What Percentage of Your Surgery Center Should You Sell?

Once physician-owners decide to sell a surgery center, they must decide on what percentage of the center to sell. Jon Vick, founder and president of ASCs Inc., which has assisted in development, merger and acquisition transactions for more than 200 physician-owned ASCs, endoscopy centers and surgical hospitals, says the decision should be based on the goals of the physician-partners.

He says there are three basic models for selling a surgery center: selling a minority share, selling a majority share and forming a three-way joint venture between an ASC, a management company and a hospital.

"Usually, we don't see both majority and minority purchase proposals for any one center," he says. "Once we know what the physicians' goals are, it becomes pretty clear which model is best."

Mr. Vick discusses the advantages and disadvantages of each model, as well as his recommendations for which centers should choose which model.

Selling a minority share
Mr. Vick says the minority interest option is best for centers that need more surgical volume and could benefit from a turnaround. These centers are generally between 40-50 percent utilized. By bringing in a management company, the center can take advantage of the company's recruiting and management expertise while maintaining control and the option to sell the center for a higher value later on.

"Let's say there's a center owned by five doctors, and it's 50 percent utilized," Mr. Vick says. "Rather than selling 51 percent, the owners would do better to sell 30 percent to a company that would increase the utilization by recruiting doctors, renegotiating the contracts and increasing revenue. Then they can take it and sell it for a much higher value."

Mr. Vick says approximately half of ASC management companies are interested and willing to purchase a minority stake in a center, and they generally purchase between 20-30 percent. These are usually smaller management companies who are interested in turnarounds.

"One of the main advantages of selling a minority interest is that a lot of the companies will work to make the center more profitable and thus more valuable," he says.

The management company will generally come in for one to three years, recruit more physicians, increase profitability and distributions to all of the partners and then sell a majority interest of the center to a larger company or joint venture with a hospital.

"A big advantage of a selling a minority interest is that some of the most successful minority-owner companies are willing to sell again," he says. "You can get a much higher multiple and a much higher value for all of the sellers."

The main disadvantage in a minority share sale is the valuation multiple is substantially less than for a majority interest — usually around 3-5 times EBITDA, or earnings before interest, taxes, depreciation and amortization. However, when the center becomes more profitable the owners can sell a majority interest at a much higher multiple, typically between 6-7.5 times EBITDA.

Selling a majority share
Mr. Vick says a center that is operating more or near at capacity — in the range of 80 percent or so — should consider selling a majority interest to a company that is looking for high cash flow, and that has the resources to expand the center.

"A center that is fully utilized and doing very well would be better off selling a majority interest to one of the larger companies that has the capital to buy very successful centers," he says. "This allows the physicians to diversify their investments."

Selling a majority share is also a good option as an exit strategy for surgeons who are near retirement as this way they will receive full value for the shares they sell, rather than a discounted value. The management company would then recruit younger surgeons to replace the older ones.  It is important that the selling surgeons develop a list of prospective buyers who could become partners.

The average valuation multiple for a majority interest sale is 6.5 times EBITDA, Mr. Vick says. This is substantially higher than the average multiple for a minority interest sale. Very rarely will a company buy more than 51 percent interest, he says. In certain cases, such as interest owned by retiring or unproductive physicians, the company will buy those shares to resell to younger, busier surgeons.

One of the presumed disadvantages of selling a majority interest of a center is the management company can assume total control, though Mr. Vick says that is easily mitigated.

"A lot of people think that by selling 51 percent, you're giving up control," he says. "Theoretically, that's true, but practically, physicians can add terms to the operating agreement so that the doctors can retain control over all the medical issues plus certain operational issues that the doctors want to have a say in. Losing control need not be a concern if the partnership is constructed properly."

Another advantage of selling a majority interest is that some companies that buy majority interest offer a combination of cash and stocks, which can result in a much higher total return when the value of appreciated value of the stock is realized.

"The stock component can be worth more down the road, so that the total return could be significantly more than a company that's just buying 51 percent for cash alone," he says. "It can boost the multiple up to 8 or 9 times EBITDA."

Even though the multiple is higher for majority interest sales, one disadvantage is that the physician owners lose the ability to resell the center down the line when it might be more profitable, Mr. Vick says.

"The disadvantage of selling 51 percent is that that's the only transaction the doctors will do," he says. "The opportunity for resale disappears."

Forming a three-way joint venture
Mr. Vick says forming a joint venture with both a hospital and a management company is a good option for a multi-specialty center that has a lot of surgeons and needs help with recruiting and contracting.

"In a three-way deal, the doctors want to maximize their ASC's sales value, so they would sell 51 percent to a joint venture between a hospital and a management company," he says. "In that scenario, the hospital might buy 26 percent and the management company might buy 25 percent."

This deal usually results in a higher valuation multiple than a sale to a hospital alone, and the ASC management company ensures that the center will continue to be operated efficiently and economically. This sale results in a "best of both worlds" scenario, Mr. Vick says. The hospital has hospital contracts but not the ASC expertise, and the management company has the ASC expertise.

"This way, the seller would end up with a hospital partner and have access to hospital contracts and a surgery center management company that knows how to run surgery centers," he says.

A joint venture generally starts with the formation of a separate company that is 51 percent owned by the hospital and 49 percent owned by the management company, or a 50/50 split, Mr. Vick says. The surgery center would be operated by that joint venture, which is governed by its own laws and operating agreement.

Because the joint venture owns 51 percent, they have ultimate control, he says. In this situation, physicians can maintain control of certain aspects by requiring a super majority vote for specific actions or adding terms to the operating agreement.

Learn more about ASCs, Inc.

More Expertise from Mr. Vick:
How to Sell an Endoscopy Center
10 Signs Your Surgery Center is in Trouble
7 Ways to Position ASCs for Success

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