure and how do you address the state law in terms of ownership. Um, is there anything else in the state and local law that has to be considered before we move on? Is there anything else other than the ownership? Um, so as you move around the states, and like I said, it is a state law issue, and I cannot sit here and say to you and your listeners that I'm an expert on every single state law. No, but I, I can say that you need to look at the state law issues with regard to ownership, with regard to the composition of the board of directors. With regard to the composition, even sometimes of the chief executive officer, whether or not somebody has that title, there are different states that look at different professional services companies and actually drill down to say the Principal executive officer at the company might need to be a licensed professional. The board of directors may need to have a majority of licensed professionals. And then of course the real focus or the primary focus is on ownership, whether the ownership has to be 100% with, in our case, medical practitioners or maybe only 2/3 or 3 quarters. Usually what you see. is a requirement of either a majority, 2/3, 3/4 or unanimous 100% ownership by the professionals. Again, different states look at the board of directors, different states look at the management team, different states look at the ownership of the equity in the business. So it really is a little bit of a smorgasbord if I can use that word. That uh you can't really, I can't really get the generality. It really is case specific, uh, or state by state. I think that's great. Well, so let's move on. Like if you look at a medical practice and we talked a little bit about like determining exactly what that is from a definition standpoint. So a medical practice for the one in Guam, for instance, was a group of clinics that in this case was owned. By a single owner. And, um, and you would have other medical practices, you know, you'd have multiple doctors maybe own, you know, and they provide services to different clients. It could be a medical practice that's, that's general or it could be a specific medical practice that has You know, a specialty. Um, so, do we wanna, like, is there anything in a medical practice we wanna define further than that, so that the, the listener can understand where they fit in this, in the scope of medical medical practices specifically? Yeah, I think my, my, my comment to that that thought, that particular question again goes back to state by state issues. Certain states may may restrict or have different laws for outpatient clinics than they do for, let's say hospitals or something closer to a surgery center or something like that. So again, go back to the state law, see how they regulate. The services that are being provided by your client or by the company that might be listening to us today and then we can tailor the structure to meet the needs of the state law requirements. Perfect. All right, so then, then the next question and, and again we're kind of in the definition part of it, but what is a good size target for a medical practice considering an ESOP is kind of the overall question and is it too small, too large, or, and let's just talk a little bit about the size of the of the actual practice. Yeah, Philip, I guess the best way for me to answer that question is to say it really my answer to the question is it's really the same as to whether it's a medical practice or it's a manufacturing company. As your readers and listeners may know. Um, we, we can do a C corporation ESOP for virtually, you know, almost any number of employees down to just a few. Um, I've actually done a Corporation ESOP for a company with 5 employees. However, of course, many of the companies today for tax reasons and other reasons are S corporations for taxes, and of course S corporation ESOPs have very, very special tax treatment, very, very beneficial. So when we get involved with an S corporation. Um, as your listeners probably know, as they've been listening to your podcasts over time, there's a section of the tax code called 409P. not important to remember that number, but it's just an easy way to call it, and section 409P restricts S corporation ESOPs. roughly, and this is a generalization to companies with at least 15 to 17 employees. Actually, the medical practice in Guam had 19 employees. We were able to meet all the needs of ERISA and and the S Corporation. 09 regulations and requirements with a company as small as 17 or 18 employees. So that's about the limit. It's a little bit of a squishy number. Testing needs to be done every year to make sure that we're in compliance, but it can easily be done. So I would say as long as the company has at least, uh, let's say 17 or 18 at the low end. Um, and then, of course, going up from there, doesn't matter how large it is, we can do an S corporation ESOP. Um, if the company happens to have less than 1415, 16 employees as a minimum. Uh, then we probably still can do the ESOP, but we'd be in the tax situation of being a C corporation, but from the standpoint of the medical practice, the standpoint of the creation of the ESOP, it still can be. Right. I think that's a great point. And I think some people when they start talking about, and again, we're talking about now, size doesn't really, it's not really particular to the medical practice, but so we're just gonna open that up. If if the companies, you know, what we call too small, um, the option that they have is always to think about doing, doing it as a C corporation, um, and then just knowing that the Corporation doesn't get the tax exemption that the Scorp gets, but there's still tax deductibility of Both the principal and interest on the financing, which is, uh, you know, a very, a big benefit to, um, you know, that is very specific to ESOPs that you don't have in the tax code outside of ESOPs. So it's still a, a great benefit and the Corp gets to leverage or use the 1042 election which, which um provides the owner selling shareholder with Uh, either a tax deferral or moving the capital gains tax out into the future or even eliminating those. So, so there's definitely benefits of being a C or an S. and I think sometimes when we talk about ESOP sizes of companies, we get, well, it's too, it's too small, but we just need to understand how that um applies itself specifically to, um, you know, as we look at general companies but also then specifically to medical. Yeah, no, I, I certainly agree with that. And I think when when people ask me the question about too small, I more think in terms not of how big the company is, but how much is the company worth, because is it, is it right? Is it appropriate for the the selling shareholder or shareholders in any company, whether it's a medical practice or not, if the company is only worth a million dollars or less. Is it really the best way for that person to get liquidity when an ESOP transaction is going to cost at least a couple $100,000 to put together. And so I more look at size relative to value than size relative to the number of employees. It's a good point. Yeah, and it's gonna be the, the whole business equation is, is the cost benefit really worth it, you know, if your business isn't as valuable or as high enough as it needs to be from a value standpoint. So, exactly. So, so let's go into a little bit of, um, we talk, we'll talk a little bit about the whole concept behind uh the ESOP the medical practice that you, you helped establish in the island of Guam. Just if you could just kind of walk us through the story, I know it kind of started very you know uniquely in terms of them contacting you, but I'll let you kind of tell the story and then that'll help the listener kind of understand how that whole thing worked from kind of the beginning to end. Uh, yes, no, it's my pleasure and as we both referenced a little earlier, it's fun to be able to tell this story because it's certainly not the typical story, but I actually had the opportunity to do a podcast somewhat similar to this with an investment advisor. in Florida, happened to be in Florida also. I know that's where you are, Philip, and he was kind enough to interview me, somewhat similar to what we're doing here today, and he put up the podcast on his website. And the doctor that did own these medical practices in Guam was thinking about selling the practices or getting liquidity for her investment in the in the medical clinics on the island of Guam. And she came across my podcast, and believe it or not, and this is how marketing I guess, gets done in the 21st century, but she heard my podcast and called me up and I had never met this lady. Actually, when she called me, she was living in Canada. She spends part of the year in Guam. And she spends part of the year in Canada. She actually is a joint citizen of the country of Canada as well as the country of the United States, so she has a dual citizenship. And she found me on the web through doing a podcast very, very similar to what you and I are doing today. She called me up. We talked about doing an ESOP. Could it be done? And um ended up a few months later. With my getting on a very, very long airplane flight from actually Newark, New Jersey to Tokyo and then Tokyo to Guam, and I certainly remembered the island of Guam from history and World War II. Um those things that maybe some of us remember from probably elementary school days, but I probably could not have put a pin on a map and gotten it exactly on the island of Guam. Hopefully I might have been close, but I don't know if I could have actually picked it out. Um, on, uh, somewhere in the, in the Pacific Ocean, uh, which I certainly found out, uh, it's actually pretty close to the Philippines and just to the east of, uh, of Manila in the Philippines, probably the closest largest city. If you will, but just as we're doing here today and hopefully this podcast is of interest to many of your listeners, that's how the doctor who owns these clinics found me through a podcast. It's, it's pretty unique, right? Um, well, I think, I think it's interesting too because of the geographic reach of this, you never know where people are listening. So I think it's really cool. One of the, one of the questions I get from, from clients is, hey, where do I, how do I get my money, um, when I, when I do the ESOP? Um, can you describe how, how it works specifically from a, from a financing standpoint for this? And I know it's gonna be, we're gonna go into some generalities with ESOP financing, but just that's always a, a good topic to talk about um when you talk about these types of um transactions. Sure. So I, I think that the most important thing for your listeners to understand is, and compared and maybe they've learned this already in your various other podcasts, but compared to some other buyers, the ESOP does not bring its own money. the ESOP as I like to look at it, is a leveraged transaction. It's a leveraged buyout of the equity in the business. So doing a medical practice, ESOP, an architectural firm ESOP, or a manufacturing company ESOP, I think from the financing side, you have all of the same questions. Now, we probably all would agree that some businesses are easier to finance than others. Certainly when it comes to medical practices or architectural firms, and again I just bring them in. Or reference them so that your listeners understand that many, many services, many, many service companies, again, architectural firms, engineering firms, or medical practices, banks look at them differently when they're looking at financing them, and certainly, let's say a manufacturing company that makes so many widgets that has a fair amount of inventory on its books. Um, has receivables from big companies on its books, and has equipment and machinery and maybe real estate to provide collateral. So when we are looking at financing a medical practice, as we're discussing today, We are looking from a banking standpoint, a financing standpoint, at financing a company that doesn't have a lot of equipment, that doesn't have a lot of receivables, that doesn't have a lot of inventory, that probably doesn't have any real estate. So from a banking standpoint, it really is a cash flow loan. For those of you that understand cash flow lending, the banks are really taking Um or completing an analysis of, you know, are the cash flows going to be there to pay back the loan. So what we find, at least what I found in the financing of these types of businesses, is that you can get banks to provide financing, certainly not for 100% of the value of the business, as we did here in Guam, we actually sold 100% to the ESOP. This was a transaction. That went from 0% ESOP to 100% ESOP in one transaction. And this particular doctor, owner of the clinics, honestly turned out to be very, very similar in her thoughts, um as I find with many, many of my clients in that they say, I really don't need a lot of money right up front. I trust the business. I'll take my money over time. The bank isn't going to give me or any bank isn't going to give me, you know, a majority of the dollars anyway. Maybe they finance 20% or 30% of the value. So I will do 100% seller financing. I do not push my clients in that direction, but what I found just from my own practical experience is many of these entrepreneurs, especially the ones that are going to be with the business for a while into the future, they have the confidence in the business and that the business will be there to pay them off, to pay back all of the purchase price that's being financed by the owner. And this was the case in Guam, where the seller decided to take 100% seller financing, not go to a bank and have to live with the bank's requirements, the costs, etc. of putting bank financing together. But we certainly could have, I believe we could have gotten bank financing for some of it. And so let's just take a conservative. Approach and say maybe a bank would have financed 20 or 30% of the value and then the seller would have taken would be in a position to take seller paper for the 70%. But again, just my own personal experience, I find many, many owners, and this was the case here. that are comfortable and it's desirable to them because we can provide them a very nice return on their investment in effect in the in the lending transaction to the company where the seller was very comfortable in doing 100% seller financing. I think we provided her uh in this particular case, a return of around 7% on her seller financing. It was not aggressive, but she was very happy to, in effect, invest your money at 7%. Um, and get the money over time and of course pay taxes on the sale of her business over time under the installment sale treatment of the proceeds of selling a business. So you can't, you can't get that on the marketplace combination, yeah, you just can't get that kind of interest rate anyways, um, so it's, it is very attractive for some owners to get that, um, interest rate on their money, especially, yeah, especially in today's low interest rate environment. Well, great. Well, I think that, um, I think the big thing here is it, it works pretty much the same. Um, there's, uh with a professional services firm, there's usually not a lot of assets anyways. And so you have what we call an air ball for the bank to finance and the bigger the air ball, the less, you know, the less desirable sometimes the financing is. So, definitely be thinking about seller financing and, and that being a good option to, in terms of getting your money when you're going through it. The, uh, let's move on to the 11 question I had was just this idea of if you have a lot of these uh medical practice owned companies and professional services companies are the same way is you have an owner operator, a lot of times, you know, that is, is providing the service and billing the client. When you get to this case, you know, you have a company, you have this clinic that was owned by somebody that was more of an absentee owner. Um, talk a little bit about the idea behind for, for medical practices and professional service companies, the importance of making sure you have a transition plan for the services being created going forward if you have an exiting owner, that's an owner operator. Um, Phillips, certainly a critical question, a very important question, and when you're doing any ESOP transaction, and especially as you referenced here, where somebody and usually the owner is providing some or all of the services directly to the clients, and I think it really comes down to the question of do you have a transferable business. Uh, is, is the business going to survive without you being there? Uh, if you are not only the owner of the business, but the one with the majority of customer or client contact, patient contact. Do you have a business that can be sold? And so I think that question relates to all types of ESOP transactions, but certainly, as you've referenced, it's it's a big focus and an important question to ask very early on in in an ESOP transaction where it really is a people business where the services, whether they be me. architectural engineering, whatever it is, are being provided by, you know, one person or a group of people, some of whom may be leaving the company. We were fortunate, as you referenced in this particular case in this medical practice, where we didn't have that challenge, and we didn't really have to worry about a transition. Because the owner of this business, the doctor that owned these clinics, was really an absentee landowner, if you will, an absentee owner for much of the year. She spent part of the year on Guam when she was there. She was the lead person, but she did not spend all of the year on Guam, and we found that the practice was running very, very well when she wasn't there. So those issues really didn't come to play, but certainly a very good question. I think that's good. So kind of to wrap up, you know, I think it's been very interesting to kind of explore this for a medical practice and and there's, um, the idea behind that that might be something you haven't thought of as a listener. Um, thinking that this would be something you'd want to go further on. I, I certainly would guide you towards our website at journey to ESOP.com. Um, guide you to Rich's website at ESOPlus.com, um, to ask more questions cause you can only do so much in a half an hour to 40 minutes. Um, so with that, I wanted to say, you know, thank you for your time today, Rich. And I think just bringing that type of specific unique niche of saying, you know, medical practices might be a good idea for an ESOP. So I appreciate your time today. Uh, Phillip, it was my pleasure, um, and uh thank you for the opportunity to speak with you and your listeners today. Great. So as we close out, I just want to remind the listener, um, if you like the podcast, please subscribe to it. Um, share it with a friend if you think it might be helpful, um, and we look forward to our next time on this journey.