Navigating the Evolving Joint Venture Landscape

Ambulatory surgery center (ASC) partnerships between hospitals and physicians are nothing new, but the field is seeing less standard agreements. From traditional hospital-physician joint ventures (JVs) to equipment-share deals, the ASC market remains flexible and dynamic.

Physician-hospital JVs account for more than one quarter of ASCs.¹ 

A proper JV can solve old problems (low reimbursements, hospital-surgeon tensions), but is complex and should therefore receive careful consideration, no matter the urgency that may present itself.² 

At the very least, JVs are interesting, says David Robeson, director of DGA Partners, which advises health systems and hospitals. Robeson’s long-time focus has been on developing and operating ASCs.

“I find (JVs) interesting because they’re multi-dimensional, particularly if it’s a joint venture between hospitals and physicians,” Robeson says. “You have the physician side and the hospital side and to try to meet the often opposing objectives in a joint venture. It enables a certain amount of creativity and there is a certain amount of technical detail.”

In the last 10 years, an increasing amount of physicians have realized that they have the leverage to spur a lucrative venture, Robeson says.

“That trend continues,” he adds. “I think doctors (especially orthopedic surgeons) more and more in this country are recognizing that they control the business and as a result you see more ventures initiated by (them).”

Defining Joint Ventures

Even the mere definition of a JV can be complex. It is subject to some interpretation, says Patsy Powers, practice group leader for the healthcare regulatory group of Waller Lansden Dortch & Davis.

“I think ‘joint venture’ is sort of a loose term and really it means joint ownership, and so the question is, by whom?” Powers asks. “A lot of times people think of joint ventures as two large owners like a hospital and a surgery center. It really is something that should be addressed on the front end on a case-bycase basis because everybody comes to it with a different definition.”

The government has further complicated the term, Powers says.

“The government is concerned with contractual joint ventures, which are not joint ventures in the traditional sense,” she adds. “Traditional joint ventures are when two or more parties come together and jointly own an entity, and contractual joint ventures do not necessarily include joint ownership, but just a division of profits.”

JVs can be categorized in two groups, according to Jerry Sokol, partner with McDermott Will & Emery.

“One is straight equity joint ventures, where the joint venture partners are owners, and the other is contractual joint ventures,” Sokol says. “The under arrangement model is a form of the contractual joint venture. Under the traditional joint ventures for surgery centers, I would further break that down based on the type of ownership.

“Traditionally, surgery centers were either owned exclusively by physicians or they were joint ventures between physicians and hospitals,” Sokol adds. “But many of the hospital-physician ASCs traditionally hadn’t necessarily preformed that well. And then, over the last decade there was an emergence of these ASC management and development companies that really focused on ASC development.”

Reaching Potential

JVs have grown over the years, but have they reached their full potential? The answer varies regionally, says Lorin Patterson, JD, partner with Reed Smith. Patterson’s emphasis is on healthcare JV formation, planning and development.

Some states, particularly where there are few certificate of need (CON) laws, have a surplus of ASCs. In other areas of the country, however, there is still room to grow as the trend toward outpatient care continues.

“Even in regions where competition is the fiercest, the question should not be ‘is there room for new ventures, but rather ‘is there room for new successfully and efficiently operated ASC joint ventures?’” Patterson points out.

“Because of the constant changes in regulations, technology, the reimbursement climate, and physician practice patterns, ASC joint ventures will always be subject to pressures to adapt,” he adds. “And there will always be room in any market for ventures which respond well to these pressures.”

There is definitely room for the market to grow, says Josh Kaye, Esq., also a partner with McDermott Will & Emery.

“I think that it does support more joint ventures,” he says. “It would be interesting to see if there is going to be any consolidation. If there is going to be consolidation, it’s going to be in these management or development companies selling to other management or development companies, so you go from a company that has an interest in 10 or so centers, selling those interests to a national company that has 50-plus or more surgical centers.”

Powers agrees that JVs have not reached their potential, and says CON is a big factor.

“I think the other thing is that as far as new facilities go, about half of the states in the country have certificate of need laws,” Powers says. “Most of those restrict the development of new surgery centers without a CON, and so the opportunities for further development are limited by state approval process. So depending on whether someone is in a CON state or not really changes their outlook about how much opportunity there is.”

At the end of the day, the overall high quality of ASCs means that more people are going to want to get involved with them, Sokol says.

“The general increase in ASC ventures continues to be largely contributable to the fact that outpatient surgery centers provide a very attractive alternative to the hospital,” Sokol says. “…As procedures and technology and anesthesia evolve … it really results in this trend of more procedures being performed in an outpatient setting, and it lends itself to the fact that more surgery centers are being developed. The types of ASC ventures really vary based on how they’re owned.”

Changes

The JV landscape is changing in a number of ways. One such way is that hospitals and healthcare systems are becoming more willing to get involved with JVs even in deals where the physicians retain significant control, Patterson says.

“(Also), the specialty mix found in ASCs continues to evolve,” Patterson adds. “This change is driven by changes in reimbursement methods and medical technology. Not surprisingly, joint ventures consisting primarily of certain specialties may no longer be feasible, while reimbursement modifications may render other ventures now practicable.

“The approach to forming and operating joint ventures has become more sophisticated,” Patterson contends.

“Not too long ago, a group of physicians could simply band together and open an ASC with an ‘if you build it, they will come’ attitude,” he says. “Little attention was paid to such matters as procuring contracts, since ASCs frequently operated on an out-of-network basis anyway. Since managed care companies have become more aggressive in dealing with such practices, more attention is being devoted to critical development tasks, such as the preparation of realistic feasibility studies.”

Another change is with personnel. As the ASC market has matured, a generation of physicians is retiring.

“They need to be replaced by active surgeons and this presents challenges to the entity,” Powers says. “There is sort of a reinvigoration of the existing joint ventures and centers with new owners. Each center has its own issues and problems and power plays but (surgeon retirement) really is an issue. It’s something that a lot of people are just starting to recognize.”

And of course, there are reimbursement issues as Medicare changes the way freestanding ASCs are paid, Robeson says.

“Freestanding ASCs would be the most joint ‘venturable’ type of entity as opposed to some kind of a hospital-carve out or any kind of an under arrangement venture, which leads to the second way things are changing,” Robeson says.

“With the new proposals to the Stark laws that will ultimately become Stark III, the other options that have existed for joint ventures (such as under arrangement joint ventures) are becoming more and more difficult to do,” Robeson adds. “They weren’t easy to do before, but they’re going to become so difficult that … some attorneys would suggest they are prohibitive at this point.”

The surgery center JV landscape has only changed dramatically in a few ways, Sokol says. “Historically, you always had physicians, you sometimes had hospitals, and the other player was these national ASC companies,” Sokol says. “What we have seen change over the last few years is that we’re representing an increasing number of regional ASC companies.

They’re happy to have maybe three to 10 ASCs. We’ve also seen companies that are kind of aggregators of ASCs with the goal of flipping their ownership to one of the national companies (after increasing the centers’ earnings, often within a year).

“Regional companies are stepping up as a meaningful player at the table,” Sokol adds. “Historically, hospitals were involved in start-up centers and a lot of the regional development companies were only involved in the startup centers. The sexy, large transactions which where multi-million dollar deals were traditionally only being shopped to the large national companies. As of late we’ve seen hospitals and regional ASC companies as meaningful bidders at the table.”

If You Can’t Beat Them, Join Them

Hospitals have certainly changed their tunes over the years when it comes to how they perceive ASCs, and in how they want to deal with them. At worst hospitals used to fight ASCs, and at best they ignored them.

“There have always been opportunities for joint ventures and hospitals have been increasingly looking for those opportunities with their physicians,” Kaye says. “The fact that there are development companies getting involved as well is just a reflection that these arrangements have really become much more mainstream.

There are more and more players getting involved in these types of arrangements.”

Sokol agrees.

“I would say that over the last several years hospitals have increased their involvement in ASC ventures probably in large part based upon the realization that ASCs are definitely here to stay and that they may as well take a strategy of joining ASCs rather than some of the historically defensive strategies that they had undertaken such as economic credentialing, exclusive contracting and those types of things,” he says.

There may be many reasons why hospitals are increasingly partnering with physicians, according to Patterson.

“I do not believe that the motivation on this issue is purely financial,” he adds. “First, this approach by hospitals may be motivated by the fact that legal economic credentialing actions have proven difficult for hospitals to win.”

Freestanding ASCs provide ample competition, and many hospitals are therefore interested in launching ASCs with would-be competitors, Powers says.

“The surgery centers are usually developed by surgeons who are often on the hospital’s medical staff and the hospitals are interested in expanding their healthcare services in the community and to work with the proven high quality physicians on their medical staff who are developing facilities,” she adds.

Another compelling factor, according to Patterson, is that hospital administrations are seeing that JVs can truly work for all parties.

“Numerous examples have shown that a joint venture and its neighboring hospital can both prosper while positive relations are being maintained with the medical community,” he says. “(Also), in the currently tight physician market, hospitals may be realizing how important it is to address the desires of specialists. Participating in mutually satisfactory joint ventures is one way of doing this.”

Overall, there is plenty of room for JVs, Robeson says, and that’s one reason why hospitals need to develop preemptive strategies. “There are too many hospitals that are simply reacting to joint venture possibilities and they’re regarding them as threats,” he says.

“Whether they truly consider them threats or not, they need to develop a strategy to deal with them and there are a lot of hospitals that have not developed that strategy.

“When the joint venture issue is raised by a group of physicians, which ultimately it will be just about anywhere, they (need to) have a strategy in place as to how they want to deal with it,” he adds. “If their strategy is simply that they’re not going to deal with it, well that’s fine, but they need to have developed that strategy and thought it through, understand the market and its potential to become competitors and understand how they’re going to deal with that if that occurs. Waiting until the (offer) materializes and then deciding what to do is really not the answer.”

Creative Solutions

For several years, there has been an increase in alternatives to traditional joint equity ventures, Patterson says.

“Most notably, the under arrangement model (through which joint ventures provide services to hospitals on a contractual basis) have been used widely throughout the country,” he adds. “Recent regulatory developments cast doubt on the legality of such vehicles, however. In addition, affiliation agreements or joint marketing arrangements are frequently entered into as well. Such arrangements may not provide the sort of concrete benefits joint venture participants seek.”

Powers has noticed trends in the form of entities wanting to maximize efficiencies from existing facilities and equipment.

“They’re not traditional joint ventures,” Powers says. “The government has addressed some such arrangements in a proposed rule in the Medicare physician fee schedule that was issued in July of this year.”

Under arrangements, Powers says, are when a hospital can contract with another entity to provide services to the hospital patients, wherein the second entity provides the services, bills the hospital, the hospital incorporates it into the fees and then pays the subcontractor.

The “alternative model” of under arrangements have really evolved, Sokol believes. “That’s really a contractual joint venture that was largely driven by the differential in reimbursement between outpatient procedures performed in a hospital outpatient department setting, vs. an ASC setting,” Sokol says. “Certainly a relatively important development recently is the disproportionate reimbursement that is obtained in a hospital outpatient department setting from a freestanding ASC setting.

That (inequality) resulted in the emergence of the under arrangement model. There has clearly been a proliferation of under arrangement models around the country to capitalize on that concept.”

This type of arrangement has gotten the attention of gastroenterologists (GIs), according to Kaye.

“As far as looking at procedure lists and specialists who historically utilize the ambulatory surgery centers, those who are sort of positioned to take a more material cut or who are very concerned about the differential reimbursement rates are GI doctors,” Kaye says. “As far as the under arrangement models, CMS has proposed rules that could impact the viability of these types of arrangements. Right now they’re only in a proposed stage. CMS has become aware of these under arrangements and are concerned that they do allow a gaming of the reimbursement system and through these proposed rules there’s the possibility that these arrangements could become much more questionable.”

Medicare rules allow under arrangements so that hospitals can obtain services and equipment to which they wouldn’t otherwise have access, Powers says. She agrees with Kaye that CMS rules could be a big factor.

“If a hospital does not have a particular piece of equipment it could subcontract out with another provider and obtain the services they needed for their patients,” she adds. “The rules that were proposed by CMS are intended to address those relationships when they involve a physician-owned entity that’s providing the services under arrangement. Under the proposed rules, those relationships will be restricted.”

Robeson, on the other hand, hasn’t seen many atypical ventures. He says that hospital administrations view independent surgery centers as competitors, and are therefore shy to team up with them outside of a standard JV launch. Powers believes that most deals involve expensive equipment, where-in a group of investors leases it to a hospital.

“Over the years we’ve seen things like some imaging equipment, lab equipment, etc., that have been permitted and later not permitted depending on the year that we’re talking about,” Powers says. Medicare authorities allowed these arrangements so that hospitals could obtain services and equipment to which they wouldn’t otherwise have access, Powers says.

“If they didn’t have a particular piece of diagnostic equipment they could subcontract out with another diagnostic imager provider and obtain the services they needed for their particular patient,” she says. Through provisions such as these and many others, the industry is heavily regulated.

“I think the regulations do stifle certain seemingly benign development and investments but the net is very wide and in order to prevent inappropriate investments they need to cast with a wide net,” Powers says.

Middle Men

Many companies offer services to ASCs, including consulting, center development and management, and can bring valuable expertise. In the case of JVs they can also act as neutral middleman between hospitals and physicians.² That sounds great, but management companies are not for everyone and there are several questions ASC physicians (and/or other owners) should ask themselves when deciding whether to solicit a management company’s help for a JV.

The first question a physician group should ask is what role they expect a management company to play in their transaction. There are several possible answers.

Management companies can provide a number of services to a JV, Patterson says, and these include:

• providing access to capital 
• providing expertise in performing business development functions (setting up initial business systems, obtaining crucial licenses, etc.) 
• conducting feasibility studies 
• assisting JVs in organizing their investor groups and preparing their governing documents 
• managing the day-to-day office operations of the facility 

Another question a physician group should ask is whether the management group in question can deliver all of the desired services. Checking the company’s references should provide and answer. Lastly, how long will the company’s services be needed?

“In some cases, a management company is primarily sought to help a project get off the ground,” Patterson says. “If this is the case, the ASC joint venture may wish to negotiate a short-term management agreement, or for a means of buying out the management company early.”

One simple, broad question must be asked, and it is vital. According to Powers, all parties involved must ask, “is this a good fit?”

“Let’s say an inexperienced group of stakeholders wants to have an experienced management company come in and get the benefit of that experience, they still need to be comfortable with the decisions they’re making and with the communication patterns,” Powers says.

“They’d want to do some due diligence about the other centers that the company manages and see how they’re doing and whether their centers are operating successfully or not. That kind of background information is helpful.”

Robeson is the aforementioned “middle man.” His company provides management consulting services in planning, finance and business of hospital-physician relationships.

“This probably sounds self-serving, but I think it’s good to include the guidance of a consulting company,” Robeson says. “The role I take is really as a neutral party between the physician side and the hospital side and it has to be that way because if I’m not in a neutral position — despite the fact that a hospital is paying my fees — then I’m not in a position to look out for the physicians’ side. And if I’m not looking out for the physician side, they will see that and the joint venture will not be developed properly.”

Balance is 100 percent necessary. “Corny as it sounds, a joint venture needs to address both sides of a venture, and if the docs perceive that I’m not looking out for what they’re trying to achieve, then ultimately the venture won’t work,” Robeson says. “And a failed venture is probably the worst thing that a hospital can do. From the hospital’s point of view, they need a neutral party also.”

It’s not always an easy role to play. Robeson says that hospital administrators should always look out for their side, but that they’ve gone too far a few times by putting him in an awkward position. Robeson promptly reminded them of the role he has to take.

Potential ASC owners have the tendency to bring in a management company to structure the venture, but this can have mixed outcomes. “The only problem with that is that management companies exist to generate management fees and you don’t generate fees unless there’s a surgery center in existence, so as a result, the management company comes into the situation with its own set of objectives that may not be the best set of objectives to ensure that the venture is structured properly,” Robeson says. “Often, the right answer is to do no venture at all, but that’s the last answer a management company is going to give you.”

Some people would disagree, but what everyone can vouch for is the importance of a great ASC administrator. Even before the members of a potential JV discuss whether to go through a consulting or management company, they should determine what their ability to bring in a quality ASC administrator is.

“I think that probably the biggest single key to a successful surgery center operation after it has been structured and established properly is an effective surgery center administrator,” Robeson says.

“Those people are few and far between,” he adds. “I believe that if a surgery center can find and hire their own really effective surgery center administrator then I don’t think they really need a management company.

If, on the other hand, they can’t find such a person — and that happens more often than not — then that’s what a management company is good for. They will bring in a person and they will support that person with the resources of the management company, so even if that person isn’t a total rock star surgery administrator, that person is supported by the management company.”

Whether through traditional JVs or through an equipment deal as informal as a contract on a napkin, people interested in the ASC market will continue to strike alliances. And chances are, few, if any deals will be on napkins. 

References 

1. Becker S., Abraham S. Ambulatory surgical centers — an analysis for the next five years. May 2007.

2. Finnerty M. Considering a joint venture ASC? First resolve these four make-or-break issues. Executive Insights newsletter. January 2006.

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