26 AE Fall 2011

Dividing Owner Incomein a Group Practice

Running the Practice Management

Derek Preece, MBA, and Maureen Waddle, MBA

Given that there is no single standardfor “fairness,” how do clinic administra-tors and managing physicians ever helptheir practice’s owners reach an agree-ment regarding the allocation ofincome?

“Our owner com-pensation planisn’t fair. Justbecause I’m ahigh producer, I

end up paying more of the overheadexpenses. I don’t use any moreresources than the other doctors; infact, I may actually use less.”

Sound familiar? Most grouppractices have faced owner disagree-ments about “fair” income distribu-tion. These disputes can become bit-ter and last years, zapping the energyof practice owners and managementand disrupting nearly every doctormeeting.

Fairness Is a Perception Here is a typical refrain that all par-ties tell us when these argumentserupt: “I just want to have a systemthat is fair to everyone.” That is anappropriate objective, but in the realworld it is easy to find two individu-als whose ideas of “fair” are diametri-cally opposed. For example, considera two-ophthalmologist practice withan agreement that the partners splitnet income in proportion to theirrespective percentage of total collec-tions. Combined revenue totals$2,000,000 with overhead expensesrunning 60%, or $1,200,000. Afterexpenses, they have $800,000 tosplit as their personal income. Thecalculation is shown in Example 1.

All goes well until Dr. Smithrealizes his overhead burden in dol-lars exceeds his partner’s. From theexample you see that he generates$1,400,000 in collections, but keeps$560,000. Therefore, he pays$840,000 in overhead expenses com-pared to his partner’s $360,000($600,000 in collections minus the$240,000 the partner keeps).

Dr. Smith suggests a system thatwould be “fairer” to him: Since theyare equal partners, why don’t theyeach pay the same amount in over-head? He suggests they equally split

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all overhead expenses, so that eachpartner pays the same each year.Example 2 demonstrates partnercompensation under the new pro-posal.

When it comes to splittingincome between partners, agreementon what is “fair” is often elusive. Inthe first example, the lower producerconsidered the income allocationmethod to be fair, while the higherproducer disagreed. In the secondexample, perceptions of fairness werereversed.

Given that there is no singlestandard for “fairness,” how do clinicadministrators and managing physi-cians ever help their practice’s own-ers reach an agreement regarding theallocation of income?

Six Methods of Income AllocationThe first step is for stakeholders tolearn about the six basic methods ofownership compensation so they cancraft a plan that produces a consen-sus. There are nearly as many formu-las for splitting income as there aregroup practices because every organi-zation takes a unique approach.However, most compensation sys-tems use one or more of these sixfoundational methods:

1. Equal Pay: In this system, thenet income (dollars available afterexpenses) is divided equally, regard-less of production levels by individ-ual doctors. An advantage of thismethod is that it creates a real “part-nership” culture because all ownersbenefit equally from any successes ofthe practice. It further reduces inter-nal competition between the doctorsfor patients since a procedure per-formed on a patient by any doctorhas the same financial effect on allof the owners.

2. Production Percentage: Thisis probably the most commonly usedcompensation system in ophthal-mology practices. The method dis-tributes funds available to the doc-

tors by the percentage each ownerproduces of the combined collec-tions. This is the method used inExample 1—Dr. Smith generates 70%of the collections in the practice andreceives 70% of the available netincome. Advocates for this methodpoint to the strong incentive forindividual productivity.

3. Equal Overhead Percentage:Overhead percentage is the amountof overhead expenses divided by netcollections. Some practices distributeincome by charging each owner thesame overhead percentage. InExample 1, overhead percentage is60%. If we subtract 60% overheadfrom the physicians’ collections, thepay for each doctor is the same as inthe Production Percentage system.For example, Dr. Smith paid$840,000 in overhead ($1.4 millionminus his income of $560,000),which is 60% overhead ($840,000/$1.4 million); likewise, Dr. Jones paid60% of his collections to overheadexpenses. Using this method encour-ages owners to manage expenses.

4. Equal Overhead Dollars: Inthis method, the total overheadexpenses of the practice are divided

equally among the owners. This isthe method used in Example 2 andgenerally results in an advantage tohigh producers, as every dollarearned above the overhead amountbecomes personal income. This sys-tem has less of a “partnership feel”than some of the others becauseeach doctor is essentially independ-ent of the other owners in terms ofhis or her personal productivity andincome.

5. Resources Used: Some prac-tices believe that each owner shouldpay for the expenses that the ownergenerates and the resources theowner uses in the practice. For exam-ple, if Dr. Brown uses one technicianto see patients, but Dr. Green usesfour techs and one scribe, Dr. Brownwill likely object to contributing tothe pay and benefits for all of thestaff Dr. Green likes to employ. Inthis case, they may decide to assignthe wages and benefits of technicalpersonnel to the respective doctors.In some practices, nearly all expensesare divided among the owners basedon usage.

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Example 1

Doctor CollectionsGenerated

Percent of TotalCollections Income

Smith $1,400,000 70% $560,000 (70% of $800K)

Jones $600,000 30% $240,000 (30% of $800K)

Example 2

Doctor CollectionsGenerated Overhead Paid Income

Smith $1,400,000 $600,000 $800,000 ($1.4 million minus $600,000)

Jones $600,000 $600,000 $0 (all collectionswould go to payoverhead)

28 AE Fall 2011

of revenue to different distributionmethods such as when a practiceallows doctors to keep a higher per-centage of speaking or consultingfees as personal income.

Dependence vs. IndependenceIn working with owners to create anagreeable income distribution sys-tem, it is important to ensure thateveryone understands these basicmethods and how they affect partnerrelationships. One question thatoften arises during income allocationdiscussions is whether the practicewants to emphasize the partnershipnature of the relationship betweenthe doctors (“we’re all in this togeth-er”) or whether it wants to focus onrewarding each doctor according toindividual production (“eat whatyou kill”). A simple way to envisionthe effects of income distributionmodels is to place them on a contin-uum between dependence and inde-pendence (see Figure 1).

This graphic illustrates how thesix basic systems emphasize eitherteamwork and dependence or inde-pendence and economic autonomy.Under the Equal Pay method, eachdoctor is directly dependent upon allpartners for income; every dollar ofcollections one doctor producesresults in a portion of that dollar

6. Ownership Percentage: Inthis method, net income is dividedamong partners based on percentageof ownership. This method is rarelyused to allocate all of a practice’sowner income. More common is acombination method in which just aportion of net income is dividedamong partners as an owner divi-dend. For example, a practice mightdivide 70% of net income by theProduction Percentage method,while the other 30% is split based onownership percentage.

Combination: What Most Practices DoMost ophthalmology practices use acombination of two or more of theseincome distribution methods. Wehave mentioned one combinationmethod in the previous paragraph,but there are many others. Manypractices split net income by theProduction Percentage method,while also employing the ResourcesUsed method for certain doctor-driv-en expenses such as CME and travelexpenses, dues and subscriptions,and sometimes even health and mal-practice insurance. In addition, thereare other, less commonly appliedmethods of income distribution suchas allocating income based on daysor hours worked or assigning sources

Running the Practice Management

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going to all owners as personalincome. In the same way, if one part-ner reduces his or her work scheduleand thereby produces lower collec-tions, all partners feel the effect ofthat decision in their take-home pay.Compare this to the Equal OverheadDollars method in which each dollarof revenue affects only the doctorwho generated those collections. Theother doctors’ income is not affectedby increases or decreases in theirpartners’ work habits. TheOwnership Percentage methodresults in a high degree of depend-ence, and the Resources Used systemis on the independence side of thecontinuum, while the ProductionPercentage and Equal OverheadPercentage models lie somewhere inthe middle. A practice that uses morethan one method to distributeincome can emphasize both depend-ence and independence elements.

Reaching an AgreementDisputes regarding the method fordistributing owner income in grouppractices will likely continue tooccur in the future because there isno single system that appears “fair”from every physician’s point of view.The best chance for reaching anagreement on income allocation isfor each stakeholder to understandthe basic methods for sharingincome and how those methodsaffect the relationships among part-ners in the practice. AE

Derek A. Preece, MBA (801-227-0527; dpreece@bsmconsulting.com), andMaureen Waddle, MBA (916-687-6135; mwaddle@smconsulting.com), are senior consultants for BSMConsulting.