Approximately 20 percent of surgery centers are currently in a relationship with a hospital, and the number is only expected to grow as ASCs seek higher reimbursement, capital for expansion and support for implementing changes through healthcare reform. Despite the benefits that a hospital partner can bring to a surgery center, Jon Vick, president of ASCs Inc., warns surgery center owners to look carefully at potential partners before jumping into a relationship.
Mr. Vick identifies the following seven factors that affect the success of a physician-hospital ASC joint venture.
1. Hospital goals. Mr. Vick says for a hospital-physician partnership to succeed, the hospital and the physicians must share a set of common goals for the surgery center. For example, the physicians may be looking to partner with the hospital to benefit from increased reimbursement under hospital-negotiated contracts. Mr. Vick says while some hospital partners can significantly increase reimbursement for their joint-venture surgery centers, this is not always the case. "Hospital contracts do not necessarily flow to the surgery center if and when the hospital becomes a partner," he says. "We've seen situations where the hospital becomes a partner with the surgery center with the goal of eliminating the center as a competitor."
Mr. Vick says physician-owners generally involve themselves in surgery centers for three reasons: efficiency, patient satisfaction and augmented income. He cautions physician-owners to rethink a potential hospital partnership if one or more of these reasons will be compromised. "Contracting should not be the only consideration when it comes to [deciding to partner]," he says. "The physician-owners almost always have personal and business goals that go beyond purely financial goals." He says physician-owners should talk to hospital administration about where the surgery center will be in five years, how ASC operations will function under the new partnership and why the hospital is seeking a joint venture in the first place.
2. Hospital expertise and experience. Physician-owners should look into the joint-venture history of the hospital prior to partnering, Mr. Vick says. "The doctors should examine the experience of other physicians who have gone into joint ventures with the hospital," he says. Surgery center leadership should ask the following questions:
• Does the hospital have a track record of successful joint ventures with physicians?
• How many other joint ventures has the hospital done with physicians?
• Are the physicians in the hospital joint ventures happy?
• Have physician distributions increased in those joint ventures?
Unsuccessful joint ventures obviously raise a red flag, but Mr. Vick says a complete lack of joint ventures is also a troubling sign. "That would show that they have no experience," he says. "You don't want to be the guinea pig with a hospital that's never done a joint venture with a group of physicians." He says if the hospital has never pursued a joint venture before, the administration may have an ulterior motive — removing the surgery center as a competitor, for example.
3. Valuation. Hospitals typically use a different method than management companies to value surgery centers, Mr. Vick says. This method — the "income approach" that uses income to determine value rather than a multiple of EBITDA — generally assigns ASCs a lower value than the "market approach" (multiple of EBITDA) used by the ASC management companies. "Another reason for the lower valuation is that ASC companies consider the acquisition of a surgery center to be a valuable addition to their business," Mr. Vick says. "The hospital considers the acquisition of the surgery center to be strategic and/or defensive, and the business value is higher than the strategic/defensive value."
Surgery centers should not rush into hospital partnerships before thinking seriously about the strength of the hospital's offer, Mr. Vick says. If a management company values the center higher, the ASC might consider partnering with a management company first and then letting the management company negotiate to bring in the hospital as a minority partner.
4. Management. Many hospitals approach surgery center joint ventures saying they need 51 percent ownership interest, Mr. Vick says. "Almost every time doctors start a conversation with the hospital, the hospital says, 'We need to own 51 percent because that's what our charter requires,'" he says. "Almost always, that's not true. The hospital wants but does not need to own 51 percent." He says while a hospital with a minority interest in a surgery center can sometimes run into challenges negotiating payor contracts for the ASC, generally a hospital with any interest in a surgery center can negotiate on behalf of the ASC. Additionally, hospitals with 51 percent interest in a surgery center may end up not negotiating better contracts for the surgery center, depriving physician-owners of control without providing more lucrative reimbursement.
Mr. Vick says once a hospital has 51 percent ownership of a surgery center, the hospital controls the ASC and may start to manage the ASC like a hospital. "That's contrary to the reason the doctors originally started the center," he says. "The doctors wanted to get away from high costs, union labor, slow turnaround times and inefficiency."
5. Control issues. Mr. Vick recommends that physicians specify the level of control they want in the operating agreement with the hospital. "That way, the Drs. can continue to control who the administrator is, which doctors come on staff and certain operational things that are important to the doctors," he says. "They can require a super majority vote so that if the hospital has a 51 percent interest, they cannot [make all the decisions] by having a majority on the board." He says physicians should hesitate to give up control over decisions that affect the efficiencies, economies and earnings of the ASC.
He says these control issues are another reason to push for hospital minority interest in the surgery center. Often, physicians are at a disadvantage in negotiating with the hospital to accept a minority interest as the hospital may have more experienced negotiators. Mr. Vick says an ASC management company can be useful in this situation. "Once the hospital says they need to have a majority interest, the doctors tend not to take a strong position because of the relationship they have with the hospital," he says. "The management company has no problem taking a stronger position."
6. Contracts. Before physicians enter an agreement with a hospital, they need to understand the hospital's existing contracts and how the hospital will help the surgery center improve its reimbursements. "It needs to be documented," Mr. Vick says. "Which contracts is the hospital willing to help with?" He says surgery centers should generally expect a hospital to help increase contractual reimbursements by an average of 20 percent. The hospital administration should bring the surgery center administration to contract negotiations and negotiate ASC and hospital contracts at the same time.
If a surgery center depends heavily on Medicare or Medicaid, Mr. Vick says the center should consider partnering with a management company to improve physician recruitment and payor mix before partnering with a hospital, as physician recruitment is a management company strength and expertise. "They can recruit other doctors and other cases so that your payor mix improves and your percentage of Medicare and Medicaid becomes less important," he says. "Centers that concentrate on Medicare and Medicaid are subject to government changes and hospitals cannot make an impact on their reimbursement levels." He says a healthy surgery center should have more than half of its total cases coming from non-government insurance.
7. Cases from the hospital. Mr. Vick says physicians should also seek knowledge of which cases will be performed at the surgery center under the joint venture. Hospital-physician ASC joint ventures can often benefit when the hospital is losing money on cases that could be performed profitably at the surgery center. "The surgery center can then make a profit on cases the hospital is losing money on," he says. "It can be beneficial for both the hospital and the surgery center to do capitated or lower-paying cases at the surgery center."
However, the physicians need to make sure they control which cases come to the center so the ASC is not forced to accept unprofitable cases. "Once the hospital sends over cases that are unprofitable at the surgery center, the doctors' goal to augment their income disappears," he says.
Best of both worlds
Mr. Vick says ideally, a surgery center should partner with a management company before pursuing a joint venture with a hospital. Unlike the hospital, the management company has expertise in profitably managing efficient, economical surgery centers and can direct ASC operations while serving as a liaison between the physicians and hospital administration.
This three-way partnership can also help the ASC achieve a higher valuation. "The ASC first does a deal with the management company and establishes fair market value, and then the management company can go out and negotiate to bring the hospital in as a minority partner," he says. "The price is already established." He says hospitals are generally amenable to this relationship because their main goal is typically to improve their relationship with the center's physicians.
Related Articles on Surgery Center Joint Ventures:
Catholic Hospital Comes Under Fire for 'Tying Tubes' at Joint Venture Surgery Center
3 Choices for Surgery Centers Seeking New Strategic Direction
10 Surgery Center Transactions and Projects Involving Hospitals
Mr. Vick identifies the following seven factors that affect the success of a physician-hospital ASC joint venture.
1. Hospital goals. Mr. Vick says for a hospital-physician partnership to succeed, the hospital and the physicians must share a set of common goals for the surgery center. For example, the physicians may be looking to partner with the hospital to benefit from increased reimbursement under hospital-negotiated contracts. Mr. Vick says while some hospital partners can significantly increase reimbursement for their joint-venture surgery centers, this is not always the case. "Hospital contracts do not necessarily flow to the surgery center if and when the hospital becomes a partner," he says. "We've seen situations where the hospital becomes a partner with the surgery center with the goal of eliminating the center as a competitor."
Mr. Vick says physician-owners generally involve themselves in surgery centers for three reasons: efficiency, patient satisfaction and augmented income. He cautions physician-owners to rethink a potential hospital partnership if one or more of these reasons will be compromised. "Contracting should not be the only consideration when it comes to [deciding to partner]," he says. "The physician-owners almost always have personal and business goals that go beyond purely financial goals." He says physician-owners should talk to hospital administration about where the surgery center will be in five years, how ASC operations will function under the new partnership and why the hospital is seeking a joint venture in the first place.
2. Hospital expertise and experience. Physician-owners should look into the joint-venture history of the hospital prior to partnering, Mr. Vick says. "The doctors should examine the experience of other physicians who have gone into joint ventures with the hospital," he says. Surgery center leadership should ask the following questions:
• Does the hospital have a track record of successful joint ventures with physicians?
• How many other joint ventures has the hospital done with physicians?
• Are the physicians in the hospital joint ventures happy?
• Have physician distributions increased in those joint ventures?
Unsuccessful joint ventures obviously raise a red flag, but Mr. Vick says a complete lack of joint ventures is also a troubling sign. "That would show that they have no experience," he says. "You don't want to be the guinea pig with a hospital that's never done a joint venture with a group of physicians." He says if the hospital has never pursued a joint venture before, the administration may have an ulterior motive — removing the surgery center as a competitor, for example.
3. Valuation. Hospitals typically use a different method than management companies to value surgery centers, Mr. Vick says. This method — the "income approach" that uses income to determine value rather than a multiple of EBITDA — generally assigns ASCs a lower value than the "market approach" (multiple of EBITDA) used by the ASC management companies. "Another reason for the lower valuation is that ASC companies consider the acquisition of a surgery center to be a valuable addition to their business," Mr. Vick says. "The hospital considers the acquisition of the surgery center to be strategic and/or defensive, and the business value is higher than the strategic/defensive value."
Surgery centers should not rush into hospital partnerships before thinking seriously about the strength of the hospital's offer, Mr. Vick says. If a management company values the center higher, the ASC might consider partnering with a management company first and then letting the management company negotiate to bring in the hospital as a minority partner.
4. Management. Many hospitals approach surgery center joint ventures saying they need 51 percent ownership interest, Mr. Vick says. "Almost every time doctors start a conversation with the hospital, the hospital says, 'We need to own 51 percent because that's what our charter requires,'" he says. "Almost always, that's not true. The hospital wants but does not need to own 51 percent." He says while a hospital with a minority interest in a surgery center can sometimes run into challenges negotiating payor contracts for the ASC, generally a hospital with any interest in a surgery center can negotiate on behalf of the ASC. Additionally, hospitals with 51 percent interest in a surgery center may end up not negotiating better contracts for the surgery center, depriving physician-owners of control without providing more lucrative reimbursement.
Mr. Vick says once a hospital has 51 percent ownership of a surgery center, the hospital controls the ASC and may start to manage the ASC like a hospital. "That's contrary to the reason the doctors originally started the center," he says. "The doctors wanted to get away from high costs, union labor, slow turnaround times and inefficiency."
5. Control issues. Mr. Vick recommends that physicians specify the level of control they want in the operating agreement with the hospital. "That way, the Drs. can continue to control who the administrator is, which doctors come on staff and certain operational things that are important to the doctors," he says. "They can require a super majority vote so that if the hospital has a 51 percent interest, they cannot [make all the decisions] by having a majority on the board." He says physicians should hesitate to give up control over decisions that affect the efficiencies, economies and earnings of the ASC.
He says these control issues are another reason to push for hospital minority interest in the surgery center. Often, physicians are at a disadvantage in negotiating with the hospital to accept a minority interest as the hospital may have more experienced negotiators. Mr. Vick says an ASC management company can be useful in this situation. "Once the hospital says they need to have a majority interest, the doctors tend not to take a strong position because of the relationship they have with the hospital," he says. "The management company has no problem taking a stronger position."
6. Contracts. Before physicians enter an agreement with a hospital, they need to understand the hospital's existing contracts and how the hospital will help the surgery center improve its reimbursements. "It needs to be documented," Mr. Vick says. "Which contracts is the hospital willing to help with?" He says surgery centers should generally expect a hospital to help increase contractual reimbursements by an average of 20 percent. The hospital administration should bring the surgery center administration to contract negotiations and negotiate ASC and hospital contracts at the same time.
If a surgery center depends heavily on Medicare or Medicaid, Mr. Vick says the center should consider partnering with a management company to improve physician recruitment and payor mix before partnering with a hospital, as physician recruitment is a management company strength and expertise. "They can recruit other doctors and other cases so that your payor mix improves and your percentage of Medicare and Medicaid becomes less important," he says. "Centers that concentrate on Medicare and Medicaid are subject to government changes and hospitals cannot make an impact on their reimbursement levels." He says a healthy surgery center should have more than half of its total cases coming from non-government insurance.
7. Cases from the hospital. Mr. Vick says physicians should also seek knowledge of which cases will be performed at the surgery center under the joint venture. Hospital-physician ASC joint ventures can often benefit when the hospital is losing money on cases that could be performed profitably at the surgery center. "The surgery center can then make a profit on cases the hospital is losing money on," he says. "It can be beneficial for both the hospital and the surgery center to do capitated or lower-paying cases at the surgery center."
However, the physicians need to make sure they control which cases come to the center so the ASC is not forced to accept unprofitable cases. "Once the hospital sends over cases that are unprofitable at the surgery center, the doctors' goal to augment their income disappears," he says.
Best of both worlds
Mr. Vick says ideally, a surgery center should partner with a management company before pursuing a joint venture with a hospital. Unlike the hospital, the management company has expertise in profitably managing efficient, economical surgery centers and can direct ASC operations while serving as a liaison between the physicians and hospital administration.
This three-way partnership can also help the ASC achieve a higher valuation. "The ASC first does a deal with the management company and establishes fair market value, and then the management company can go out and negotiate to bring the hospital in as a minority partner," he says. "The price is already established." He says hospitals are generally amenable to this relationship because their main goal is typically to improve their relationship with the center's physicians.
Related Articles on Surgery Center Joint Ventures:
Catholic Hospital Comes Under Fire for 'Tying Tubes' at Joint Venture Surgery Center
3 Choices for Surgery Centers Seeking New Strategic Direction
10 Surgery Center Transactions and Projects Involving Hospitals