Transformative Health Care System Affiliations: A Growing Trend

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By Roger Strode

We continue to see activity in the hospital and health care system affiliation space. While few actually believe that the “Medicare for All” proposals will garner the support of a majority of the American people and are unlikely to find a foothold in the United States Congress, there are still continued changes in reimbursement structures in the forms of Medicare Shared Savings Plans, Bundled Payments for Care Improvement, narrow network arrangements, and more. Moreover, many experts are not willing to discount the idea that, at some point in time, we may, at some point, see a “public-private option” designed to allow those who want one or the other type of coverage to opt-in or opt-out, as the case may be, at varying costs and benefit levels.

In light of these nationally focused discussions, the Country’s larger, well capitalized health systems, increasingly, are looking at creative network and population health management strategies, including forming or investing in insurance providers and developing narrow provider networks. Health systems are partnering with traditional financial investors—venture capital and private equity firms—and are investing in health care startups, developing telemedicine ventures, or forming outpatient ancillary service line business such as urgent care centers, or micro-hospitals, all as examples. Certain, disease state-focused systems are developing their own trademarked intellectual products, such as devices and biologics. They are partnering with their physicians in ways heretofore not yet seen. In sum, these organizations are becoming sophisticated business systems that deliver whole person health care rather than simply being providers of inpatient care. 

The New Transformative Partnerships

In response to the foregoing developments, we are starting to see “transformative” partnerships or affiliations, which are occurring with increasing frequency and urgency. Rather than traditional “large system swallows smaller system” deals, these transformative arrangements involve the larger, more sophisticated partners described above. These arrangements often span multiple states and geographies and create organizations with combined revenues in the tens of billions of dollars. These deals resemble “textbook” joint ventures in that, often, both parties have complementary structures, geographies, management teams, service lines, intellectual capital, payer bases, etc. Moreover, because the partners in these transactions are often equally sophisticated, neither is generally interested in—at least early on—ceding control of its organization to the other. These relationships are not borne out of necessity, but out of strength and opportunity. 

Structure and Terms of These Partnerships

Because of the unique nature of these transactions, their structure and terms are equally distinctive, most especially with respect to the relative strengths of the participants. Yes, there generally is still a commitment by the larger organization to deploy capital, and often in significant amounts over a period of years. However, the uses of the capital may not be specifically directed or limited—such as construction of a new facility or building out an electronic medical record—but, rather, may be focused on network development or growth outside the smaller organization’s traditional market area.  What is noteworthy, however, is that the level of the commitment may not be commensurate with the fair market value of the business enterprise of the party to which it is committed. However, the “gap” between commitment and value is often filled with non-economic covenants that recognize the strength and expertise of the smaller system, such as

  • Granting the smaller organization the right to a meaningful number of board seats on the larger, parent board, and coupling those seats with certain “supermajority” voting rights with respect to the overall system, all for some period of time.
  • Retaining the smaller organization’s board of directors and, for a period of time, granting that board significant approval rights over its own activities, such as termination of the CEO, approval of operating and capital budgets (so long as they are in line with overall larger system’s budget or guidelines), the deployment of the committed capital, approval of any changes to its organizational documents, etc.
  • Commitments to retain the management team, including the CEO, at the smaller organization along with most traditional reporting relationships, at least for a period of time.

Summary

As health care delivery systems and networks mature, and we see larger, more complex deals among sophisticated, well-run organizations with ambitious goals, the nature of the transactions between these companies has begun to morph into creative structures and operational commitments.  The smaller of the deal partners have begun to demand, and receive, terms not traditionally seen, such as large capital commitments, stronger governance and management rights, and the ability to utilize its core strengths in connection with the growth of the overall system.  We expect to see more of these deals in the coming years.

Roger Strode, partner and health care business lawyer with Foley & Lardner LLP.

This article was originally published here: https://www.foley.com/en/insights/publications/2019/12/transformative-health-care-system-affiliations

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