Pitfalls to avoid when investing in ASCs

Over the last three to five years, ASC acquisition and investment activity has intensified. ASCs have been recognized by the public, insurance carriers and large self-insured corporations as a cost-effective, safe venue in which outpatient surgery procedures can be performed. A Medicare-certified ASC, accredited and licensed has in place safety procedures, infection control and other factors critical to the safe performance of surgical and diagnostic procedures. As a result, ASCs have become more commonly reimbursed by insurance payers and promoted by third party administrators to large corporations. ASCs offer a financially viable delivery system which is attractive to physician and financial investors as an investment opportunity to augment their income. Additionally, hospitals and health insurance companies have invested in ASCs to diversify their revenue streams and offer more cost-effective services making them more attractive to payers and consumers.

This content is sponsored by ASD Management.

Medicare and other payers reimburse a larger number of complex procedures in surgery centers. Effective Jan. 1, 2017, interventional cardiology, radiology, nephrology and vascular procedures can now be done in surgery centers, which heretofore were only done in hospitals and select in-office physician procedure rooms. Physician entrepreneurs, ASC management companies and venture capital group recognize ASCs as an exceptional delivery system and understand a well-managed ASC offers a solid financial return on investment. New physicians not aligned with an existing surgery center now recognize them as a good opportunity for investment. Investing and working in an ASC allows physicians to be more productive with their practice time, while augmenting their practice income. In addition with new physicians seeking ownership and retiring physicians attempting to sell some of their shares to take a financial return on their initial investment, there is a high level of interest in surgery centers. The investment field has become much more competitive with many others attempting to invest in ASCs.

Current physician owners are being offered various financial arrangements to purchase or sell minority shares in their centers. When physicians aim to sell shares in their centers, there are many financial pitfalls to avoid, even with a good financial advisor. In this piece, I’ll highlight specific pitfalls I’ve experienced through my years developing, managing and investing in surgery centers in the U.S. I’ve been involved with surgery centers since 1977 when I developed and managed my first surgery center at the Ochsner Clinic in New Orleans, since then I’ve seen the trials and tribulations of buying and selling ASCs firsthand. With my more than 30 years in the field and my past and current surgery center investing and management activity, I’ll share my experiences, observations and the input I received from physicians that have endeavored to sell or gain partners for their centers with another entity.

Increased competition

ASCs have become a prime target for investment and acquisition. After speaking with many ASC physician owners, they have been besieged by offers from various healthcare players to buy or invest in their centers. This is especially true for physician owners in their 60s with profitable centers. Many are looking to sell a portion of their stake, for a financial return, while still staying involved in the center. Most owners seek to retain a portion of the ASC to perform future procedures. These owners want relief from the debt and the ongoing financial pressure of managing the center in a more complex healthcare environment.

Changing from out-of-network to in-network cuts back center’s profits which created challenges for physician owners. Many owners have decided to sell part or all of their surgery center as a result. However, there are pitfalls to avoid during the sale process, especially when there is significant interest in their center by several investors and a perceived timeliness to the deal due to the investor competition. In these situations, owners face the challenge of remaining profitable while debating “what comes next?” In some cases, physicians have used the surgery center as a plank in retirement plans and want proper compensation.

Physician owners must determine how much of the ASC they want to sell, when the optimum time is to sell and what the ownership structure will be going forward. During the selection and decision process physician owners must take time to assess the best partner. This is not a matter of just looking at financial data and coming up with a proper EBITDA. This is a more complex process and requires more due diligence. The seller needs to ascertain if the buyer shares similar approaches to managing the center and continuing interaction with the physicians which the surgery center serves. One must determine whether the two parties will jointly commit to help grow the business post-sale. Existing partner physicians can assist in identifying unaffiliated physicians in the area that might want to join the center. But before adding them administrators should find out whether current physicians are amenable to adding new specialties to the center, and if they are open to reducing staffing and vendor costs to increase profitability.

The pitfall of misunderstanding your environment

Another important pitfall is in not understanding the future managed care environment. To sustain and then increase profitability, the investor needs to have a better understanding of: current competition, reimbursement factors and available physicians in the market area. Investors want high returns on their investment. This means revenue growth is essential.

Investors and sellers must understand the current state and projected future reimbursement trends in the ASC’s market area. The two new partners in the ASC need to decide and agree on how to price services to stay competitive in the market, while increasing center profitability. Understanding reimbursement in the area and having the ability to participate with existing payer contracts in the area is a critical pitfall to avoid. I have been in markets where the surgery center is very attractive but due to the concentration of many surgery centers in the area, the surgery center was not able to participate with large payers because the payer(s) had contracts with too many other ASCs in that area. Different reimbursement techniques such as flat fees, published fees, bundled fees, availability of workers comp contracts and personal injury work all need to be considered.

Investors should not assume current contracts at the center can be carried over. A thorough review of payer contracts should always be done during a sale.

The pitfall of joint ventures

Successful joint ventures are not based solely on market environment, reimbursement and financial factors, but on the personal relationship between the investor and seller of the center. Parties must have chemistry and common goals going forward. Sellers have often admitted to sellers’ remorse even though they just received a lot of money for their shares. To the remorseful seller, it seemed like the sale was just a transaction, and not a true partnership. This is a major pitfall which limits future success.

I believe the resulting relationship after a sale is dependent on the effort to build the relationship before the transaction. I do not believe this is emphasized enough as part of the investment process. There is an outstanding business book entitled “Selling Your Baby,” where the author had to consider their emotional attachment to the business when they realized it was time to sell. A sale is a very difficult decision because the entrepreneur owner’s professional reputation, ego, financial resources and emotional attachment to the business is huge. The relationship formed between the seller and investor is critical when the physician seller will stay involved in the center and continue to own interests and use the ASC. This relationship demands a level of trust and a continued positive working environment. It is imperative to create this relationship and nurture it before, during and after the investment.

The buyer’s pitfall

Investors should do a significant amount of due diligence on the center’s environment prior to making an offer. The investor needs to estimate new physician availability and whether there is a service differentiation between that surgery center and others in the market that can be used as competitive advantages to grow the business? So how does an investor validate center potential? One method is through asking current partners how they see the center’s current strengths and weaknesses. Speaking with anesthesiologists or groups that service the center and other centers in the area is very critical in this analysis. Speaking with other ASC owners and/or ASC companies that are in the market is sometimes helpful especially if there is a relationship between the ASC executives. Physician and ASC owners have a tendency to share information given past relationships. They sometimes help each other with supplies, staffing and other services to help their own financial bottom line. Some partner to offer services to large companies and insurance carriers in their area. These centers form consortiums without breaking any compliance statutes and/or regulations. There are no secrets in medicine or the ASC world. ASCs are a small community, and it is not hard to understand market conditions when investing in an ASC.

The pitfall of not doing background and reputation due diligence

Those of us who have been in the ASC field for a long time know to perform thorough background checks on key surgeons in the surgery center before investing. To some this may seem insulting but it is critical to examine the reputation and legal background of the center’s key owners and physicians. As that saying goes, “You are judged by the company you keep.” I recently passed on an investment after the financials, market environment and reimbursement checked out, because the reputation of the center due to some of the key doctors was not good.. Investing is about the quality of partners as they will affect future numbers and growth of the facility as well as the investor’s reputation. Reputation also impacts the ability to recruit other physicians.

The pitfall of a lax transition strategy

Investors should have planned a transition with timelines and duties outlined. This does not have to be in excruciating detail, but there needs to be an overall plan to implement changes. In our case, we designated a transition officer in the company to focus on the transition strategy and partner integration. Transitions typically take from three to four months and need focused, individual attention to make sure physician sellers feel they are part of the process. Love the transition, so the seller-investor relationship grows even stronger.

Deals do not end when the definitive agreement is signed; that’s when they’ve just begun. The transition plan must be tailored to the specifics of the environment, considering attributes of the surgery center to make it a successful investment for both parties. The transition plan includes bi-weekly updates so the sellers can understand whether the transition is going well or to immediately address any problems.

There are many other pitfalls to avoid when investing or acquiring controlling interest in the center. I’ve highlighted several of the most important ones I’ve experienced during my years of developing, investing and managing surgery centers. The relationships I’ve formed in the field have given me valuable input as to what was critical to our joint success in partnering in a surgery center. I have relayed what I have found was most important to the physicians and me. These comments reflect what I have gained from their professional input and guidance to assist in the successful investment and development of their “babies” — now ours together to nurture and grow as partners.

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