I am frequently asked how to set up an ambulatory surgery center (ASC). I always emphasize the importance of the exit plan. In my experience, one of the top reasons for the failure of an ASC's infrastructure is the failure to properly consider the exit plan. Here human nature betrays us: It is indeed difficult to think of an exit plan when we are giddy with excitement about our forthcoming venture. This is where good external counsel can help—a guiding hand, with a focused goal—to protect the integrity of the ASC entity. I have been fortunate to work with Bruce Maller for more than a decade. Bruce's advice in this column should be heeded by all current and future ASC shareholders.

-Pravin U. Dugel, MD

Redemption of a terminated partner's interest in an ambulatory surgical center (ASC) is an important and often overlooked issue in the formation and operation of a successful ASC. Careful documentation of these contingent events should protect the integrity of the entity and thereby ensure stable operations following the departure of an owner-surgeon. There are several issues, however, that should be considered in developing an effective redemption strategy for an ASC, and these are addressed in this installment of Retina in the ASC.

First, the entity form will drive the type of documentation required to effectuate your redemption plan. For example, in the case of a limited liability company or partnership, an operating or member agreement is used. Alternatively, a corporation will require a shareholder's agreement or what may be referred to as a “buy-sell” agreement.

Another important consideration is to retain health care legal counsel with experience in these matters. There are unique health care laws, ie, federal and state anti-kickback statutes, that will have a material impact on redemption provisions.

The content herein focuses on the business issues involved with the termination of an owner in the event of death, disability, retirement, and voluntary or involuntary termination. Matters pertaining to center governance, admittance of new owners, covenants not to compete, and accounting and tax issues should be reviewed with your lawyer and accountant.

DEATH OF A PARTNER

In general, the payout to the estate of the decedent should be made up of the following:

  • the decedent's proportionate share of current year net income calculated to the date of death, reduced by any distributions made during the current fiscal year;
  • a sum equal to the book value or adjusted book value of the partner's shares as of the date of death; and, in some cases,
  • some additional amount related to the income stream value of the facility (note: many centers choose not to include any amount for the income stream value of the center in part because there is no guarantee the surgical volume of the decedent will actually stay with the facility.

In some cases, the partners may decide to insure the payout amount or simply provide extended payout terms with a market rate of interest applied against the unpaid balance. If the partners are insurable, term-life insurance may be a good solution to the death contingency. If the partners decide to purchase life insurance, consideration should be given regarding whether the buyout amount should be the greater of the life insurance proceeds or the amount determined per the agreed-upon formula. There is no right or wrong answer; however, one must assess the cash-flow needs of the center following the loss of a key producer.

DISABILITY OF A PARTNER

It is normally recommended that if a partner is disabled (per the definition provided for in the redemption agreement), any profit distributions remain unaffected for some agreed-upon timeframe (eg, 3 to 6 months). Assuming the disability continues beyond this timeframe, the disabled partner's interest is often redeemed. This provision may be mandatory or optional (as determined by the remaining partners). The payout to the disabled member is most often handled in a manner similar to the death payout. In the case of disability, however, the buy-out amount is often reduced by any distributions received by the partner during the period of disability.

Although acquiring disability buyout insurance is an option, most centers do not acquire this type of coverage because of the cost and limitations on benefit entitlement. Instead, most centers provide for payout of the disabled member's interest over an extended period of time (eg, 36 to 60 months) with a market rate of interest on any unpaid balance. The extended payout helps to protect the integrity of the entity.

The definition of disability should be set forth in the redemption agreement. In most cases, the definition stipulates that if the partner is unable to perform surgery customarily provided at the ASC for some agreed-upon timeframe, he or she would be considered disabled. It is important that the center protect itself against a situation where a partner is disabled and can no longer perform surgery, yet continues to enjoy the benefits of center ownership for an extended period of time.

RETIREMENT OF A PARTNER

It is common that a partner's interest in the ASC entity is redeemed when he or she ceases to be engaged in active practice. Ordinarily, a partner is required to provide at least 6 to 12 months written notice of his or her intent to retire to be entitled to receive a full payout. It is not common nor is it generally a good idea for a retired partner to maintain any share of ownership in an ASC following his or her retirement from practice. If there is a “carryover” ownership opportunity for the retired partner, this should be limited to a specific number of months or years.

In many cases, the retiring partner may choose to sell shares to partners in his or her professional practice. The ASC or ASC partners are normally required to approve the sale to the new surgeon and in some cases may require a “right of first refusal” on acquiring the shares from the retiring partner.

Some ASC owners may expect to receive a big payoff at retirement, often “benchmarking” to market multiples of earnings or cash flow paid by public companies for majority ownership in ASCs. These higher multiples are uncommon when involving transactions between physicians. Multiples of earnings or cash flow are often discounted by 25% to 50% when involving the sale of a physician's interest in a privately held ASC.

The payout to a retiring member is normally handled in a similar manner to the disability payout discussed above. Some redemption agreements will even include a provision to protect the entity in the event that more than one partner chooses to retire at or about the same time. This provision generally limits the payout to terminating members so as not to exceed an agreed-upon percentage of gross or net income.

VOLUNTARY TERMINATION OF A PARTNER

If a member decides to voluntarily terminate his or her ownership in the ASC, it is important to consider several factors, including 1) determination of the value of the shares, 2) payout term, and 3) any restrictions on competitive activity. Most redemption agreements do not prevent voluntary termination; however, the agreements must protect the entity so that the sellers are not financing competitive activity. Your attorney should guide you with respect to enforceability of restrictive covenants for your state. Penalties for early termination, (ie, less than 10 years as a partner) are common. The penalty normally takes the form of a reduced payout (eg, 75% of what one would have otherwise been entitled to under the valuation formula).

FOR-CAUSE TERMINATION OF A PARTNER

For-cause termination customarily includes:

  • material breach of the shareholder or operating agreement;
  • disqualification to practice medicine or surgery;
  • revocation of hospital privileges;
  • cancellation of malpractice insurance coverage;
  • commission of a felony; or
  • bankruptcy of a partner.

Assuming that a triggering event occurs requiring redemption of a partner's shares, the payout normally includes the items noted in the death-payout terms set forth above without any increment for the incomestream value of the center. In other words, the payout would be limited to the current year share of net income plus the book or adjusted book value of the center as of the effective date of termination. The payout is normally provided over an extended timeframe, not unlike the recommended payout under the disability buyout provision. In some cases, a for-cause termination may also result in application of a penalty, not unlike what was discussed in the voluntary termination section.

CONCLUSION

Regardless of the termination or redemption event, the payout amount should be determined by an ASC-employed accountant. In addition, it is important for ASC owners to understand that redemption provisions should be designed to protect the integrity of the entity and not to provide any type of windfall for the terminating partner.

Bruce Maller is the President of BSM Consulting, a global health care services company with offices in Incline Village, NV, and Scottsdale, AZ.

Pravin U. Dugel, MD, is Managing Partner of Retinal Consultants of Arizona in Phoenix; Clinical Associate Professor of Ophthalmology, Doheny Eye Institute, Keck School of Medicine at the University of Southern California, Los Angeles; and Founding Member of the Spectra Eye Institute in Sun City, AZ. He can be reached at pdugel@gmail.com.