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Business Advisor
How to Create Your Succession Plan
Stephen Dobias
Publish Date: January 18, 2008

Creating a successful surgery center requires building a business around an active group of physicians with sufficient caseloads to generate the cash flow necessary to operate the facility and provide a return to the investors. As time passes, however, the mix of cases as well as the physicians who perform those cases will change. For a center to succeed long-term, you'll need some level of planning to ensure that you replace unproductive physicians with new, productive physicians.

Who's pumping the brakes?
The first step in succession planning is to identify doctors who've begun to slow down and whose departure is imminent. One area of focus should be changes in case volume. Research declines in volume on a quarterly basis. Develop a database to track each physician, including non-owners.

Hopefully, agreements are in place that you can use to facilitate change. Review the operating agreement, or buy/sell agreement, to determine whether there are mechanisms to remove non-productive physicians. Be prepared for a surprise. It's not unusual to find that agreements aren't up to date, don't incorporate safe harbor provisions or lack the mechanism to remove non-productive physicians. In this situation, you'll have to amend the agreements to facilitate the buy-back of shares or units from non-productive physicians.

Clearly, it's best to construct your agreements to address these issues before one of them becomes an event. But that's not always the case. Often, when a doctor leaves, the owners and management of a facility look at the agreement and everyone says: "Oh no!" That's when the trouble starts.

When an issue not covered in the documents first rears its head, prepare for a battle. The first conflict will be with those physicians who may be impacted immediately by a change in the agreement. They'll oppose any provisions that result in their termination from the ownership group. There will also likely be a group who, while not currently in a slow-down mode, may not be far behind. They also won't be in favor of such changes.

It's popular to use the two safe harbor one-third tests as a criterion for eligibility for ownership. The first stipulates that at least one-third of each physician-investor's medical practice income from all sources during the past fiscal year or 12-month period must be derived from the performance of procedures on the list of Medicare-approved ASC procedures — regardless of where the procedures are performed. The second one-third test requires physician-owners of a multi-specialty ASC to perform at least one-third of their Medicare-covered procedures for the past fiscal year or 12-month period at each surgery center in which they invest.

Create exit scenarios
Once systems are in place that track physician retirement and agreements, update them regularly. This way, you'll be in good position to plan for the future. You also can take the time to model the impact to the center when a physician departs. For the sake of simplicity, focus on the revenue aspect only, as this should be easy to extract from a billing system.

Obviously, the true impact to the operation would be the net income after the reduction of expenses. However, in many situations, staff and indirect operating expenses are unchanged when a physician departs. In other words, the center loses the income but retains the affiliated expenses except for the direct supply costs attributable to that physician's cases.

As you begin to understand the economic impact associated with the loss of a physician's cases, you can develop a recruitment plan to replace the physician. One source of potential recruits is those physicians who perform cases in your center but aren't owners. This is the easiest form of recruitment. Otherwise, you may have to go back to the community and recruit physicians with large outpatient caseloads. In some markets, this could be a challenge because many physicians already have invested in facilities that have non-compete clauses.

Many physicians simply can't afford the high share valuations typical of mature centers. But in some situations, the concept of fair market value is overly broad. Depending on how you value your center, you can reduce the value of the ownership interests to make them more affordable. Creative examples of discounts that would lower share prices include restricting physicians from selling the interests they purchase, offering too few ownership units for new investors to exert any control over operations, non-competes, a poor payor mix and competing facilities.

Keep in mind that you can't arbitrarily reset the price. Be sure that a healthcare lawyer and a healthcare accountant review the valuation.

The danger in failing to plan for succession
Failure to plan for succession could lead to a number of legal and financial issues. At a minimum, you run the risk of not being able to replace the physicians who are needed to create the cash flow to pay the operating expenses and generate profit. Key to managing your ownership base effectively is to have enforceable agreements with your existing physicians as well as mechanisms in place to recruit new physician-owners as warranted. With such careful planning, your center should be able to turn over the ownership group and remain successful.