Originally published in The Deal, September 18 2011
The economic challenges facing tax-exempt healthcare providers have created fertile ground for partnerships with investor-owned companies, including private equity sponsors.
While these arrangements would have been unusual a decade ago, they will likely become more commonplace as providers seek creative ways to address the challenges and opportunities presented by healthcare reform.
Recent examples of joint ventures and other transactions between investor-owned companies and tax-exempt providers include: the February formation of a JV by Ascension Health and private equity firm Oak Hill Capital Partners to acquire Catholic hospitals and other healthcare providers; the January formation of DLP Healthcare LLC (Duke/LifePoint) by Duke University Health System Inc. and LifePoint Hospitals Inc. to build a network of community hospitals in North Carolina and surrounding areas; and the November acquisition of Caritas Christi Health Care by Cerberus Capital Management LP-owned Steward Health Care System LLC.
For tax-exempt providers, these arrangements offer much-needed capital that can help finance new service lines and information technology mandated by healthcare reform. For their part, the investor-owned companies gain important access to new markets and critical mass. There are, however, several issues to consider when structuring, negotiating and completing these deals.
External factors that must be addressed include federal tax regulations and antitrust enforcement. Healthcare reform placed new requirements on not-for-profit hospitals to maintain their tax-exempt status. Codified in section 501(r) of the Internal Revenue Code, the new regulations call for regular community needs assessments, formal policies on financial assistance and emergency care, and revised billing and collection practices. While the Internal Revenue Service has offered some guidance, it remains unclear precisely how 501(r) will be applied to joint ventures between tax-exempt health systems and investor-owned companies.
Another issue that must be addressed is the potential risk of antitrust enforcement. Healthcare transactions of all types have been more closely reviewed for antitrust implications over the past few years, and any deal between investor-owned and tax-exempt parties could come under scrutiny from the Department of Justice, the Federal Trade Commission and state attorneys general.
Political and cultural issues are critical both to completing a tax-exempt/investor-owned transaction and the ultimate success of the resulting entity. Culturally, tax-exempt entities have been more consensus oriented, and investor-owned entities have been more results oriented. Accordingly, on the front end, the parties need to focus on the leadership of the joint venture and governance structure moving forward -- whether it's a team from the tax-exempt side, the investor-owned side or a new group. While a new team has the advantage of not being perceived to favor one particular camp, it can be difficult for a group of outsiders to lead effectively from the commencement of the venture.
A second key consideration involves the manner in which future capital investments in the new entity will be funded. It is important that this be clearly defined to avoid disruptive conflicts about the level of capital contributions (for instance, specify whether capital calls and bank guaranties be mandatory) that both the tax-exempt and investor-owned parties will make in the future and how decisions regarding obligations to commit additional capital will be made.
When entering into this type of joint venture, both the tax-exempt provider and the investor-owned company must consider how to exit the partnership. Do the parties plan to operate the entity together indefinitely, or will the entity eventually be taken public or sold to one of the partners or a third party? Both parties should also consider the inclusion of triggering rights and other provisions that would set the stage for an exit from the JV, such as change in law or lack of profitability.
While many of these considerations are found in any joint venture, arrangements between tax-exempt healthcare providers and investor-owned companies are often complicated by the different backgrounds and objectives of the parties. Trust is the most critical factor for success in these transactions, and overcommunication, especially at the beginning, can go a long way to removing organizational obstacles that could ultimately derail the joint venture.
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