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Quick insights on converting an HOPD to a freestanding, joint-venture ASC

Now that site neutrality is on everyone’s mind, Avanza is regularly called upon by hospitals and health systems to assist in converting provider-based entities, i.e., hospital outpatient department (HOPD), to freestanding, and often joint-ventured, ambulatory surgery centers (ASCs).

Two of the most common development issues we are asked to discuss concern employed physicians investing in the ASC and the legal structure of the ASC partnership.

Here are some quick thoughts concerning these issues.

Employed physicians investing in a freestanding ASC with their employer hospital
In 2018, Avanza conducted a nationwide survey of hospital senior leadership covering issues related to joint-ventured ASCs. The survey results showed that there is a 50/50 split on whether or not hospitals allow employed physicians to invest in ASCs they joint venture. This mirrors our experience with clients. Here are a few of the reasons we hear as to why hospitals do not allow investment by employed physicians.

Even though hospitals can't require where employed surgeons perform their cases, many hospital executives feel that surgeons should use the hospital's ASC if they are employed, regardless of whether they have an investment. An argument to this is that one of the main reasons you want physician investment in an ASC is to have the people who drive the operations to have a vested interest in controlling costs and improving efficiencies. If the employed physicians are not allowed to invest, they may not be incentivized to control costs and may also be frustrated that they are putting money in other physicians' pockets without an opportunity to participate. This may subconsciously hurt operational efficiencies and create other challenges.

There are fears that any distributions from the ASC investment would put the doctors over the compensation threshold. An argument to this is that investment distributions received from the ASC are not considered compensation. The hospital would not be providing the physicians with equity in the ASC; rather, the physicians would be using their own capital to invest and would be at risk for at their pro-rata share for any liabilities, especially if personal guarantees are required.

Independent physicians would not be happy if the employed physicians are allowed to invest. This arrangement may come across as "double-dipping." This may be the case and is something to be considered. If your ASC's success is dependent upon many independent physicians, you should get their opinion on allowing employed physicians to invest. Typically, if the employed physicians are quality surgeons and perform appropriate ASC cases (and are nice people as well), the independent doctors usually do not have an issue with the fact that they are employed. This needs to be looked at on a case-by-case basis.

Key takeaways: The decision of allowing employed physicians to invest is up to each individual hospital/health system. We are not aware of any prohibition to it. Avanza's overarching belief is that if you are developing an ASC, you should encourage all eligible, appropriate cases to be performed in the ASC. It is the appropriate venue for healthy patients to undergo elective surgery.

Legal construct of "Newco ASC Partnership"
Here are a few of the topics we cover when discussing the legal construct of the new freestanding ASC.

Structure. We typically see joint-venture ASC partnerships set up as LLCs. This decision may be impacted by state statute or tax implications, but 95% of the joint ventures Avanza has worked with in our 20-plus years of working with ASC joint ventures are set up as LLCs.

Equity split. The ownership/equity percentages vary greatly. You can look at our survey datasurvey data to get an idea of how other hospitals have structured their joint venture. This is usually an issue we discuss with the physicians prior to finalizing the structure.

In the past, many doctors did not want to be in a joint venture if the hospital was to be the majority owner. But now if the hospital payer contracts can be carried over to the ASC, then we can show the doctors how they actually make better returns with less equity if they allow the hospital to be the majority partner.

We also discuss the differences between equity and control and how the operating agreement can have reserve powers for both classes of investors. Concerning not-for-profit hospital partners, the areas that the hospital needs to maintain control over to protect their status are not typically matters physicians care much about. Physicians typically want control over hiring and firing the administrator, approval if the organization takes on debt that requires personal guarantees and have budget input and other operational issues that impact them as surgeons utilizing the ASC.

Board composition. This also varies. I have worked with attorneys that say the not-for-profit hospital — even if it wants to consolidate the ASC on its books and own a majority — may not need a majority of the seats. I have worked with other attorneys that always want the not-for-profit hospital to have the majority of the seats on the ASC board. This should be assessed on a case-by-case basis. For appearances, we always recommend that a physician hold the position of board president.

Other issues. Other issues that typically need to be discussed and negotiated include individual versus practice investment, restrictive covenants, divestiture triggers, payback provisions and formula versus independent valuation.

Key takeaways: We typically advise setting up a physician/hospital ASC steering committee early in the conversion process. This committee can meet and discuss all of the issues covered in this column and other pertinent matters related to the ASC structure and operations. Taking this approach can help the hospital and physicians feel confident about the information covered in the offering documents and that their input was included.

We also believe that having the steering committee work through the development of the operating agreement and other documents provides a forum for hospital and physician education on how the ASC partnership should work and why the partnership has a particular structure. It is time well spent and can increase the opportunity for successful operations and an enduring relationship between the partners.

Finally, it is worthwhile for the hospital to use outside healthcare counsel for this effort. It is nice to have someone who is not employed by the hospital work on the documents as this helps put both parties on an even playing field and remove an appearance of potential favoritism. You can keep the cost of developing the documents down by facilitating the conversations around many of the sensitive issues prior to engaging legal counsel.

Joan Dentler (jdentler@avanzastrategies.com) is president and CEO of Avanza Healthcare Strategies, which provides healthcare organizations with strategic guidance, with a focus on outpatient services. For more than 25 years Ms. Dentler has been consulting on, developing or operating ambulatory surgery centers, hospital outpatient services and community health initiatives.

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