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Playing the Partnership Long Game

Editor’s Note: Sg2 Associate Principal Jennifer O’Connor contributed to this post.

Partnerships are increasingly a full-time job for strategy leaders as health systems look to expand their geography, collaborate across the continuum, mitigate risk, and better meet health and social needs of their communities. Academic medical centers (AMCs) were early pioneers in partnering, as they worked with community hospital affiliates to bring access to complex care and specialty services to outlying and rural areas. While the recent full asset merger and acquisition (M&A) whirlwind gets a lot of attention, partnership efforts like joint ventures still play an important role, though they bring their own unique challenges.

AMC Member: Management Fee an Issue in Joint Venture Negotiations
We recently talked with an AMC member as it considered options for a cancer center joint venture with one of its affiliated community hospitals. Plans called for a 51% AMC/49% community hospital ownership split, with the community hospital paying management fees to the AMC for overall management including leasing back all employees. The AMC would have responsibility for overseeing day-to-day operations, financial (cost) management, and facility performance including quality and outcomes, which was important to it as it extended its brand to this outpost. The AMC had proposed a management fee of 5% of collections (this was a full-service cancer center providing a wide range of treatments including infusions, radiation oncology, chemotherapy and specialty pharmacy), which it felt was a reasonable offer. The community hospital wasn’t so convinced.

So, the member came to Sg2 asking what might be a reasonable management fee if 5% wasn’t? And how should it respond to the community hospital’s concerns?

Consider 3 Standard Approaches to Determine Management Fee
Management fees are typically determined in 1 of 3 ways:

  1. Cost Approach: Major cost categories such as medical and nonmedical personnel who will be provided are added up, a standard markup for oversight is applied, and that aggregate cost is correlated to some percentage of revenue or collections
  2. Market Approach: Management fees for comparable ventures are gathered and used to generate a proposed fee. This tends to be the most commonly used approach based on several factors, including fewer variables in the methodology, a greater number of available industry data points to compare against, and because it is viewed as more “commercially reasonable” compared to the cost and income approaches for this kind of transaction.
  3. Income Approach: Fees are based on the anticipated net earnings of the venture (this approach may make more sense for a center already in existence where the income, even if it is expected to grow, has a baseline).

Of course, it’s impossible to pinpoint a valid management fee without doing a complete fair market valuation, but the AMC’s offer was below what we might have expected to see given Sg2’s extensive experience in valuation and the kinds of management fees we’ve seen in similar deals. Given the comprehensive nature of the cancer center and the level of management services provided (which would include senior leadership, human resources, business development/marketing, contracting, billing/collections and other items), we might have expected something more in the 7%–10% of net revenue range.

Emphasize the Value Proposition to Potential Partners
That led us to the next question—how should the AMC frame the conversation with the community hospital regarding management fees? We encouraged AMC leaders to help the community hospital leadership better understand the value proposition of the venture, in general, and the management fee, in particular.

  • The cancer center required oversight and responsibility for several complex clinical areas, which would have been quite difficult to manage if the community hospital were to go it alone.
  • The AMC would deploy management expertise that was not as readily available at the community hospital, such as business development, marketing and administrative oversight offered by physician leaders.
  • The AMC would assume responsibility for all human resources functions, including physician recruitment. All back-office functions would be run by the AMC using its EHR, billing system and purchasing contracts.
  • The AMC’s ability to help fund capital needs would quickly come into play. The second LINAC was going to need to be replaced somewhat unexpectedly and the AMC would help cover the cost (future capital expenses would be jointly funded, proportionate to ownership percentage).
  • The AMC would bring its brand (and reputation) to the partnership; as the leading AMC in the state it is well known and respected.
  • Finally, there is risk in setting the management fees too low—or in other words, below fair market value. Not only does it not make good business sense for the AMC, it potentially runs afoul of Stark rules and IRS regulations for not-for-profit entities. Put simply, no partnership is worth that.

What Happens Next? Playing the Long Game
This led to an interesting question to our AMC member: “What happens next?” This AMC was playing the long game of partnerships, which is to say it admitted that at 5% it expected to break even, not to net a large financial return; however, that wasn’t the whole picture.

The partnership was important to the AMC’s growth strategy. Redefining the relationship to ensure the AMC had oversight of operational and quality issues was a priority. AMC leaders weren’t planning on going back with a new, higher management fee given our discussion…but their newfound insight equipped them to return to their community hospital partner and frame the original offer in a new light. A 5% management fee is a great deal compared to 10% (and still within the range of fair market value, albeit at the low end)! The AMC also emphasized that what it brought to the partnership was considerable (and valuable) to the community hospital and its community.

True, no investment banker would settle for an unexciting breakeven venture, but of course not-for-profit healthcare is (thankfully) about more than the bottom line. In playing the long game, this AMC was creating an opportunity for a win-win for both parties, which of course is the foundation of a good partnership. (Note: Sg2 did recommend the AMC position the 5% management fee for the first year and then reevaluate, which could result in adjusted management fees in the future.)

Did You Know: Properly structuring management fees, determining shared savings goals and calculating practice valuations/physician compensation are all key parts of alignment deals. Sg2 offers fair market valuation services to support these efforts. Not an Sg2 member yet? Contact us to learn more.

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