Secrets of a Successful Joint Venture

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By: Daniel Cook

Published: 10/10/2007

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Can surgeons and hospital administrators come together for a common goal? Yes, and our experts tell you how.


The ASC of Spartanburg, S.C., is an example of a joint venture done right - the physicians were willing to work with the hospital, the hospital's administrators were progressive thinkers, and both parties relied on the experience of a third-party consulting firm. As you'll see, developing a JV that works is challenging, but it is possible for surgeons and hospital administrators to come together.

Tricks of the trade
Since opening in April 2002, the ASC of Spartanburg is thriving. The 28,000-square-foot facility has 800 cases flowing through its seven ORs and two procedure rooms each month. For a chance at matching the success of the Spartanburg model, implement the following guidelines in your partnership plans.

  • Know when to fold 'em. Make sure a jointly owned surgery center is feasible from a financial standpoint. Even the best-intentioned partnerships will fall short in circumstances that are simply set up for failure. A good consulting firm will help you forecast the future success of your JV with a feasibility study: What will the return on investments be for both parties? Will there be enough outpatient cases to justify the surgery center? Where will the funds come from to build the center, and can enough cash be raised?

"A consulting firm needs to have the integrity to tell parties when a JV won't work," says David James, president of Surgery Center Solutions in Mishawaka, Ind. "Sometimes those involved fail to realize when their plans don't make sense from a financial perspective."

A JV will fail if case volume and investment revenue are lacking, but parties who simply can't get along will also grind a potential partnership to a halt. "In some cases the likelihood of a successful JV has nothing to do with surgical volume," says Caryl Serbin, RN, BSN, LHRM, president of Surgery Consultants of America and Surgery Center Billing in Fort Meyers, Fla. "The last thing you want to do is join two parties that have no chance of getting along."

Four Equity Joint Venture Models
Equity joint ventures take many forms. Here are the four most popular.

- 50/50 deal. In this model, the hospital and the physicians equally share ownership interest and management responsibilities. While the model might change based on the current regulatory structure, the basic model is that the physicians and the hospital make comparable contributions and have comparable responsibilities. This model is based on the principles of parity and shared control.

- Management model. Here, the physicians and the hospital share ownership of the ASC, and an outside company manages the center. This is based on the recognition that an ASC is a different corporate animal than a physician practice or a hospital, and that it needs management with expertise in the specific operational requirements of an ASC.

- Tri-party model. This is similar to the previous model, but it revolves around the principle that a management company with an equitable interest will perform its management duties better. The hospital, physicians and the management company all contribute equity and have ownership interests. The tri-party model continues to increase in popularity.

- 70/30 deal. With the increasing popularity of the equity joint venture, physicians have become more confident in their abilities to manage ASCs. This confidence has led to the 70/30 deal, in which the physicians have a majority ownership interest and are clearly in control. This model reflects the physicians' recognition that, while they may be able to manage the ASC on their own, hospitals still add value in terms of branding, managed care contracting and patient confidence.

- Ira Coleman, Esq., and Amanda K. Jester, Esq.

Mr. Coleman ([email protected]) is a partner and Ms. Jester ([email protected]) is an associate in the healthcare department of McDermott, Will & Emery in Miami.

Ms. Serbin says a review of past dealings between the docs and the hospital will provide an accurate indication of what the future holds. If both parties haven't worked well together in the past, don't think they will in the future.

  • Develop trust. A JV's ultimate success depends on developing trust between the surgeons and hospital administration. "Trust evolves over time if both sides stick to guidelines and a definition of roles that are established on day one," say Raymond Shingler, vice president and chief information officer of Spartanburg Regional Healthcare System. "If everyone sticks to the rules and principles, you'll see the trust meter start to build."

Mr. Shingler developed a steering committee and limited its size to foster an atmosphere in which decisions could be made. The committee was comprised of four docs, four hospital administrators and chaired by a surgeon.

The group met weekly to hash out expectations and to keep the lines of communication open in the beginning of the JV process. Additionally, it listened to staff focus groups and used the information to make policy decisions. "It was not a CEO-driven project," says Mike Pankey, RN, administrator of the ASC of Spartanburg. "We allowed for input from everyone involved because we were all learning."

Fostering communication and trust between both parties doesn't stop once the surgery center is complete. Remain diligent in practicing what you preach. "Our docs stay active within the hospital and volunteer their time by taking leadership positions on committees." says Don Schreiner, MBA, chief operating officer for Rockford Orthopedic Associates in Rockford, Ill. "The hospital leaders are also invited to our Christmas party - we treat them like part of our family."

  • Walk a mile in his shoes. "Surgeons need to understand the impact a joint venture has on a hospital," says Mr. James. "They'll be giving up 100 percent of their revenue to become a partner. It might take years for the hospital to get back to the same level of revenue."

Jeffrey Martin, president and CEO of the Gritman Medical Center in Moscow, Idaho, tells of an ownership share that helped his hospital get over the hurdle of short-term loss. "For the first three years of the partnership, the hospital retained 60 percent ownership of the facility, the docs 40 percent. After the initial three years, it was agreed that we would sell an additional 10 percent back to the surgeons to make it a 50-50 partnership."

Mr. Martin says hospital administrators took a long look at how the loss of surgical cases would affect the facility's bottom line. The deal only worked because the surgeons recognized the hospital's needs and were willing to concede revenue on the front-end to ensure the long-term success of the partnership.

  • Eliminate emotions. A third-party consultant is a big help in making each party aware of the other's needs by taking an impartial, unemotional stance. Hospital administrators and surgeons often have their best interests in mind; a consultant, however, is concerned only about the success of the surgery center. "Meet with each party separately and listen to what the major issues are," says Ms. Serbin. "Prioritize the concerns - what does a party want, what do they need and what are the deal breakers?"

Ms. Serbin says it is also important to let the parties let off some steam - another benefit of including a neutral third-party in JV negotiations. "The JV process is stressful, and sometimes the people involved just need to vent," she says. "If they're allowed to vent to a neutral third party, nobody's feelings will get hurt, and emotions will stay out of the deal."

  • Sign a letter of intent. You'll eventually have to agree on the nuts and bolts of the JV, but you can take steps to ensure both parties see eye-to-eye on the essentials before you waste time and money on an inch-thick business plan.

Reasons To Consider a Joint Venture

It's estimated that there are about 800 to 1,000 joint-ventured ASCs, with perhaps twice as many in the planning stages. Why are more and more hospitals and physicians groups entering into joint ventures? Here are the benefits of a JV from physician and hospital perspectives.

Benefits to the docs
- Assistance with regulatory hurdles. Obtaining a CON or obtaining permission from a local licensure board is a political process, and hospitals do it all the time. Hospital administrators have the contacts and experience to help secure regulation paperwork faster than any surgeon group could do alone.

- A diversification of physician support. A hospital's presence provides stability and makes it easier to get a surgeon to sign on to a JV deal. The docs can draw a more diversified group of surgical specialties; higher case volume leads to more revenue.

- Access to contract services. Hospitals can provide access to contract services that are cost-effective - biomedical services, information systems, maintenance, radiology to name a few. If a hospital has a good managed care department, the docs can benefit from that hugely valuable asset.

- Private practice growth. Improved efficiency in the surgery center's ORs means more free time for the docs, and more free time results in additional time that can be dedicated to growing a private practice.

Benefits to the hospital
- Limitation of future competition. Working with a physicians group is a sure-fire way for a hospital to ensure it won't be competing against the docs for future outpatient cases. If hospital administrators don't work with surgeons when approached for a JV, they can be sure the physicians group will build a surgery center on its own - or worse - build one with a competing hospital.

- An established model for future JVs. A successful surgery center JV can be the glue to bind the docs and the hospital together, and will serve as a model for many collaborative efforts between a hospital and a physicians group.

- Inpatient improvements. Freeing up OR space will let the hospital focus on what it does best: inpatient cases. After docs take more of an ownership in the outpatient cases of the surgery center, they'll then look at ways to make the inpatient services more cost-effective.

- Increased doc involvement. Once a physicians group starts to work with a hospital toward the common goal of a successful surgery center, you'll see individual docs start to take more of a leadership role in the hospital's committees and surgical departments.

- Caryl Serbin, RN, BSN, LHRM

"Work on writing and getting both parties to agree on a letter of intent," says Scott Becker, Esq., CPA, co-chairman of the healthcare department at Chicago-based law firm McGuire Woods. "The document identifies key points of a deal and serves as a handshake agreement. If both sides can't even agree at that stage, it doesn't make sense to continue."

The letter of intent - and eventually the business plan - should outline the split of ownership, the makeup of the board of directors, an identification of the services to be provided, investment responsibilities in capital equipment and redemption provisions, says Mr. Becker.

Documents carefully delineate lines that both sides shouldn't cross, but you should also include the benefits both parties bring to the table. "Hospitals are wonderful resources in areas of credentialing, pathology, imaging, financial advice, salary surveys and business support," says Annamarie Carey-York, executive director of the Kendall Pointe Surgery Center in Oswego, Ill. "Don't be afraid to detail the use of these services in the language of the written agreement."

  • Define control. Splitting ownership percentages between the hospital and physicians group is an important part of any JV. The ownership pie should be divided in such a way that both parties own enough to remain interested in the success of the facility, but not enough to force the other party's needs out of the relationship (see "Four Equity Joint Venture Models" on page 29).

"History has shown that if a hospital does not own enough interest in the JV, it is likely to treat the venture as a strict competitor rather than an alliance," says Mr. Becker. "In contrast, if the hospital owns too much, there will not be enough shares left over for physicians, and physicians will lose interest in the venture."

To avoid problems arising from percentage splits, develop an ownership and management structure that addresses the definition of control for both parties, says Wayne Lee, vice president of facilities development for Health Inventures of Broomfield, Colo. Control is defined by a hospital as its ability to identify legal and debt service issues, the preservation of its tax-exempt status and the economic and legal risks involved in the JV. For the surgeons, having control over the JV applies to the clinical experience of the patients and the docs while maintaining the surgical efficiency of the surgery center.

Mr. Lee says the development of a clinical review committee - made up of the surgery center's management team, a representative from each physician specialty group and a hospital board member - creates a balance between both groups' definition of control.

"The committee reports to the ownership board but it is empowered to construct the clinical environment of the surgery center," says Mr. Lee. "This way, the docs still have the control of the facility they want, even if the hospital administration has control over what it wants - a greater ownership share."

  • Hire staff separately. "Hospitals usually say its staff is off limits," says Ms. Carey-York. "Because of the nursing shortage, a physicians group could run into resistance if they try to take the hospital's staff over to the new facility."

Not having access to the hospital's staff is just as well for the ultimate success of the new surgery center, says Ms. Serbin. "The employees at Spartanburg had a choice from day one and applied to positions they were interested in before going through the interview process. Hiring that way was more successful than if we had forced a change on the staff."

According to Mr. James, avoid hospital personnel because surgery center staff must work at a faster pace and use different skill sets. "Don't rely on the hospital for staffing the surgery center because they hire for different reasons," he says. "The surgery center needs to have its own people, so let a third party or a neutral manager take care of the staffing."

Pinch here, dash there
Success of a JV rests in the ability of the parties involved to retain their identity while adapting to the needs of the other. "It's like baking a cake," says Ms. Serbin, who guided Spartanburg Health System to yet another successful surgery center opening last December. "You have to have the right ingredients for success, at the right time and in the right mix."

The proper recipe, says Ms. Serbin, is not found on a boilerplate index card. Be willing to adapt. Be flexible. Work to make your situation succeed. "Every single JV is unique," she says, "and no one will approach the process in the same way."

Three Urban Myths of Joint Ventures
Here are three common misconceptions of doctor-hospital joint ventures I'd like to debunk.

1. The hospital must have majority control of governing board. In the typical ASC joint venture, in almost all circumstances, the physicians group can control the board. That's because the investment amount - not the number of seats on the board - is what really matters. The hospital generally has hundreds of millions of dollars in assets, and its level of investment in the ASC is likely less than $10 million. If you take into consideration the operating revenues and the days in A/R, the amount contributed by the hospital to the ASC - and vice versa - is not substantial in relation to the total value of the hospital or health system. Five percent to 10 percent is not considered substantial and will not jeopardize a hospital's non-profit status. For example, say the hospital owns 50 percent of the JV, using 2 percent of its assets or $5 million. The return on the ASC isn't likely to bump the hospital's take into the substantial range. If the hospital decides that, as a business principle, it wants to have control, it's free to make that choice. But it's not a legal-based decision.

2. Distributions from a for-profit JV will jeopardize the exempt status of the hospital. This is related to the previous myth. Now, if the JV is a tax-pass-through entity, such as a limited liability corporation - and most ASCs are, because this structure allows more flexibility - the distribution to the hospital will be designated unrelated business taxable income (UBTI), and it will be subject to tax at the hospital/corporate level. Substantial UBTI could jeopardize tax-exempt status, but as discussed, it's almost inconceivable that the profits will be considered legally substantial. You could always set up the ASC as a plain old C Corp - but then the physician-owners will be taxed twice: once at the corporate level and once at the personal-tax level, sending more than 70 percent of their take to the government. Since an LLC is allowable, it's better to use that structure.

3. An ASC development company cannot manage the JV in a long-term, lock-in contract. This depends on whether substantial charitable assets of the hospital are being contributed. If they are, then a long-term, turnkey management contract with a for-profit entity will look as if it ceded control through the vehicle of the contract to the management company. Again, though, in almost every circumstance, substantial assets will not be involved. A management contract can be as short as one year or as long as about 15. The rule of thumb: The more the agreement looks like a fixed-fee, lock-in price arrangement that's not going to vary, the easier to generally justify a long-term arrangement. If the contract is based on unit price, time used and other variables, it should be toward the shorter end of the spectrum.

It's important to not confuse legal and business issues. As you can see, these three situations don't bear critical analysis even though, on their faces, they might seem likely to jeopardize a hospital's tax-exempt status. Really, they are business issues that come down to negotiations between the parties involved in ownership.

- Michael Blau, Esq.

Mr. Blau ([email protected]) is a co-partner-in-charge of the health department at McDermott, Will & Emery in Boston.

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