Successful Hospital-Physician Joint Ventures

            Many observers see the hospital-physician joint venture as the ownership model that will endure and grow in the future.  It’s easy to see why.   Simple economics tell us that surgical services will continue to migrate toward sites of service with healthier reimbursement rates.  Surgeons know that joint venturing not only lets them share in HOPD-type rates, but also softens the negative impact that an ambulatory surgical center might have on the hospital’s patient base.  At the same time, joint ventures let hospitals solidify existing relationships with physicians and even encourage future referrals from them for other hospital services. 

On the surface, it seems like a no-brainer that hospitals and physicians should partner to form or reunite to co-own and operate a surgical center.  But it’s not always smooth sailing once the hospital and the physicians tie the knot.  Here’s a review of the key governance issues that go a long way in determining the success of a hospital-physician joint venture.

1.         Deciding and dividing ownership.  The first issue to address can be a dealbreaker:  How much equity will each side hold in the ASC?  Physician-investors may want a greater share because, in many cases, they generate the business that supplies the ASC’s revenues.  If the hospital is serving as the ASC’s primary promoter, however, the hospital may expect to receive the greater share.

Also, if the hospital’s investment is greater than the physicians’, the hospital may demand a greater amount of equity interest, and rightfully so, especially if the hospital is bringing such resources as physical plan facilities, technology or administrative expertise to the joint venture as an in-kind capital contribution.  Those types of investments may be too costly for physicians to reproduce on their own, or may require a prolonged implementation process.

Such considerations aside, political and economic prudence may lead to a 50-50 division of equity.  So long as neither side fights over the hyphen, this can serve a dual purpose. First, it signifies from the start that both sides are equal partners in the joint venture and it keeps them all interested in the deal.  Second, each side bears half of the expenses, which creates an incentive for both to drive down costs and remain active partners in the venture. 

2.         Calling the shots.  Management, in particular the composition of the newly formed company’s board, is another key issue.  Both parties have an interest in, and arguments for, dominating the board and exercising control over the ASC.

Physicians believe, for instance, that they can manage an ASC more efficiently and robustly than a hospital can (and in many cases, they’ve proven themselves correct).  Plus, if the physician-investors have contributed a greater amount of capital to the project than the hospital has, they expect to have final say over financial and operational issues.

On the other hand, hospitals have frequently taken the position that their existing managements and their experience in dealing with physicians, not to mention their access to available capital, makes them better suited to operate an ASC.

Regardless of which side ultimately wins board control, hospital partners should always require certain provisions to be incorporated into the ASC’s organizational documents.  A not-for-profit hospital must retain the right to veto the decisions that might negatively impact its tax-exempt status.  Faith-based hospitals guided by religious beliefs should require that a joint venture abide by those beliefs and that its governing documents prohibit particular types of procedures (most notably, abortions).

3.         Autonomy and authorization.  While the physician side of the joint venture is generally granted the autonomy to handle day-to-day issues on its own, the hospital may dictate that action on certain matters will be subject to its prior approval.  Physicians may also want to require that the hospital seek their approval as well in the event that it chooses to exercise any of these options. 

Examples of such central policy decisions include:

• selling or merging the venture;
• selling all, or a substantial amount of, the venture’s assets;
• incurring debt in excess of a total specified amount in any 1-year period.
• entering into a contract or commitment that may involve an expense, investment and/or corporate guarantee in excess of a specified amount;
• entering into any agreement or arrangement regarding the compensation of any member(s) of the joint venture;
• repairing any joint venture member(s) to lend money to the venture;
• requiring additional capital calls or personal guarantees by any member(s);
• admitting new members to the venture; or
• adopting, amending or modifying the venture’s governing documents.

4.         Buyouts and restrictive covenants.  The valuation of the venture’s ownership interests will become a particular concern as the members of the partnership change over time.  With regard to the physician-investors, the events that typically trigger a buyout are death, disability, retirement, resignation, termination for cause without cause.

It is considered fair and reasonable to adopt different approaches to valuation depending upon the triggering event.  For example, if an investor is being terminated for cause, clearly something bad has happened and the buyout amount may be reduced accordingly.

Many ASC ownership transactions have vesting schedules to ensure a partner’s commitment to the venture before departure.  For example, if an investor (including the hospital decides to leave before the venture’s fifth anniversary, the valuation might be limited to the book value and a cash basis.  If, however, the investor (including the hospital) stays in the venture for more than 10 years, a fair market valuation would be conducted. 

A decision must also be made as to whether participants in the venture may enter into other joint ventures, or whether they’ll be bound to restrictive convenants that limit their ability to participate in other ASC’s.  These restrictive covenants that limit their ability to participate in other ASC’s.  These restrictive covenants work 2 ways, hindering hospitals from joining other physicians in different projects while also blocking physicians from collaborating with other hospitals or starting new ASC’s.  Critically, however, they serve to ensure that all the participants are completely dedicated to the joint venture, which is absolutely necessary if the ASC is to succeed.