Your ASC's Life Cycle: Part 1

In many ways, ambulatory surgery centers (ASCs) are like living organisms in that centers inevitably pass through “life cycles” as their investor bases age, relocate and otherwise change. Consequently, it is essential that centers constantly be on the alert for ways to add new and productive investors.

It has been our experience, however, that many centers get ahead of themselves when attempting to add the investors. Crucial contractual and legal requirements are frequently overlooked in the rush to add “fresh blood.” The purpose of this article is to highlight some of the issues that centers seeking to add physician investors should consider when recruiting these new partners. Hopefully this brief article can make the recruitment process more “seamless.”

Internal Considerations

For the typical center, the process for adding new investors has already been set forth in the center’s governing documents. Accordingly, before structuring a new investment opportunity, a careful review of applicable governing documents (e.g., articles of organization or incorporation, operating agreement, partnership agreement, bylaws, shareholders agreement, written consents or other resolutions of the center) will be necessary in order to determine the steps that will be required, or the special approvals needed, if any, in order to add new investors. The following are things to look for.

Authorization for New Ownership Interests

There are two primary ways to add additional investors to a center. First, the center may issue new units of ownership interests directly to the new investor with the sales proceeds being received by the center. Second, the existing owners may sell a portion of their existing units to the new investors and receive the proceeds from the sale. The option used will be a matter of preference, though it is our experience that existing investors in a center often resist selling their own interests in such cases.

In analyzing the issuance of new units, the first questions to be asked are what must the center do to authorize the issuance of new units, and are there any units that have already been authorized but not yet issued? When our clients first organize a center, we frequently encourage them to authorize a “pool” of “treasury” units for the center to hold after the initial offering in order that these units may be issued to new investors with as little delay as possible from having to require member approvals or other formal action. These treasury units will then be offered to new, qualified investors at the discretion of the center’s governing body.

Once all the initially authorized units and treasury units have been issued, the center will need to authorize new units to issue to any new investors/owners. Typically, the governing documents will require that new units be authorized by some special action — often some kind of supermajority vote of the owners or the governing body. Obviously, knowing whether any authorized units are available to be issued, and knowing what approvals may be required to authorize the issuance of additional units before an offer is extended, will greatly facilitate the successful completion of the sale to an investor.

Preemptive Rights

Some governing documents include provisions that reserve to one or more owners — frequently institutional investors such as hospitals — the privilege to maintain a certain percentage of the units in the center. In the case where new investors are being added by means of authorizing and issuing new units, such a preemptive right will mean that one or more owners must be given the opportunity to purchase that number of the new units which would allow the holder of such rights to maintain the same percentage of ownership in the center. If a center’s governing documents include preemptive rights for one or more owners, the effect of those rights, and whether the owner(s) will choose to exercise the rights, will be important threshold questions to be answered before structuring the offer to new investors.

Rights of First Refusal

Though similar to preemptive rights, rights of first refusal are more typically associated with sales of units held by existing owners. If the center, or one or more of its owners, plans on adding new investors by having the current owners sell a portion of their existing units to new investors, then a right of first refusal contained in a center’s governing documents will come into play. Typically, a center’s governing documents will require that any owner who receives a third-party purchase offer must first offer the units to the other owners or the center on the same terms as those offered by the prospective purchaser. In that case, the new investor will have the chance to purchase the units only if the other owners and/or the center choose not to purchase the units. Presumably, if the present owners are in agreement that new investors are needed, then a right of first refusal would not be expected to hinder the offer of units to new investors. However, if there are certain owners who oppose the new investment, or simply wish to hold up matters as a means for addressing other matters, then these rights of first refusal must be resolved before the sale to new investors can proceed.

Regulatory Considerations: Eligibility

Due to healthcare regulatory considerations, most governing documents for physician-owned businesses contain requirements providing for who may own units. Therefore, before offering units, the center must assure that the new investors are eligible to become owners in the center. For example, in order to meet the requirements of the federal anti-kickback statute safe harbor applicable to investments in ASCs, a physician investor in a multi-specialty ASC will be required to derive at least one-third of his or her annual medical practice income from all sources from performing outpatient surgical procedures and must perform at least one-third of his or her outpatient surgical procedures in the ASC in which he or she is investing. To evidence the center’s compliance with this requirement, a new investor should be required to sign a certification indicating that he or she satisfies the income requirement and that he or she intends to perform one-third of his outpatient cases in the center during the 12 months following his or her purchase of units in the center. Compliance with all other eligibility requirements should be similarly ascertained and appropriate measures taken in connection with the transaction to confirm compliance.

Regulatory Considerations: Fair Market Value

Similar to the pre-closing certification to confirm regulatory compliance in regard to eligibility, regulatory constraints require that the center also take steps to assure, pre-closing, that the new units are sold to the new investors for a proper purchase price. This is extremely important since any sale of units to a physician investor at a price below “fair market value” may be construed as payment of an illegal kickback under the federal and state anti-kickback laws. Centers are best advised to obtain third-party appraisals or valuations as proof that the purchase price of the new units is fair market value or to, at least, have the price calculated by their management companies or other consultants in accordance with a reasonable business model. Most importantly, no calculation or appraisal should take into account a new physician investor’s past or future anticipated referrals.

Preparing for and welcoming new investors will be a crucial and ongoing process for any center. By taking the time to prepare for and properly structure the transaction, including the review and implementation as required of the items set forth above, a center can better assure an efficient and positive start to its business relationship with its new investors.

For the detailed external considerations, titled “Your ASC’s Life Cycle Part II: External Considerations When Adding New Investors,” be sure to pick up the August issue of today’s surgicenter magazine.

Lorin E. Patterson, JD, partner with Reed Smith LLP, practices business, corporate, commercial and securities law, with an emphasis on healthcare joint venture formation, planning and development. He can be reached at LPatterson@ReedSmith.com.

Jeffrey L. Heninger, is an associate with Reed Smith. He practices health care regulatory law. He can be reached at JHeninger@ReedSmith.com