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Legal Update
5 Strategies for Selling Shares to Surgeons
, Jerry Sokol, Joshua Kaye
Publish Date: May 13, 2008

Many surgical centers are having a hard time selling equity interests to physician-investors — and it's not due to a lack of interest. It's because it costs too much to buy in when you consider the fair market value of some successful centers. Here are some creative financing strategies that could let ASCs sell larger ownership interests to physician-utilizers at lower prices without running afoul of health law.

Dividend recapitalization. Some centers are tapping real estate and private equity playbooks here. The ASC borrows funds from a third-party lender. The borrowed money increases long-term debt and decreases the ASC's value. The borrowed money is either paid out as a dividend to existing physician-owners or channeled into the ASC. Given interest rates' current historical lows, many ASCs are strongly considering this strategy.

Preferred dividends. This strategy has the same effect as dividend recapitalization in decreasing the ASC's total value. But in this approach, the ASC declares an amount to be paid out to existing physician-owners as a preferred dividend instead of borrowing the money from a third party. (The new investors don't share in this dividend, but are entitled to their pro rata share of any profit distributions in excess of it.) It is typically paid out over two or three years, during which time a successful ASC can make both preferred dividend distributions to previously existing investors and regular distributions to all of its investors. Because it doesn't require the ASC to incur interest, it may be a better strategy than dividend recapitalization.

Local lender. While neither an ASC nor another physician-investor can loan funds due to anti-kickback regulations, an ASC with strong ties to a local lender may be able to assist a potential investor in securing capital by encouraging the lender's willingness to finance the investor. In light of the recent credit squeeze, this connection could be a particularly valuable asset.

Direct sale. If the timing is right, a departing physician-owner may sell directly to a new physician-investor. Unlike continuing physician-owners and the ASC itself, the departing owner is under no obligation to sell his interests at fair market value. Be careful with this strategy, though: An ASC could be accused of orchestrating such a sale for less than fair market value depending on the level of the ASC's involvement before and during the consummation of such a transaction.

Group practice investment. If the ASC is owned in part by a group practice, the practice's members may be able to depart from the fair market value requirement by letting the physician-utilizer participate through ownership in the group practice. See "The Advantages of Group Practice Investment" (December, page 21) for a discussion of the benefits of group practice ownership of ASCs.

Setting the Buy-in Price

The purchase price for an equity interest in an existing surgical center is typically based on the following calculation:

  • the ASC's earnings before interest, taxes, depreciation and amortization (EBITDA) for the prior 12-month period,
  • multiplied by a fair market value multiple,
  • minus the ASC's long-term debt,
  • multiplied by the percentage of ownership that the new physician-owner is acquiring.

Advantages of the sale
Besides profiting physician-utilizers, selling equity interests benefits the ASC on many levels. Selling shares to a physician-utilizer bolsters that physician's commitment to performing procedures at the ASC. An ASC is most profitable when it has the proper number of utilizing physicians.

While there continues to be an upward trend in the multiples that health systems and ASC management companies pay for a significant equity stake, such buyers are often skeptical of completing any transaction with an ASC where utilizing physicians aren't equity owners and subject to restrictive covenants. Indeed, many ASC management companies now require a successful physician syndication as a prerequisite to closing a sale in which they're purchasing a significant equity stake. Further, many group practices in which physicians own interests in the same ASC use the ASC investment as a method of attracting new physicians into the practice. Some ASCs owned in part by one or more physicians who are planning retirement or relocation see the sale of interests as a way to replace the departing ownership with new physician-utilizers.

There's a catch, though. Your ASC's success might price potential physician-investors out of the market (see "Setting the Buy-in Price"). While the physician might inquire as to whether the ASC can offer the share at a discounted price, the federal Anti-kickback Statute requires that the purchase price for equity interest equal at least fair market value. With limited exceptions, failing to meet that standard would result in regulatory risk. One possible solution for the ASC is to sell the physician a smaller portion or a fraction of an ownership interest. But many ASCs prefer physician-investors to have more meaningful ownership interests in order to solidify their relationships to the facility. Moreover, a physician-utilizer often desires a greater ownership interest in order to feel a greater sense of partnership.

Closing the deal
As the ambulatory surgery industry continues to expand, existing centers depend on continually attracting new physician-investors to survive and thrive. While the purchase price for ownership interest in a well-managed facility sets a high bar for consummating a successful syndication, incorporating one of the five strategies we've presented here into the deal may well be the solution that physician-owners are looking for.

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