Legal Update

By: Scott Becker

Published: 10/10/2007

Share:

Make It Easy for Young Surgeons to Buy In


It's a vexing problem for physician-owners: The talented young surgeon can't afford to buy into your center and you can't discount shares below fair market value. Here are five ways to add new docs without running afoul of the law.

Determine fair market value. To be safe, have an independent, third-party appraiser establish the fair market value of units in the company and sell them at this price. Such an expert can take into account lack of liquidity or minority discounts when establishing unit value for a new investor. Clearly document the nature and amount of any discounts. If you choose to set the price by doing an internal analysis, you must have a clear, documented method of establishing the valuation.

Let them borrow. New investors may obtain loans from an unrelated party - a bank, for example - in order to invest in the surgical center. If the bank requires new investors to pledge their units as collateral, either your operating agreement should specifically allow this or the other owners should provide a written consent to permit such a pledge.

Sell him just a few shares. To reduce the cost of a buy-in, you could let the surgeon buy fewer units than existing investors own. For example, if each existing investor owns 10 units, the new investor might buy only two. He would have proportionately less ownership and receive proportionately less distributions than the other members. But the upshot is that he gets to be part of your center and still pays fair market value - it's just what he can afford at the time. If subsequent offerings are made, he'd still have the opportunity to buy more shares, albeit at the new fair market value price. Such an offering should generally be open to all physician-owners with less-than-equal ownership, regardless of the volume or value of referrals.

Lower the share price by increasing your debt. You can lower the price of the buy-in for a new physician by recapitalizing the company. One way to do this is to increase your debt through a loan or large purchase. You can then immediately distribute the proceeds of the debt to existing members. When the fair market value is calculated thereafter for a new physician, the share prices will be lower because of the increased debt - making it easier for a new investor to buy more units.

The upshot: You infuse existing physicians with immediate cash, and new docs may purchase a larger ownership share. The downside: The debt burden may take years to overcome. Plus, any substantial increase in debt reduces company value, increases risk of default and decreases your ability to obtain additional debt should you need it. Paying down the principal of the debt also negatively impacts later distributions and won't generally provide corresponding tax deductions to shareholders. Finally, such an effort may be viewed as evidence that your center doesn't genuinely need new capital.

The Rules and Regulations of Physician Buy-ins

What will cause you consternation in your attempts to extend investment opportunities to other physicians? That's right: the Anti-kickback Statute and the Stark Act. The OIG has also released two relevant special communications on the topic. Here's a quick look at how those regulatory bits affect buy-ins.

  • Stark Act. Simply, this requires that physician-investors purchase membership units at fair market value.
  • Anti-kickback Statute. You've heard it before, but it bears repeating: This statute prohibits the knowing and willful solicitation, receipt, offer or payment of "any remuneration (including any kickback, bribe or rebate) directly or indirectly, overtly or covertly, in cash or in kind" in return for or to induce the referral, arrangement or recommendation of Medicare or Medicaid business. Offering a discount on an item of value, particularly an ownership interest in an ASC, may be considered remuneration by the OIG and the courts. So may any gift, gratuity, relief from a financial obligation (such as an interest-free or guaranteed loan) or benefit conferred by one party on another, directly or indirectly. The OIG has promulgated several safe harbor regulations to clarify and narrow the scope of the Anti-kickback statute:

42 CFR 1001.952(r), provides that return on an investment interest in an ASC will not be considered remuneration so long as the terms of the investment are unrelated to previous or expected volume of referrals and the return on investment is directly proportional to the amount of capital investment.

The commentary to the ASC safe harbor regulations, 64 Fed. Reg. 63536 (1999), further clarifies that you cannot sell units to a primary care physician who would refer patients to the ASC but not perform surgeries there, and that you should avoid jointly investing in an ASC with physicians in other specialties who often refer to one another.

You must fully comply with these safe harbors in order to gain the absolute defense to prosecution they afford.

  • Special Fraud Alert. In this document, the OIG identified what it considers the features of suspect healthcare joint ventures: the selection of investors solely on the grounds that they're in a position to make referrals to the joint venture; offering greater investment opportunities to investors likely to make a large number of referrals; actively encouraging investors to make referrals; requiring only a small capital investment by physician-investors or loaning the investment capital to physician-investors; and investments with disproportionately large returns compared to similar investments with similar risk. The OIG issued this alert in 1989 and revalidated it on Oct. 6.
  • Special Advisory Bulletin. An April 2003 OIG communication addressing broader concerns regarding joint ventures clarified that a discount is considered a form of remuneration and that safe harbor protection relies on the use of fair market values as determined in an arm's length transaction.

- Scott Becker, JD, CPA, and Ronald Lundeen, JD

Remember: Buy-in price need not equal buy-out price. If you'd like to redeem units from existing members at or near an offering of units to new physician-investors, there may be situations in which you can offer the buy-in shares at a lower (or higher) price than the buy-out shares. While buy-in price should never be below fair market value, buy-out price is often calculated according to your operating agreement's valuation formula. This may result in a per-unit buy-out price that's lower (or higher) than the per-unit buy-in price.

What if the per-unit buy-out price is higher than the fair market value buy-in price? In this case, you may redeem several units at a higher price (as determined by the operating agreement) and bring in new investors at a lower price (as determined by a fair market valuation). Be sure that the buy-in price is supported as reflecting the then-fair market value.

There are times when you don't have the right to buy out members, such as if your facility was formed before the ASC safe harbors were adopted and, therefore, your operating agreement doesn't provide for buy-out upon non-compliance. In this case, to encourage the physician member to redeem his units entirely, it may be appropriate to buy him out at a premium.

From the "what not to do" files

  • Don't sell shares for less than fair market value.
  • Don't act as a lender for investors taking out loans to buy shares.
  • Don't let a new doc buy a small ownership interest for a fair price with a guarantee that he'll be able to buy incremental interests (one or two units a year) at the same price. This is improper in the OIG's eyes.
  • Don't let investors buy extra units because of their past or expected abilities to refer patients.
  • Don't let investors earn extraordinary returns on the investment in comparison with the risk involved.

Related Articles