Legal 123s with ByrdAdatto (Blind Spot – Partnering With A Friend)
They say you should never do business with a friend… Tune in as Michael and Brad share a cautionary tale of best friend plastic surgeons who decided to leave their academic hospital and partner together to build their own private practice. In the second half of the episode Michael and Brad are joined by a special guest to break down the 4Cs – Cost, Compensation, Control, and Contingencies.
Listen to the full episode using the player below, or by visiting one of the links below. Below is the episode’s transcript which has been edited for readability. If you have any questions or would like to learn more, email us at firstname.lastname@example.org.
Intro: [00:00:00]Welcome to Legal 123s with ByrdAdatto. Legal issues, simplified through real client stories and real world experiences. Creating simplicity in three, two, one.
Brad: Welcome back to another episode of Legal 123s with ByrdAdatto I’m your host Brad Adatto with my cohost Michael Byrd.
Michael: Thanks, Brad. And you’re looking kind of handsome today.
Brad: Thank you.
Michael: All right. As a business and healthcare law firm, a client call is usually a request for help. The problem lies with the client’s timing on when they ask for help. Sometimes they bring their own biases and assumptions into a situation and miss the cues to know that they are not on the same page with their partner. That they need to seek some help.
Brad: Yeah. And Michael, in today’s episode we’re going to start our new fun element of this podcast. We’re going to do book reviews and we can start with a classic marriage book. Men are from Mars and women from Venus.
Michael: Well, Brad, I knew you were going to say that. That’s why I [00:01:00] tried to butter you up at the beginning. It says we’re in a business marriage.
Michael: And you are aging yourself once again. I mean, I think most of our younger audience has not heard of that book that our parents were talking about in the eighties. But funny enough, we could actually talk about that book based on today’s story because we’ll share a story about two people who do seem like they were from two different planets, at least what they were bringing to each other, as they had their business marriage. Today’s story actually reminds me of a trip my family took Ethiopia back in 2016.
Brad: Yeah. Yeah. I remember that. Well, you know, our firm was relatively young at the time and you’re like, hey, we’re going back to Ethiopia and I’m gonna take full two full weeks off. I was like, hmm, cool, yeah.
Michael: And I think that’s the first time I’ve took two weeks off and the last time I took two weeks off. I look forward to the next one. Yeah it was great. And for [00:02:00] context, our youngest daughter, Elyx who I’ve mentioned a few times on prior episodes, she was born in Ethiopia. This was a first trip to Ethiopia for many in our family, for the siblings, and we had grandparents. This was also Elyx’s first trip back since she came to the United States as a baby.
Brad: I remember this, not only did the whole family come, I believe you also took the nanny with you.
Michael: Yeah, our nanny has family in Ethiopia. She herself is from that region and was going to be our guide and translator. Her first language is Amharic, which is the primary language in Ethiopia.
Brad: All right. This has been fun memory lane here, but what does the Ethiopian trip connect with today’s story?
Michael: Stay with me. As part of our trip it was of course, as you know, two weeks, Brad. We first went to the Capitol Addis and we were there for the first week or so of our trip. And about that midway point, we were going to [00:03:00] fly to Gondar and go visit the Simien mountains. Natty had been at that point in the trip staying with her family and was just going to meet us at the airport to catch this one hour flight. We get to the airport and Natty had not arrived when we got there. And so we’re of course in a foreign country without our navigator. And we ended up figuring out how to check our bags. We ended up going through security. We ended up boarding the plane.
Brad: And no Natty. So, so far, this does not sound good.
Michael: Yes. And for me, I’m normally a pretty calm person, but in this element of being in a foreign country, I was definitely feeling the pressure. And so we were in our seats and we were trying to call her, no answer. The plane was leaving in 10 minutes and I found in our travel notes, a number for her [00:04:00] brother and called and got him. They had just taken the exit off the highway and were approaching the airport.
Brad: So 10 minutes not there. Uh, I guess she did not make that flight?
Michael: No, she did not. And the whole hour long flight, my wife, Stephanie and I were trying to figure out how we’re going to meet up with Natty. Not only did we have to get there, but we were going to take an hour and a half long shuttle ride to the Simien mountains. You’re the logistics master, but this had a lot of moving pieces and in a foreign language.
Brad: All right. What happened?
Michael: We landed. We got our luggage, we found the shuttle driver. This was all going great. But then we were trying to figure out how to explain to him that we were missing someone and trying to figure out how we were going to, are we going to wait? Are we going to go ahead and go and figure out how to have someone pick her up? And so we’re going back and forth with this and we look up and see Natty walking out of [00:05:00] the airport. This is literally 20 minutes after we landed. Yeah, I have no, I mean, that would be like, think about flying from Dallas to Houston and landing. And there was another flight that landed like 10 minutes later. It made no sense, but there was a flight that left from Addis to Gondar that left within 15 minutes of the flight that we were on and she was able to jump on it. It was crazy.
Brad: All right. So far it sounds like a fun story through memory lane, but again, what does that have to do with today’s story?
Michael: The Ethiopian culture has a different relationship with time than the American culture. And so we brought our assumptions on the importance of the itinerary and the timeline, and that just didn’t resonate in the same way with that. In fact, we kind of knew this because prior to that, we had been invited to an Ethiopian church service with Natty in Dallas and the service started at 5:30. And of course we show up punctually at 5:15 ready to [00:06:00] go. There was no one in the room at 5:15, there was no one in the room at 5:30 when it was supposed to start. It started filling up at 6:15 people started showing up and the service actually started at 6:45. So at our church, we would have already been on our way home at this point and they were just starting. So yeah, we had had some prior experience with the kind of Ethiopian time.
Brad: Well, how did the rest of go?
Michael: It was amazing. It was a trip of a lifetime. After the airplane incident, we were more acutely aware of our different biases and assumptions on time. So we made sure to be super specific on communications as it related to knowing when it was time to leave. And then of course, for us, we kind of chilled out a little bit on the itinerary and let things happen a little bit more on Ethiopian time.
Brad: Yeah. All right. Great story about understanding the differences. Let’s jump in to today’s story. [00:07:00]
Michael: So for today’s story, Brad, we had a client call us for a partnership wind up. The backstory of how they ended up at this point was fascinating. He and his partner had previously worked at an academic hospital for over 20 years together in the plastic surgery department.
Brad: Pause for a minute and let our audience know what you mean when you say they worked at an academic hospital.
Michael: Now Brad, you know I love context questions.
Brad: I thought you’d like this one.
Michael: All right. So when doctors leave school, they essentially go to one of three routes. When they are starting into the real world into practice, they can go into hospital employment, they can go in and have an academic appointment, or they can go into private practice.
Brad: For our audience we’re going to give them a little behind the screen or whatever you want to call it. So hospital employment means that the physician is not only on staff with privileges, like most doctors, but they’re also either employed directly by that hospital or a related hospital [00:08:00] entity.
Michael: Yeah, an academic hospital is similar and that’s the case with our story today, but it is slightly different. The physician in this setting actually teaches, does clinical research, publishes educational articles and has a clinical practice. And for the audience, many cities have teaching hospitals where patient care is provided and young physicians are trained.
Brad: Yeah and now last, but certainly not least. In private practice, this is where the physician owns or is employed by a medical practice that is privately owned. Often when we go to your doctor’s office, this is typically a private practice. None of this necessarily means that one is better than the other. They’re just a ton of different ways in which we look at these practices.
Michael: Yep. So back to the story, we will call our client Dr. McDreamy and his medical partner and good friend, Dr. Grey.
Brad: I see what you’re doing here. These names are straight out of that TV show Grey’s Anatomy, [00:09:00] which for us is pretty amazing because that’s somewhat of a modern show for this podcast. But why these names?
Michael: We make a cultural reference that’s something that’s still happening. It’s crazy. I wish I had a more clever answer or that I was being more culturally relevant, but the show just popped into my mind when I was on this initial call and Dr. McDreamy shared his story about working in the same hospital with Dr. Grey for over 20 years. I think Grey’s Anatomy I just looked it up and is in season 17 right now. And so it just made sense. That, and Dr. McDreamy is easy on the eyes.
Brad: And I believe you’re correct on both of those assumptions. One is that the 17 years, but we have both met Dr. McDreamy and he is a good looking man. So I’ll accept these names and let’s get back to the story.
Michael: Is that why you prettied yourself up today? A few years prior to my initial call with Dr. McDreamy, he and Dr. Grey decided [00:10:00] that they wanted to take their skills into private practice. As we talked about, they had worked with each other for years and they got along great at the hospital so transitioning into private practice with good friends and colleagues seemed like a no-brainer.
Brad: Yeah. And there’s a common story we’ve heard many times before, especially with plastic surgeons. They tend to eventually gravitate towards more of the cosmetic side of surgery as they become more experienced. And for our audience, cosmetic surgery is mostly more on an elective side and tends to go on the private practice side rather than the academic or hospital systems. I could spend 20 minutes alone just discussing these reasons, but let’s get back and focus on Dr. McDreamy story.
Michael: Yeah, perfect. Dr. McDreamy and Dr. Grey were excited. They formed a medical corporation, they signed the lease, quickly executed some base corporate documents, I mean, they were ready to take on the world.
Brad: Yeah. I just heard a red flag there. Michael, did you say base corporate [00:11:00] documents?
Brad: Okay… and for those that didn’t catch it, Michael is setting us up that these parties mostly did not spend any time and energy in developing their custom corporate documents needed to be partners, friends, or otherwise.
Michael: Yeah. Well, way to catch that, Brad. You were listening. You surprise me every day. As I unpack the story, they relied on their long friendship that ultimately broke it to have one major difference of opinion. And they didn’t have these base documents to back them up at this point. So they did not discuss deep enough on the front end to see where there was a problem on this one area. And then just to make matters more complicated, eventually when they started the practice, they took out an SBA loan. [00:12:00]
Brad: I think Michael we just hit our first vocabulary word for this podcast. SBA loan again, for our audience, the SBA for you for not familiar with it, they’re backed by the federal, but it’s known as a small business administration. These loans are common for a lot of startup companies and they’re common strings attached to like any other loans, which are generally the personal guarantees. So you’re basically putting your personal assets on the line and agreeing that you’ll pay for it or that they can go after you, if you fall into debt. And a lot of you may be more familiar with the SBA right now because of all the PPP loans. Yeah but this is definitely more of a traditional loan for these clients.
Michael: Yeah. Using the old marriage analogy with this business marriage, it’s like getting married, which is a commitment and then buying a house with a mortgage. So they were tied to each other. And we’ll talk about that a little bit more later.
Brad: Yeah. So I’m curious what happened next.
Michael: So Dr. McDreamy had attended the [00:13:00] plastic surgery conferences for years and had listened to all his private practice friends give these exciting lectures on digital marketing strategies, through their websites and social media. And he had heard the experts in the field give similar lectures and the essential message was, hey, you know, this is elective surgery, it’s competitive, and you got to spend money to make money. And he assumed linger on that word that this was the way everyone did it. And he was excited for how this would work at his practice.
Brad: You and I have seen this movie play out before, so let me guess. You said the word assume Dr. Grey was not big into marketing and she obviously came from the academic world where patients just kind of pop out of thin air.
Michael: Nailed it. And we Brad, we both know of other law firms and lawyers who view websites as a big waste of money.
Brad: Yeah they do that same thing that a [00:14:00] potential client would just ask a friend if they need a lawyer. And we’ve heard this before, you know, no potential client would ever use that worldwide web to find a lawyer, right, Michael?
Michael: Yes. And we have many physician clients over the years who have shared this view for medical marketing.
Brad: So what did she assume was the way they were going to market?
Michael: I mean, she thought they were established for 20 plus years in the community and the teaching institution of the community, physicians, friends, and past patients would be the engine that would fuel their growth. And they’d be able to pay themselves more money by not spending so heavily on the marketing side.
Brad: And we talked about the dangers of unmet expectations on other episodes. Why were they not able to work this out?
Michael: Well, there’s a couple of reasons. One was probably poor communication, but the real pressure point was that the practice was not growing [00:15:00] and busy. I mean it was limping along. Dr. Grey was doing a little better and was able to take home a little bit more money to pay the bills, but still not busy enough. And Dr. McDreamy was feeling the pressure as he was much slower than Dr. Grey and they weren’t spending any money on marketing, which was super frustrating to Dr. McDreamy, because he thought this was the reason that they were not busy.
Brad: What happened did Dr. Grey win the argument and they decided not to market?
Michael: Well, that would have been healthier because that would have meant they actually talked it through and made a decision together, even if it ended up being the wrong decision. No, Dr. McDreamy spent countless hours trying to demonstrate the importance of a digital marketing strategy and Dr. Grey would not budge. And then they would just kind of leave the conversation and keep on rolling with their day-to-day lives. They [00:16:00] had set the practice up with these base documents, Brad, so that everything was a unanimous decision. And so when she didn’t agree to spend money on marketing, marketing just didn’t happen because she didn’t end up agreeing to it. And so there was a lot of dysfunction that developed.
Brad: Yeah. It sounds like it since Dr. McDreamy, I think when we started this episode and noted that you were calling to do a business divorce.
Michael: Yeah. That’s how my first call was over that subject, he was ready to move on. So let’s go into a commercial and on the other side, talk about how this could have turned out differently if Dr. McDreamy and Dr. Grey had confronted this on the front end and we’ll bring in a special guest to help us talk through it.
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Brad: Welcome back to Legal 123s with ByrdAdatto. I’m your host, Brad Adatto with my cohost Michael Byrd. Now, Michael, this season’s theme is when should I ask for help? So for the second half of this show, we are joined by our friend and colleague Sam Pondrom who is going to help us break down the story. Michael, let’s bring Sam in.
Michael: Well, Sam, who is our Mr. McDreamy here, he’s a tall drink of water. He was from Oklahoma state university graduated in 2006. Then he went on to a SMU school of law. He was the student bar association vice-president and [00:18:00] Interestingly, Sam has a business background before law school. So he became a little seasoned before he went back to school. His wife is Heather, son, Leo and daughter, Sloan. And yes, they are all tall. Sam, welcome.
Sam: Thanks for having me.
Brad: That’s one thing I love about this podcast is they can’t tell how tall everyone is.
Michael: Works out well for you.
Brad: It does. We talk to our clients a lot of times in the front end, you know, we’re trying to push them away from the base documents that we’re talking about, but we always talk about the 4 C’s and we’ve talked about this in other episodes, but that’s cost, compensation control, and contingencies. Now Michael, just to help remind our audience on a high level can you talk a little bit about some of the 4 C’s?
Michael: Yeah. It’s just our language of here are the things that are going to make or break a partnership arrangement. If you deal with them on the front end, odds are you’re going to be on the same page and not going to have these nasty unmet expectations. And [00:19:00] then if there is something that goes wrong, you have documentation to deal with it. You have a process to deal with it. So cost is essentially, if you’re starting something together, how much are you capitalizing it with and what are you getting in return? So are you going to be 50/50 owners, what’s the ownership expectation? And then what are the future capitalization requirements? The same kind of thinking goes into it if you’re buying into a practice, what are you doing? What are you getting? Compensation now that you’re a partner is how are you going to pay each other for the day-to-day work that you’re doing. And then control, how are you going to make decisions? And then the final one is contingencies, and that’s just dealing with the what ifs, whether it’s death, disability, divorce. As we see here, business divorce or personal divorce can all be things that need to be dealt with in your partnership [00:20:00] arrangement.
Brad: Sam, let’s dive into control as this probably could have changed the outcome with Dr. McDreamy and Dr. Grey. Talk about the control infrastructure and how this can be set up, in your governing documents for these small businesses.
Sam: So, yeah, control, like Michael said is added space. It’s all about how decision-making within an entity works. And this sounds simple and generally it should be simple, but as the McDreamy, Grey examples, so hopefully demonstrated a failure to plan for control can take this simple situation and make it very complex. And there, even though I might be contradicting myself a little bit here, there are many aspects to control. So it’s important to address the high level structure of it. There’s some variation to what I’m about to discuss, depending on the structure you choose, but [00:21:00] really at its base control is about voting as who gets to vote when and what volume is really needed to approve a decision. But when it comes to voting, like I said, there’s a lot to consider. So first and foremost, we look at management groups and these are directors for corporations and managers for LLCs. And if you talked to anyone here at ByrdAdatto before you know that we strongly recommend establishing these management groups make that LLC manager managed. The reason for this is the old, too many cooks in the kitchen, large ships turn slowly. You can pick your adage, but the same consideration holds true. The more people that are required to vote the harder it is to comply with your entities particular voting requirements. So when you’re planning, plan ahead, think hard about who would be best for the board of directors or managers, avoid that urge to throw everyone on there a voice. And really the point for [00:22:00] the management group is to be thoughtful and accountable to the entity, but also nimble enough to make decisions and keep the business moving forward. So the second group, when it comes to control and voting are the owners, you know, shareholders for corporations, members for LLCs. And just because you’ve established a management group doesn’t mean that all the owners get to be on it. They don’t necessarily get a vote in all decisions and we’ll touch on this a bit on my next point, but there are key decisions you don’t want your management group making it a vacuum. And so really the owner group voting tends to function as a check on the power for that management group. It requires a second level of approval for these key decisions. And here, when we talk to people about planning ahead, you really want to put serious thoughts thought into the types of decisions that require owner approval. You don’t want them on all. [00:23:00] And again, we’ll touch on this more in a second, but you have to look at ownership interests as well and think through the level or levels required for approval on a vote. So related to what we were just talking about. In control there’s a couple of different ways to handle approval types. Typically you’re going to see either per capita voting or ownership percentage voting. And this is an important facet in designing your control scheme, because you have to think about the type of vote you want for a particular decision. So per capita basically means one person, one vote per head, right? And this is common at the management group level. But one thing you really have to think about here is ties. Odd numbers work great but if that’s not an option, you got to make sure to think through, okay, what happens next? What happens if we tie, throw on a tie break provision and you can get creative with those. We structured tie breaks [00:24:00] in a lot of different ways on the ownership interest side. It’s talking about an owner’s vote is weighted on how much of the entity they actually own. And this is very common at the owner level, which you have to be careful about imbalances. For example, if someone owns 50% or more, you got to think twice about majority in interest decision-making because they can essentially ram something through. So a helpful way to handle this is to create sort of a tiered structure. Meaning that the more meaningful a vote is the higher percentage of approval is needed so that more owners get a meaningful say in what happens. So planning ahead here, the best time to discuss this and agree on approval types of levels is when everyone’s on board. Everyone’s excited about getting the entity up and running the venture off the ground. So do it early. Plan ahead. If you wait until [00:25:00] there’s a problem, it’s probably really too late to address this. And then finally there’s decision types, right? There’s day-to-day decisions and major decisions, which we referenced a little bit earlier. And this goes back to management group voting and owner voting. You want to empower your management group to make day-to-day decisions in the best interests of the company. But you don’t want them to have to stop and get permission for every little decision what you can do is set logical limits based on your business, on the types of decisions they can make. And for day-to-day decisions we’re talking about entering into and making contracts, opening accounts, collecting money, paying debts, things like that. On the other hand, you want to have a second level of approval, that ownership level on major decisions that would materially change the business. When we talk about major decisions, we’re talking about bringing on new owners, issuing new classes of ownership or equity, uh, mergers and acquisitions, changing the purpose of the [00:26:00] company, things like that.
Michael: That’s awesome. And one thing that just popped in mind listening to you is there’s actually an another layer of infrastructure you could put in to deal with the day to day where the managers can actually delegate that down to an officer. So you may have a couple of managers and there may be the one person that likes to oder the supplies and do all the mundane day-to-day tasks. And they can actually delegate that with those similar boundaries to that person so that you don’t get stuck literally deciding whether to vote on buying more staples.
Brad: Yeah. All these are awesome points but Michael, we still have to address the elephant in the room.
Michael: No, Brad, I’m not going to start calling you lawyer McDreamy.
Brad: Come on. See, I should’ve had written that in up in our partnership documents, it would probably have been all right. No, seriously Sam brought up some great points there, but we have two people in this story, [00:27:00] right? And so as creative as these governing documents can be, and we really talked heavily on the 4 C’s, especially the control. You can’t change the fact that you have two owners with two different people it will ultimately be making this decision for this business.
Michael: Yeah. And they owned 50/50, so there’s no per capita or ownership work around. I mean, they both own half the business and there’s two people. So it’s really challenging to build an infrastructure with just two people. And you have to just acknowledge, there’s not a perfect setup. We want to be creative for the circumstances and you take the stuff that Sam was just teaching us on and set it to the side for a moment and really just start talking through how the doctors in our case would envision that it’s going to work. How are they going to work through things? And here had we started and picked up on this difference, which I think that that could have been identified on the front end. They were [00:28:00] talking about these things, they could have set up a direct expense bucket for Dr. McDreamy to have his own little ability to spend marketing on himself that would come out of his share of the profits. And then Dr. Grey could continue to try to save money, but hoping for the referral system to work. What are your thoughts, Brad?
Brad: Yeah, I mean, great acknowledgement. I think you and Sam nailed a lot of the things that are super important to something like this. We’ve seen situations, especially in this case are 50/50, same number of years of practicing. But a lot of times, especially when you’re an older physician bringing on a younger physician, there’s a process that we have worked through as to eventually flipping it where the senior physician is no longer in control and the younger physician takes over. We probably could spend 15 minutes alone just really talking through that, but I want to get back to something you talked about earlier in this episode that I didn’t want to lose is when we talked about that SBA loan. [00:29:00] How did that impact this arrangement?
Michael: Well now it’s time to get divorced and there’s this debt hanging over the practice that is made the practice essentially insolvent. I mean, there was no real assets. So we were divorcing over the debt. And guess what, the bank wants both people to pay it back and they both have personal guarantees. And so it made it really complicated and messy to unwind that relationship. And it’s something that, to this day, Dr. McDreamy and Dr. Grey are dealing with, and they’ve been separated for a few years now. What are your final thoughts, Sam?
Sam: So when it comes to control, I always tell our clients plan early and plan often, you know, it’s not a formulaic, let your counsel decide. I mean, we can guide this decision, but you really have to tailor it to your business and your people [00:30:00] and what you’re going to be doing. And the reason we say plan early is everyone’s getting along, everyone’s excited there. There’s going to be a tendency to want to work these things through in a meaningful, workable manner. And so even if it’s a simple decision or it’s a difficult decision that maybe you don’t want to think about at the beginning of the business, you really have to take the time and maybe make yourself a little uncomfortable doing this planning in order to work through the control issues. Because like I said, once people are unhappy it’s not going to happen, it’s going to be a fight. And then the plan often piece is because businesses are ganache and they change over time. And one of the things we see is clients who had a great plan going into it and then their business changed, they didn’t change. So you have to make sure that you’re thinking about the [00:31:00] state of your governing document as well, and update it along with your business and your people and your sort of needs and direction.
Brad: These are all great points. And we didn’t mention it Michael, but that’s really as the 5th C, which is communication. You can set those expectations up front, but continuing to communicate as Sam just mentioned, Is very powerful 5th C, which maybe one day, we’ll add it. But I think our audience at this point, Michael, wants to know what was the final outcome of Dr. McDreamy and Dr. Grey.
Michael: Yeah. They did get separated. There wasn’t a lot to split up other than the debt. We were able to work with the SBA to get the transition so that they could split and they are still dealing with a little bit of the after effects and they will be until that loan’s paid off. But I think they’re both doing well and both have some lessons learned.[00:32:00] They kind of learn the same lesson that I learned on our trip to Ethiopia that communication is key.
Brad: Join us next Wednesday for the final episode of season four with our special guest who is a plastic surgeon and national speaker, the title for next week is Signing Blindly- Physician Employment Agreements with Dr. Gary Tuma.
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