Bringing in an associate: Protecting yourself and your dental practice

Bringing on an associate to your dental practice is a huge decision. Protecting the owner/dentist during this time is very important. Making sure the associate is in the best position possible is also important. Here are some ideas to get started on the best foot.

In a few years’ time Dr. Smith explores selling his practice and retains a firm to conduct a valuation. He’s surprised when the firm determines that, of the $1,000,000 of goodwill in the practice, only $600,000 is considered his; the other $400,000 of goodwill is assigned to his associate. He asks if the non-compete means the goodwill belongs to him. But the valuation attorney says that the five-year. 100-miles non-compete in the employment agreement is overly broad, therefore it is unenforceable. Dr. Smith is obviously not pleased with this outcome.

Adding an associate to your dental practice can be either a great personal and financial boon, or a recipe for disaster. What legal issues should you be aware of when bringing on a new dentist, and what pitfalls should you be careful to avoid? Here is a basic overview of some of the contract and employment law issues that will come up when you prepare to have an associate sign an employment agreement.

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Can you add an associate?
The first question is whether your practice can support another dentist. Is there sufficient space or equipment to allow another dentist to practice? Is there enough work to keep a new associate busy? A financial analysis of the practice should answer whether adding another dentist makes economic sense.

Get it in writing
Once you’ve decided to add a new associate, determine what issues of concern you want to capture in the employment contract. Every situation is different, but there are some basics. You need to decide how to classify the new hire, as an employee or as an independent contractor. How will you compensate the new hire, and on what metric will you base that compensation? You need to determine the scope of your new hire’s job duties. You’ll want to plan how the employment relationship will eventually end, and what will happen if things go badly.

Planning for the worst means you will want to include non-compete and non-solicitation clauses to make sure you protect the value of your business. You’ll also want to plan for what happens if things go well, including provisions for the sale of practice, the option to purchase, or the right of first refusal for either.

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Employee or independent contactor?
One of the first decisions to make is whether the new dentist will be an employee or an independent contractor. If you’re unfamiliar with employment law, this may seem like a strange place to start, but this question of classification will affect all other aspects of your legal relationship with the new dentist, so it’s important to get it right.

What’s the difference? The IRS, the Department of Labor, and common law principles all have different definitions, but the general principles are the same. Generally, an independent contractor supplies his or her own equipment and tools, has multiple clients, controls how and when to complete work, and is not a permanent worker.

Employees, by contrast, are provided with the equipment and tools needed to do their job. The employee’s employers have some control over the manner in which they do their work, and the work they do is a permanent and integral part of the business.

As you can see from these descriptions, it is highly unlikely that the new dentist meets the definition of an independent contractor. That said, very often dental practices will classify new hires as independent contractors instead of employees. They do this for the strong financial incentive. Employees have half of their Social Security and Medicare taxes (FICA) paid for by the employer. Independent contractors have to pay 100% of their FICA taxes when they file their return, which means the employer pays in nothing.

An employer will also avoid overtime, employee benefits, unemployment compensation tax, and worker’s compensation insurance. For employers, it can be much cheaper to misclassify employees as independent contractors, even if they don’t meet the definition.

But there are consequences if you get caught. The IRS might levy criminal penalties of $1,000 or one year in prison for failure to properly classify and withhold wages. If the IRS obtains a felony conviction against a person or company for “attempting to evade or defeat tax,” the fine can be up to $100,000 ($500,000 in the case of a corporation), or imprisonment of not more than five years, or both, couples with the costs of prosecution.(1) In 2013 alone, the Department of Labor Wage and Hour Division collected over $83,000,000 in back wages for misclassified workers.

That’s not even the biggest risk. As a small firm it is unlikely the IRS will pursue you for incorrectly categorizing your staff. The bigger issue is that it is much more difficult to enforce restrictive covenants on independent contractors than it is to enforce them on employees. In states such as Indiana, where courts are already hostile to restrictive covenants, you create a substantial risk that your non-compete will be unenforceable if you classify your associate as an independent.

Compensation
An employment agreement will generally cover the terms of an employee’s (or independent contractor’s) compensation. You should ask what metrics go into determining the associate’s compensation, and how you want those metrics to be calculated. Is the dentist to be paid on profitability or a per diem basis? Are there any bonuses built in to incentivize the growth of the practice? There is no one right answer, but if you want to be competitive in hiring talent, you should be familiar with the compensation benchmarks in your region.

Job duties
An employment agreement should cover the scope of the new dentist’s job duties. Specificity is key here. The agreement should describe the number of days per week in the office, the number of clinical hours per day, and any administrative responsibilities. The on-call obligations should be enumerated, marketing or community development obligations, and minimum production/collection goals for the new dentist.

Restrictive covenants
It’s important to protect yourself from the risk of a new dentist departing your practice and taking your clients or staff with them. Restrictive covenants are one of the most important elements to consider in drafting an employment agreement. The ones most relevant to you will be non-compete agreements and non-solicitation agreements. A non-compete is an agreement not to compete with your business for a specific period of time over a specific geographic area after the end of the employment agreement. A non-solicit prohibits contacting customers or staff of the employer after the end of the employment agreement.

The most important element of a restrictive covenant is its ability to be enforced. For a restrictive covenant to be enforceable, there must be three elements: it must exist to protect a legitimate interest of the employer (this can include customer goodwill, trade secrets, or current employees); it must be reasonable as to geographic area and the duration of the restrictions, (a good rule of thumb is the area from which you draw the majority of your clients); and last, it must be supported by some form of consideration (something of value).

Bringing things to a close
Associate agreements should have a limited term; they can’t last forever. Since you might discover early on that a relationship isn’t going to work, you should include provisions to allow either party to terminate the agreement with reasonable notice. You might also want to provide notice and an opportunity for the associate to correct any deficiencies before being terminated.

Finally, don’t forget fit
You may have the best legal agreement in the world, but if your associate’s personality is not compatible with you, your staff, or your patients, the agreement won’t make a bit of difference. Does the associate fit the culture of the practice and the community? Good grades are important, but does the associate “play well with others”? Never underestimate the power of soft skills, particularly if you want to see your practice grow under the influence of your new dentist.

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(1) See I.R.C. §7201.