An elderly physician has built up his own practice into a quite valuable busines

Question

An elderly physician has built up his own practice into a quite valuable business. Now that he is thinking of retiring, he wants to take on a partner to learn the business and eventually buy the practice in three years. Her compensation will be a salary plus 25% of the profits if they are below the historical average and 50% for any increase above the historical average. The eventual purchase price for the practice will be 5 times the average profits over the three years. Discuss the plusses and minuses of this contract with respect to efficiency aspects and transfer of the business to the new partner. Do you think the incentives of the buyer and seller aligned?

Explanation / Answer

There are a few points:

· Overlapping tenure for the retiring and new physicians tends to increase the transfer of practice specific knowledge.

· Profit sharing with the new physician increases her incentives to maximize profits.

· However, since the sale price is a multiple of the profits during this 3 year 'probation' the new physician has an incentive to shirk to keep the profits low. It might have been better to use a multiple of profits from the period before she began this probation.

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