Who Can Pay More for a Surgery Center: Hospital or Management Company?

The following article is written by Curtis H. Bernstein, CPA/ABV, ASA, CVA, MBA, director of valuation services for Sinaiko Healthcare Consulting.

Like surgery center management companies, hospitals are restricted from paying above fair market value for a surgery center under the Anti-Kickback Statute because of the referral relationship between the physician-owners and the center. Since surgery center management companies are typically the more active companies purchasing controlling interests in surgery centers, the prudent seller would be better suited to understand how these companies determine value, how the purchase price converts into an earnings multiple and how hospital acquisition prices compare to those of the management companies.


Management companies as buyers

Management companies will generally purchase a 30-51 percent interest in a center with an interest in having management control of the surgery center through a management agreement paying 5-7 percent of net revenues, depending on the scope of services provided.


Overall, the management companies are looking to earn a 15-20 percent cash-on-cash return on their investment. The management companies will look to earn this return through the continuation of historical cash flows, growth in future cash flows through higher revenues and reduced costs and their management fee.


When a management company purchases a 100 percent interest in a surgery center, which is very rare, the management company will not pay top price for the surgery center because of the desire to keep the physicians locked into the future of the surgery center through ownership and non-compete agreements. Since the management companies prefer physician ownership, the management company would likely sell non-controlling interests to physicians after the purchase of the 100 percent interest. For interests that lack the ability to control surgery center operations, prices paid would be expected to be at lower multiples (e.g., a 3x multiple of EBITDA for a non-controlling interest versus potentially a 6x multiple of EBITDA for a controlling interest). The lower returns on re-syndication will result in lower returns to the buyer and, accordingly, the buyer will pay less up front.


In mathematical terms, a company would not pay a 6x multiple of EBITDA for a 100 percent ownership interest and then have to sell between 30-49 percent for a 3x multiple to non-controlling shareholders. This would be dilutive to the controlling shareholder and significantly lower the cash on cash return of the investment.


For this reason, a properly syndicated surgery center will generally sell for more money as a multiple of earnings because it removes the effort that a potential buyer has to expend and the possibility of an unsuccessful syndication.


Hospitals as buyers

When a hospital purchases a surgery center, the hospital is generally going to purchase 100 percent of the ownership interest in the center. The reason for this is that such purchases typically are made with the intent of converting a freestanding ASC to a hospital-based ASC, which must be owned entirely by the hospital. This allows the hospital to begin billing the ASC services as a hospital outpatient department, which may result in significantly higher reimbursement. Another recent trend is for hospitals to purchase a 51 percent interest in a center or create a joint-venture management company that owns 51 percent of the center. One purpose of these arrangements is to use the hospital's leverage in negotiating with payors in an effort to increase reimbursement to the surgery center.


Since a hospital is restricted by the FMV standard, the difference in hospital reimbursement cannot be considered for valuation purposes. This is the case because other hypothetical buyers, which are not hospitals, would likely have an interest in the surgery center and therefore have to be considered among the universe of hypothetical buyers. In certain cases, however, it is possible that revenue may be appropriately adjusted upwards if it is determined that the overall universe of potential buyers would have the ability to improve revenues.


If the hospital currently owns a controlling interest in the surgery center, the remaining non-controlling interest is likely not as valuable since the hypothetical buyer is unable to gain control (i.e., even though the hospital is adding to its control interest).


In certain circumstances, the hospital may enter into a management (or co-management) agreement with the former owners of the surgery center. Since this agreement is part of the overall transaction, any payments under the management agreement should likely be included as consideration as part of the transaction. Overall, the management agreement reduces the return to the potential buyer (e.g., the hospital).


The cash-on-cash return available in the market should dictate the return the hospital should expect to receive. While a hospital might actually achieve better results under its payor contracts or through a move to hospital-based reimbursement or other improvements it may make, because of the FMV requirement under Anti-Kickback, the reimbursement and other improvements specific to the hospital should likely not be used in determining the value. Also, any post-transaction management arrangements should be considered in determining the value as these agreements affect the overall return to the hypothetical buyer.

So, who can pay more?

Based on the above analysis, a hospital would likely pay a lower multiple of earnings for a 100 percent interest than a management company would pay for a 51 percent controlling interest. The amount likely would also be further reduced if the hospital does not internally manage the unit, but, instead, outsources the management to the prior owners. The following summarizes an example of this analysis:




Here is a mathematical example of the value of a 100 percent interest in a sample surgery center to better explain this analysis. This example is not an actual surgery center and does not represent any opinion of value as it relates to a specific surgery center's value.



Traditional purchase

Purchase without management Fee

Purchase with co-management





Less: Management fee




Adjusted EBITDA








51 percent of EBITDA








Purchase price








49 percent of EBITDA








Purchase price








Total purchase price




PV of future management fees




Adjusted purchase price




Effective multiple of Unadjusted EBITDA





As the table above illustrates, a purchaser of a surgery center is willing to pay more upfront when the purchase involves a management agreement payable to the purchaser because of the future guaranteed cash flows that will be received through management services remuneration. The management fees are negative when paid to the purchaser in the future and are positive when paid to the seller in the future.


Ultimately, assuming the same level of ownership, the same projected level of profitability and the same expected rate of return, a hospital and management company should pay the same. However, hospitals are generally looking to purchase a larger percentage than the surgery center management company. The multiple of EBITDA that can be paid on the higher percentage (e.g., 100 percent) should not be the same multiple that would be paid for a smaller controlling interest (e.g., 51 percent) in the same center.


Note that all companies may not offer the upper end of FMV and that certain parties may have different thoughts on what constitutes a market rate of return, with the party willing to accept a lower return being able to pay more for the purchase. Ultimately, the FMV of the equity interest is a range-based on the expect returns in the market for the investment. The range should be fairly precise based on the specifics of the transaction. Sellers and purchasers must be aware that synergistic factors, such as billing under a hospital's provider number or reduced billing costs, cannot be considered under the FMV standard.

Learn more about Sinaiko Healthcare Consulting.

More Articles Featuring Sinaiko Healthcare Consulting:

When Not to Pursue Renegotiations on Third-Party Payor Contracts: Q&A With Curtis Bernstein of Sinaiko Healthcare Consulting

Impact of Referral Volume on Surgery Center Value: Q&A With Curtis Bernstein of Sinaiko Healthcare Consulting

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