Raising needed capital through a ‘tithing’ system
June 1, 2000 4 minutes read
Raising needed capital through a tithing’ system
Orthopedic practice shows how it can work
Access to readily available and reasonably priced capital is key to a medical group’s ability to compete and grow in today’s managed care-driven marketplace. However, many groups are finding it harder to raise the increasing amounts of money needed to finance a leading-edge practice without having to accept onerous contract terms and escalating interest rates.
"The rise in power of managed care eroded physicians’ autonomy over their fee schedules, driving their practice overhead up and their incomes down," says Michael J. Pulaski, FACMPE, chief executive officer of Atlanta’s Peachtree Orthopedic Clinic. "The pressure on practicing physicians to keep their medical businesses viable in this environment became unbearable for most, driving many into the hands of practice consolidators or physician practice management companies."
The physicians at Peachtree, however, have been able to avoid this situation by taking a leaf from the physician practice management com-pany (PPMC) playbook and creating an alterna-tive source of low-cost self-financing to underwrite the group’s growth. "Historically, medical groups have run their businesses by the eat what you kill’ or Darwinian’ method. That is, the physicians take home whatever money is left after income is received and expenses are paid, leaving no corporate earnings," notes Pulaski.
In turn, capital acquisitions by the practice normally have been financed using either debt or lease agreements. "These capital acquisitions, along with satellite office expansion and the addition of contracted physician employees, sometimes mean that the pool of money available for distribution to the group is diminished by the added expense," he points out. That often forces a group to take out loans to maintain physician compensation at current levels.
Complicating this situation, consolidation in the health care marketplace has driven up the amount of capital most groups need to operate, a cost that is starting to become "more than the average group with a Darwinian compensation scheme and tax strategy is willing to pay," says Pulaski.
PPMCs have taken advantage of this situation by marketing their ability to finance medical projects. Rather than perform some kind of financing magic, "all the PPMCs really do is leverage the management fees they collect from their physician clients," he says.
A typical PPMC’s management fee, for instance, is 15% of the client’s practice income. Ordinarily, the physician practice agrees to pay this management fee for 40 years. The fees the PPMC collects from its client practices are then consolidated into a single revenue stream — a stream that can be pledged, in part, to finance cash loans to the PPMC. The PPMC, in turn, agrees to pay back the loan principal with interest using a portion of its income stream received from its physician practice clients.
Trying a different approach
Peachtree Orthopedic Clinic has developed its own variation of this PPMC financing model, which it calls a "tithe," to finance its capital needs. Under this mechanism, each practitioner in the group agrees in writing to have 10% of his or her compensation withheld for five years. The money is accounted for separately and only used to underwrite group-ratified strategic projects.
Money going into the tithe account creates an income stream that can be used to leverage outside lines of credit to finance the group’s operations and acquisitions. "Like the PPMCs, the group pledges its tithe revenue stream as payment of principal and interest for any use of credit facilities," Pulaski notes.
For participating providers, the system works something like a "second buy-in" through an income-deferral program, he explains. In turn, "when a tithing physician leaves the group, [his or her] stock is re-purchased and the tithe amount is repaid as compensation, and the group takes the tax deduction," he says. If they choose, groups also can include the time/value of the tithe in its re-purchase agreement with program participants.
Another advantage of this tithe approach to financing is that it can enhance a group’s attractiveness to local lenders compared with other practices, the Peachtree physicians say. Similarly, "your tithing group will be perceived as more formidable by your local hospital administration, medical product companies, and insurers, making them more likely to strike favorable joint venture deals with your group," predicts Pulaski. Practices with money or profits still on the books at the end of their tax year — which a tithe will do — are subject to corporate tax. "However, there are reasons why showing profit may be better than many practices commonly think," he says.
In most cases, the marginal tax rate for individuals is about 5% greater than for professional corporations. In turn, if a physician leaves money in the professional corporation, the tax is 5% less than if it had been paid out, Pulaski calculates.
Also, there is the potential value of such things as better insurance contracts, added ancillaries, more satellite offices, more providers sharing call, access to sophisticated information systems, more autonomy, and greater stability the tithed money would bring.
"It is entirely possible for the tithing group to plan its use of tithe money so well that the only amounts subjected to corporate tax would be depreciable capital items or investments in outside businesses," Pulaski says.
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