9 ASC joint venture operating agreement issues that make or break the partnership
1. Balance of power. The most basic element of a joint venture operating agreement will define ownership: the majority and minority stakeholders. One of the largest appeals of a hospital joint venture is access to hospital contracts, but relinquishing majority control is the price physicians must pay. Hospitals, on the other hand, are largely concerned with preserving tax-exempt status. The key is to strike the right balance in which both the hospital and physicians benefit and feel comfortable.
2. Board representation. Hospital majority ownership that does not necessarily mean it will have ultimate control over a surgery center's daily operations. "Governance and ownership do not have to mean the same thing," says Joe Zasa, managing partner of ASD Management. "Hospitals can own a majority share but the physicians can hold the majority of the governing board seats." Major decisions regarding the future of an ASC will be made by its board, which if negotiated in the operating agreement, can include more physicians than hospital representatives, regardless of majority and minority rights. Notwithstanding, any major decisions must require a supermajority of the board members. "The determination of what is a majority board decision and what takes supermajority vote is a critical element in the negotiations. The ultimate goal is not to jeopardize the tax exempt status of the hospital and allow the physicians control over operational decisions to allow the surgery center to be efficient," says Mr. Zasa
3. Physician recruitment. Hospital majority ownership just for the sake of higher reimbursement can be short-sighted, though beneficial. "Too much non-physician ownership discourages recruiting," says Paul Skowron, senior vice president of operations at Regent Surgical Health. "Make room for new volume and revenue-producing shareholders."
In the majority of scenarios, existing physician ownership will be diluted when bringing on new investors. But, if the joint venture reaches the point in which hospital ownership deters new physicians from coming on board, the hospital may need to sell down to ensure the viability of its partnered center. Take into account how ownership division will affect future investment during the operating agreement negotiations.
4. Physician buy-in and buy-out. The details of physician buy-in and buy-out can be lost in the shuffle, but these terms can later come back to haunt the owners. For example, some operating agreements require physicians to hold their shares for up to 10 years. Selling within that period would be considered "adverse termination," or a cut of 30 percent to 40 percent in profits, says Mr. Skowron. "Physicians should strive for a shorter hold period. Market conditions could become negative and they may want to sell sooner."
Determine how physicians want to hold share in the centers. Some operating agreements will only allow individuals, not entities, to invest, effectively barring physicians to invest collectively as a practice. "If it is beneficial for the LLC in a particular market, you may have to restate the operating agreement to allow for entity and individual ownership," says Mr. Skowron.
While buy-in and out will be an active decision in the majority of cases, operating agreements will need to include a provision for passive investors "It is key to have active investors at the center," says Mr. Zasa, "It is good business sense but more importantly a compliance issue. Thus, expulsion provisions for physicians who are not active participants in the surgery center is a suggested approach."
5. Permissible relationships. A central operating agreement provision will define how physicians are able to act as a part of the joint venture. "A physician shareholder does not always see the connection between Anti-Kickbacks and contractual changes," says Mr. Skowron. For example, the hospital cannot lend equipment to the ASC free of charge. "Hospitals will not directly compete with ASC and will not try to induce referrals by doing free things for the ASC," he says.
6. Non-compete clause. While non-compete clauses are not an operating agreement requirement, they are the industry standard. It is important to not only understand the basics of non-competes, but also its future implications. "As markets become more saturated, a 10-mile non-compete zone becomes difficult for all shareholders," says Mr. Skowron. "Maybe a five-mile radius would be more appropriate. This needs to be flexible over time, not just at the time a hospital buys shares."
"On the flip side, the hospital needs to agree to the same kind of thing. For example, it cannot develop another ASC," says Mr. Zasa. "It has to be equitable." Effective non-compete clauses are designed to affect both joint venture partners, not just physicians.
7. Reserved powers. Each class of investors — physicians, hospital and management company — has the right to exercise reserved powers, as defined in the operating agreement.
Hospitals may reserve the right to restrict what kinds of cases are performed at the ASC.
"The biggest thing physicians want is microeconomic control," says Mr. Zasa "How does the center operate on a day-to-day basis: hiring, firing, dividends, etc."
8. Agreement amendment. What works in theory may not work in practice; no operating agreement is created perfectly. Any number of factors can demand a change in the operating agreement, but how that process is completed will be formalized in the initial agreement. "You cannot have unilateral amendment," says Mr. Zasa. "The key is to balance governance and ownership so both parties feel enfranchised." Generally, it takes a supermajority board vote, 75 percent or as defined by the agreement, to make an amendment to the original operating contract.
9. Restrictions. Hospitals may lobby for operating agreement clauses that physicians find overly restrictive. For example, hospitals may disallow certain procedures from being performed at the ASC based on religious affiliation or they may push for extreme non-compete clauses. Hospitals are unlikely to budge on religious issues, but the issue of non-competes leaves much room for discussion. "It is all in the negotiations. This is the time for physicians to make their strongest case," says Mr. Skowron.
More Articles on Transactions and Valuation Issues:
22 Physician-Owned ASCs Opening or Announced in 2014
Industry Mega Mergers: What Do the AmSurg-Sheridan & Surgery Partners-Symbion Deals Mean for ASCs?
3 Major Revenue Cycle Considerations in ASC-Hospital Joint Ventures
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