April 19, 2006
Not-for-profit hospitals nationwide are increasingly being approached by physicians and for-profit surgery center management companies about establishing joint venture ambulatory surgery centers (ASC). Some hospitals and health systems are heading off potential competition from new market entrants by proactively developing an ASC, typically through a joint venture with physicians.
The strategic and financial evaluation of a joint venture ASC is complex, involving significant market, operational, financial, regulatory, and legal issues. However, competitive threats and physician pressure often create a sense of urgency that prevents the kind of thorough consideration they deserve.
In the January 2006 issue of Executive Insights, Michael Finnerty, a vice president with Kaufman, Hall & Associates, Inc., in Northfield, IL, explains how slowing down and resolving some key issues can make the difference between success and failure. The following are two of those issues.
Outside Management
Myriad companies offer management services to ASCs, including center development, onsite management, and consulting. In many instances, outside management companies, some of which are publicly traded, provide capital to develop the ASC in return for an equity position and management contract. Such companies can bring valuable expertise. Perhaps more important, they can act as a buffer between the hospital and the physicians, helping to preserve good relations, which often is the hospital's original impetus for the joint venture.
However, hospital leaders must consider certain drawbacks to using an outside management company. In many cases, the financial interests of the company in the planning, development, and management of the ASC may run counter to those of the hospital, especially tax-exempt institutions, suggesting the need for rigorous independent analysis of the proposed arrangement. For example, because a management company typically focuses on profitability growth, it is unlikely to embrace restrictions on the types of services that will be offered at the ASC -- restrictions proposed by the hospital to more carefully coordinate with its existing hospital-based outpatient program.
Hospital leaders also must carefully analyze an ongoing financial relationship with an ASC management company in light of the strategic and financial objectives of the joint venture partners. Fees for ongoing management services based on percentage of revenue, which many management companies seek, can put tremendous pressure on monies available for supporting the hospital's mission.
Valuation
Ongoing valuation is a part of most joint ventures, and joint venture ASCs are no exception. In situations where the hospital is contributing existing outpatient business, a valuation is often required to ensure that it receives fair market value for this contribution. Failure to do so can expose the hospital to risks associated with private benefit (IRS inurement) and/or anti-kickback regulations. The standard for valuing contributed operations typically is their fair market value as a going concern, as opposed to book value or asset value, which usually is much lower. This can create tension between physicians and the hospital, as physicians often consider the contributed outpatient surgery business to be theirs.
Following the establishment of the joint venture, valuations will be required to determine the fair market value of the ASC when existing equity is repurchased and/or when new shares are issued. Because shareholders' incentives are often not aligned during events requiring valuations, it is prudent to establish in advance the methodology by which fair market value will be determined.
Maximum Flexibility, Minimum Risk
Healthcare financial leaders must ensure rigorous and independent evaluation of all potential ASC joint ventures. Such ventures can be an effective way to intertwine hospital-physician success, expand relationships and market share, and grow profitability. However, given that outpatient surgery is one of the most profitable service lines for most hospitals, joint venture ASCs come with significant financial and strategic risks. Hospitals evaluating these ventures should consider structures that allow for future flexibility and retention of outpatient surgical business in the event of market, payment, or other industry changes.
Proper consideration of these critical issues -- including market, strategic, and financial implications; structure; management; and valuation -- can help organizations ensure such flexibility and achieve nearer-term financial and strategic goals.
SOURCE: "Considering a Joint Venture ASC? First Resolve These Four Make-or-Break Issues," by Michael Finnerty, January 2006 Executive Insights newsletter.
Additional Resources
If you have questions or comments about HFMA Wants You to Know, contact editor Laura Noble.
HFMA Wants You to Know ISSN: 1540-0697. Volume V, Issue 9. Copyright 2006, Healthcare Financial Management Association. All rights reserved.