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Is It Time to Cash Out?
Key questions to answer before deciding to sell equity to a corporate partner.
Stephanie Wasek
Publish Date: October 10, 2007   |  Tags:   Patient Safety

If you're selling equity to a corporate partner, you can expect a financial windfall. Multi-specialty ambulatory surgery centers are, after all, routinely valued between $10 and $15 million, and you'll get a chunk of that, often much larger than your initial investment. But before you decide to sell majority ownership in your facility, experts say you should ask yourself several questions.

Amos Willis, MD, wishes he had. When the Virginia Highway Department decided in 1996 to widen the road Surgi-Center of Central Virginia sat on, Dr. Willis had little choice but to accept $1.4 million from the state to relocate.

Things were different when Dr. Willis, an ophthalmologist, looked for a corporate partner to buy a majority interest in the new facility he ended up with: a 17,000-square foot, two-story, four-OR, multi-specialty ASC. He had choices. Lots of them. As you will, too.

He interviewed eight companies and got what he calls lousy bids from most. One, despite a confidentiality agreement, tried to align the minority physician-owners against him. One firm finally bid $7.4 million for 79 percent ownership.

"Of course, they did send this 700-page contract that was just the worst thing you've ever seen," says Dr. Willis. "And I found out later I probably shouldn't have taken their first offer - they pay up to $10 million for facilities like mine."

Whether you're considering an exit strategy or are concerned about recent scrutiny of physician-ownership, you may need a corporate partner. When you do, you'll want answers to these five questions.

Will a corporate partner improve financial performance?
Centers with corporate partners have higher utilization and average more than $300 more revenue per case than independent centers, says Jon Vick, the founder and president of ASCs, Inc., a firm that matches buyers to sellers.

"The reason doctors don't make much on multi-specialty centers is that they don't have power or time to negotiate with HMOs," says Dr. Willis. "Before our corporate partner, we were getting $650 for arthroscopy. But they have guys who do nothing but negotiate, and with 65 centers, they can bludgeon the HMOs. They got us up to $1,400 for arthroscopy. In fact, all HMO payments are way up."

However, cautions Shannon Marie Smith, CPA, the founder of the Rush Group, "if a center has simply plateaued, it doesn't have to sell out. There are consultants and lawyers who can help it be more profitable. If your center is run well, it's a fallacy to think a corporate partner will automatically increase revenue; it can't do cases."

And cases are what bring in revenue. Dr. Willis agrees. When he needed to raise revenues post-move, he didn't turn to a corporate partner; instead, he added physician-owners.

But a corporate partner can recruit new physicians, identify additional services, renegotiate payer contacts and get volume discounts on surgical supplies and capital equipment.

"Group purchasing allows us to buy supplies 15 percent to 20 percent cheaper for our facilities," says Billy Webb, the chief development officer at Symbion Healthcare. Certainly, he says, a corporate partner won't decrease revenues: "If if we own 51 percent, why would we want to increase expenses? We'd be paying 51 percent of those increases."

Top 10 Reasons To Seek A Corporate Partner

If you want to do one or more of the following, it might make sense to look for a corporate partner, says Jon Vick, the founder and president of ASCs, Inc.

1. Take some cash off the table
2. Take advantage of favorable multiples
3. Improve financial performance
4. Re-syndicate ownership
5. Get professional management
6. Replace non-utilizers with utili-zing physicians/physician-owners
7. Expand your center
8. Convert from single- to multi-specialty
9. Do retirement/estate planning or transition
10. Avoid possible future anti-physician-owner legislation

- Stephanie Wasek

Is a partner necessary for capital?
A corporate partner can provide access to capital without personal guarantees or joint and several liability, says Mr. Vick. However, if you're only looking to add an expensive piece or two of capital equipment, plunging into corporate partnership is not necessary.

"If you talk to the capital equipment companies," says Ms. Smith, "there are many creative financing options - per-use rates, leasing - and the interest rates are so low right now. You don't need a corporate partner to buy equipment."

If you want to add ORs, convert from single- to multi-specialty or add significant new procedures such as pain or orthopedics, says Mr. Vick, a corporate partner may be the way to go, because it relieves physicians of some of the risk.

Ken McDonald, the president and CEO of AmSurg says this is common and notes that, at any time, about 10 percent of his firm's centers are expanding.

For example, Tom Deas, MD, the medical director of Fort Worth Endoscopy Center in Texas, found his facility's corporate partner especially helpful when he and his colleagues decided to open another center, Southwest Fort Worth Endo-scopy Center, across town.

"They own 51 percent, they put up 51 percent of the capital," says Dr. Deas. "A lot of physicians like corporate partners because it makes them more comfortable sharing the risk." The downside, he says, is "at the same time you hedge your risk, you hedge on the potential returns; if your center is a success, you share the profits."

A corporate partner may appeal to physicians who want this expansion but who don't want to dip into their pockets, says Steve Diagostino, CPA, a principal in the healthcare group at Indianapolis-based Somerset Accountants and Advisors. "But I think they would be better served to first do a strong internal self-financial investment to analyze current ownership and whether they can raise the money through financing on their own or by recruiting other physician users/investors in the center."

Do you need help dealing with non-productive physicians?
"Some surgery centers may have had some physicians leave the market or partnership, or they may find themselves without as vigorous a participation as they used to enjoy," says Derril Reeves, the executive vice president of development for Surgis, Inc. "We can help revitalize and restructure. A lot of times, our coming in encourages the other physicians to come back. They may have just felt isolated over the years."

But so-called dead wood should not be the only reason you join with a company, says Ms. Smith: "They should be clearing dead wood away anyway." She advises you use a lawyer to request the billing data of physicians to monitor compliance. "Then meet with the physicians who are not complying with the law and say, 'Either you're in or you're out.'"

But if you find it would be difficult to replace them, the combination of these factors may warrant help, says Mr. Vick.

"When the transaction is more complex, with buying out, restructuring, recruiting and re-syndicating, a corporate partner can be beneficial; it can relieve physician owners of the financial burden of buying out non-utilizing physicians," he says.

Avoiding The Risks Of Corporate Partnerships

Follow these six steps to avoid the potential risks of joining with a corporate partner, says Scott Becker, Esq., co-chairman of the healthcare department at McGuire Woods in Chicago.

1. Avoid commingling. Write the agreement so the local surgery center's cash is not mixed with national accounts. Many venture documents let the company invest ASC money and national money in a cash-management program.

2. Police check-writing. Negotiate a policy that dictates checks larger than a certain dollar amount - such as $5,000 - or checks payable to the national company or another affiliate also require the signature of a physician representative. This can help ensure money isn't being mishandled or stolen.

3. Audit annually. Insist on a yearly audit of the center's finances by an independent accounting firm, preferably one without financial ties to the company.

4. Secure assets. Don't let the national company take liens against the assets of the surgery center. For example, when some companies acquire ASCs, as part of their acquisition financing, they ask that the local center's assets be used as collateral for the national company's financing.

5. Know your position. The millions of dollars you could receive from a deal are very tempting and may decrease the desire to fight for after-the-deal issues. Be willing to fight hard for these points, such as barring commingling - and be ready to walk away if needed.

6. Choose carefully. Rigorously check out a company before developing a joint venture with it. Look for firms with many centers, minimal disputes with partners and very solid references from unbiased parties.

- Stephanie Wasek

Will you lose control of your center?
"Bringing in a corporate partner means change, period," says Ms. Smith. "If you're not willing to make any changes with regard to the way you practice day to day, adding a corporate partner is not the right thing for you."

She recommends you ask a corporate partner that you're interviewing to come in and look at your center, then ask them what they would change. When you get the answer, ask yourself honestly, "Can I live with that," she says.

"A lot of times, the corporate partner will be asserting more stringent management techniques to fine tune the cost and profitability of the center," says Ms. Smith. "For example, if you ask for a box of supplies, you might get 10 units instead of the box. You might only need 10, but having the whole box would be nice. Think about what level of control you can deal with."

Not all companies are overly controlling, though; many realize there needs to be some flexibility at the local level for the partnership to last.

"Say a competing hospital shuts down an OR," says John Rex-Waller, the president and CEO of National Surgical Hospitals. "If you need to wait six weeks to get approval to hire new nurses so you can open another OR, it's too late - the opportunity is missed. The amount of decentralization practiced by the corporate partner and the degree of autonomy given to the staff and facility itself is very important to running of that facility."

Mr. Vick advises you negotiate the important points into the operating agreement.

"Companies want 51 percent and to provide management services because that allows them to consolidate revenues," he says. "But control issues should be clear in the operating agreement; physicians can reserve almost every element of control by making decisions subject to a super majority [two-thirds or three-quarters]."

And if you argue for this, stick to it, says Lorin Patterson, Esq., a partner with Shook, Hardy and Bacon, LLP.

"The discontent I've seen stems from poor and infrequent communication and the failure of the parties to observe the provisions of their documents," he says. "For example, if an operating agreement calls for monthly board meetings or establishes a medical executive committee that will oversee clinical affairs, but this is ignored in practice, I can guarantee a pall will hang over the venture. In these cases, it may be as much the fault of the phys-icians for not asserting their rights as of the management company for ignoring them."

Before You Sign On The Dotted Line

Don't let dollar signs obscure the fine print on the legal documents you'll be signing - you will be living with the effects of these documents for a long time after you sign. Here are the basics Joseph A. Sowell II, a member of Waller, Lansden, Dortch and Davis, PLLC, in Nashville, Tenn., says you need to know about the three legal documents you'll see in an equity transaction with a corporate partner.

' Purchase agreement. This will provide the purchase price to be paid to you, the seller, at closing and will include representations and warranties from the selling physicians about the business and its economic performance. Typically, the buyer must pay the entire agreed purchase price at closing in cash. Earn-out provisions, in which the amount paid to the seller depends on the ASC's performance post-closing, are suspect from a regulatory standpoint. This is because economic performance post-closing will depend in part on the volume of referrals made by the surgeon-owners who receive the earn-out payments. This could be construed as a kickback.

The purchase agreement will include a working-capital settle-up that requires the buyer to pay the seller (or decrease the price) if the ASC's working capital - current assets, such as accounts receivable and cash, less current liabilities - exceeds (or doesn't meet) normalized working capital levels. You should also negotiate an indemnity basket, the dollar amount of losses the buyer must sustain before it can hold the physician-owners responsible for misrepresentations and untrue warranties. Also negotiate the time after closing during which the buyer can sue you for such misrepresentations. There are two types of baskets: the first lets the buyer collect damages only in excess of the basket's dollar amount; the second lets the buyer recover all losses if the threshold is reached.

' Partnership agreement/operating agreement. You and your corporate partner will be co-owners after closing, so you'll need this to set forth how the center's profits will be shared, how it will be governed and whether physician-owners will be restricted from owning an interest in a competing business. It will also typically seek to ensure that each physician-owner complies with the ASC safe harbor under the Anti-kickback Statute.

' Management agreement. This typically runs for 10 years to 15 years and provides for a management fee that's a percentage of the center's net revenues, usually between 4 percent and 7 percent. You can consider trying to negotiate a management fee percentage that declines as net revenues increase. For example, 5 percent of the first $10 million in net revenues, 4 percent between $10 million and $20 million and 3 percent in excess of $20 million. Keep in mind, however, that this will reduce the buyer's expected cash flow from the relationship and therefore will likely reduce the purchase price.

- Stephanie Wasek

Do you really want to cash out?
There are two big reasons a doctor may be looking to join with a corporate partner as an exit strategy, says Mr. Vick:

  • the founding investors can sell their interests at a higher price than they could sell it for to new physician-investors; and
  • it's a safety net to guarantee a buy-out at a pre-determined multiple in the event legislation limits or prohibits ownership.

"They might say to themselves, 'We've maximized our value under our ownership and leadership, let's see if we can't get some more out of the center with the addition of a corporate partner,'" says Mr. Diagostino.

According to Mr. Webb, equity transactions for these reasons are on the rise, though recent scandals may have stemmed the tide.

"The dynamics in play right now are that you've got centers that were built and developed by surgeons several years ago, and now they're reaching retirement age and looking for a liquidity event," says Mr. Webb.

Raider or crusader?
You're not done yet. While there's little doubt ASC owners interested in a corporate partner can realize significant financial and operational benefits from such an affiliation, there's no guarantee you won't hit a few snags on the way. Experts say that after you've asked and answered these five questions yourself, don't be afraid to ask questions of other physicians regarding their experiences with corporate partners.

"Get references and check on the reputation of the corporate partner with physicians who have worked with that corporate partner before," says Mr. Rex-Waller. "The physician-to-physician talk is critical; it's a terrible mistake not to talk to other doctors."

Our Partnership Nightmare

We had a terrible experience with our first management team, just short of complete disaster. My partner, Dan Curhan, MD, and I were rookies when we joined with them; Santa Barbara Surgical Center was the first surgery center we'd ever built. There was a lot of big talk, and we trusted them - a little too much.

Our center ended up markedly undercapitalized, and at a time when we needed finesse handling creditors, we got bullying and lies. We acquiesced to purchasing overpriced equipment that was all wrong for us. For example, we were urged to buy a $75,000 fluoroscopy unit that was outdated and inefficient; we finally sold that for a significant loss. We bought surgical instruments through one of the partner's contacts (and discovered they were receiving kickbacks), one of whose hemostats simply collapsed in my hands. We got scalpels that never cut and boxes and boxes of casting equipment that we would never use.

On the bright side, the company did get us a non-recourse loan for tenant improvements and equipment in our building, which would be nearly impossible in today's environment.

Still, we just about went bankrupt and came close to quitting. It was about four months into it that it wasn't working and began interviewing other companies. We considered legal action, but signed a mutual agreement to get them out of our center as quickly as possible. I think they were happy to leave and realized that they were significantly underperforming.

Our shareholders are still reeling from that experience, and it's difficult for some to trust our new managers. Luckily, we've now found the right company for us - Regent Surgical Health, a Chicago-based firm that focuses on managing and acquiring under-utilized ASCs. Regent manages the doctors, the creditors, the equipment, the billing. They let the docs do well, which lets the patients do well.

If we had known all the details of the business side of things when we started, we probably wouldn't have gotten into the ASC business. So we're happy to have someone else manage it - we just had to learn the tough lesson that if it seems too good to be true, take a second look.

Dr. Rhodes ([email protected]) is a urologist and physician-owner.