Shareholder Agreements: 12 Critical Items

March 26, 2019 | Featured Articles

Download PDF

Whether it is a seasoned consultant, attorney or accountant, when it comes time to draft a shareholder agreement, it is recommended to hire someone with experience in these matters. An experienced consultant can assist stakeholders in establishing a fair and equitable contract. However, while most practices have competent legal counsel that can help shareholders with their agreements, not all experts have keen insight into the nuances of medical practices.

The good news is that shareholders can use their priorities to determine specifics that work best for them and their practice. Consider addressing these often overlooked items when collaborating with your trusted advisor:

Personal responsibility for coding audits

Improper coding or documentation penalties followed by a healthcare company’s recoupments efforts can negatively impact a practice financially. To mitigate the risk, consider including a stipulation that emphasizes that providers are responsible for their coding and documentation — as well as forerror penalties. Also, include “clawback” provisions specifying how potential recoupments are handled after a shareholder is bought out or
leaves a practice. These provisions should not be limited to shareholder agreements but also included in an employment physician agreements.

Spouse approval

To avoid any potential conflict after a shareholder dies or goes through a divorce, it is essential that shareholders’ spouses sign the shareholder agreement. Appropriately crafted, this eliminates inherent challenges to the practice valuation and buyout process. Moreover, such a requirement is quite useful when facing buyout opposition from an estate or soon-to-be ex-spouse.

Personal guarantees for financing

Shareholder agreements often have generic language about how personal guarantees for practice loans are handled. Address whether such guarantees are on a pro-rata basis and if shareholders will indemnify each other’s allocated warranty. Whatever language you decide on needs to correlate to the final loan agreements, which would likely take precedence over the terms of your shareholder agreement.

Consecutive days out of office

A practice retains a certain amount of overhead regardless of whether a shareholder is actively seeing patients. Therefore, a shareholder who is away for an extended length of time can complicate a practice’s ability to
keep up with such costs. Determine up-front how many days a shareholder can be away before enforcing an alternative compensation formula or buyout.


The best shareholder agreements include a clause that says compensation will continue at the usual rate until a shareholder’s disability policy kicks in. A disability provision requires shareholders to carry a disability policy that begins 45 to 60 days after the beginning of a disability. This stipulation minimizes the financial impact to the practice during a time when additional expenses may put downward pressure on the practice’s finances. Those shareholders who can’t obtain disability insurance may seek a variety of ways to escrow a portion of their salaries each year for such contingencies or provide an alternative compensation formula for them.

Mediation or Arbitration Clauses

Including a mediation or arbitration provision in case of stalemates over major decisions is recommended. Shareholders may call upon a neutral third party to facilitate a resolution in such instances. The agreement should further state that the issue will be resolved by binding arbitration should mediation not work. These terms motivate involved parties to come to a consensus in the mediation phase. Without such verbiage, the mediation phase will lack the teeth needed to drive a resolution.

Medical Malpractice Tail Coverage

The agreement should address how the tail coverage for a departing physician will be paid and whether or not this amount will be deducted from the buyout price. Tail coverage can be very costly, depending on how long the departing provider has been on the policy as of their last date with the practice, and whether it is a claims-made policy.

Force Out Provision

Assuming the shareholder agreement contains the explicit formula to value the practice, there should be a premium allocation (10 to 25 percent) to be paid should a majority of shareholders wish to buy out a particular
shareholder. A force out provision presents a financial incentive to carefully select partners aligned with the shareholders before adding a new partner. More importantly, it contributes some motivation for all the
partners to weather challenges.

Failure to Plan Provision

Practices should have as much notice as possible of individual shareholder retirement plans, due to the time and expenses related to recruiting and grooming another shareholder. The agreement should stipulate that the buyout amount is discounted by 25 percent in the event of a physician not providing at least two or three years’ notice of retirement. Obvious exceptions would apply for disability and death. Consideration should also be given to scenarios in which a shareholder loses his or her ability to be covered by medical malpractice, retain board certification, or remain on provider panels.

Pledging of Assets

The shareholder agreement should specify that individual shareholders cannot collateralize stock ownership. Specifically, they cannot pledge stock in the practice as a guarantee for any personal loans or the like.

Personal Bankruptcy

Practices should seek legal counsel concerning how to minimize impact resulting from a shareholder filing for personal bankruptcy. The last thing a medical practice needs is third-party meddling.

Future Expansion and Financing

Consider the following scenario. Two physicians invest $100,000 in a new location. Instead of taking a loan, they reduce their income for the year by $50,000 each. One of partners dies during the next year, and a significant portion of the valuation formula takes into consideration the “benefit of owning the practice.” How do you compensate the heirs for the reduced income in the previous year and loss of benefit from that

While every situation is different, one way to mitigate this problem is to obtain outside financing to fund expansion efforts. While this does not reduce all the issues, it does address one part of the equation. Similarly,
care needs to be taken to avoid a scenario where a shareholder reduces his or her earnings in a given year to fund the acquisition, yet is bought out before the investment is recouped.

If you have concerns about your current agreements or lack of succession plans, there is no better time than now to begin to address those. Start by reviewing your partnership agreements. Run scenarios such as described throughout this article: if your senior managing partner had a heart attack tomorrow, are their plans in place to quickly and deftly manage their departure? Don’t wait until you need a plan; prepare a plan in place in advance of a disaster, and your partners will thank you for that in the future.