Written by Dylan Alexander, CVA and Karly Bruss
The ambulatory surgery center (ASC) industry continues to experience steady, reliable growth, and remains a highly profitable segment within the healthcare provider sector. This growth has attracted significant attention from investors, captivated by the sector’s promising returns. The ASC industry’s success is underpinned by several key factors: an increase in demand for outpatient procedures, enhanced operational efficiency, technological advancements, favorable regulatory changes, elevated patient satisfaction, and, in some cases, favorable relationships with commercial payers. However, the success of ASCs has introduced a unique challenge: the difficulty of attracting and securing new physician investors.
Successful and stable ASCs typically have high profit margins and generate substantial returns to their investors. While health systems, management companies, and other corporate investors are common in ASCs, the most important class of investors in an ASC are its surgeon utilizers. For physicians to be investors, they are required to conduct a certain percentage of their surgical case volume at the ASC. In addition, most ASC operating agreements have redemption provisions requiring the sale of ownership to be valued at stated multiple of profitability or at fair market value (FMV) when physicians are not meeting case volume requirements, retiring, or exiting the marketplace.
As exiting physicians sell off their ownership, ASCs seek out new surgeon investors to buy in, provide care, and maintain a strong base of physician equity partners to retain case volume and protect or increase profitability. ASC operating agreements typically have buy-in provisions at the same multiple of profitability or at FMV mirroring the redemption provisions. Therein lies the challenge of attracting new investor or utilizer surgeons into the ASC depending on the life cycle of the ASC. New physician investors may not have the ability or the desire to pay the price required to have an ownership interest in the ASC that is on par with legacy investors. Potential new physician investors may be relatively new to their practice, have large debt burdens from medical school, young family considerations, or considering alternative investments in the financial marketplace.
The ASC Life Cycle and Physician Investment
The ASC life cycle, though similar to other businesses, is distinctive due to its cyclical nature and dependence on surgeon volume and investment.
Phase 1: The Start-Up Phase
In the start-up phase, significant investments are made to secure a facility, purchase necessary medical equipment, recruit staff, acquire the appropriate licensure, and fund initial working capital. Because the overall value of an ASC is typically at its lowest during the start-up phase, potential physician investors may be unwilling to accept the financial risk of a new venture that may not be cash-flow positive in the immediate future. However, the returns on their investments for the initial physician investors can be the highest for a successful ASC. During this phase, physician shareholders are usually unlikely to exit, and the ASC’s focus is syndicating the initial physician ownership base for what is expected to be a highly successful ASC given the desired surgical specialty mix.
Phase 2: The Growth Phase
In the growth phase, the ASC establishes its relationship with physician utilizers (both investor and not), managing surgical block times, developing its patient base, refining payer contracting, and reaching operational efficiency through case volume adequacy given the size and specialty mix of the ASC. During this phase, ASCs are often profitable but still not ramped to optimal and full capacity levels. The growth phase can represent an ideal time for new physicians to consider buying in, as the purchase price is often less and the potential for higher returns still exists. Physician investors exiting the ASC can also get strong returns on their initial investment from the start-up phase.
Phase 3: The Maturity Phase
ASCs have achieved financial stability and operational efficiency in the maturity stage. Mature ASCs typically generate significant cash flow, leading to high valuations. As discussed, high valuations can be a barrier to entry for new physician investors. In a sense, ASCs can be a victim of their own financial and operational success. Though returns are stable, mature ASCs have usually reached their maximum capacity or are nearing capacity. Additional capital investment in space and equipment could be required to maintain the ASC’s current level of profitability. Most importantly, the ASC must manage the retirement and exit of certain key physician investors by replacing them with case volume from newer physicians. If new physicians successfully replace exiting physicians in ownership, the maturity stage can be maintained for the foreseeable future. Valuations at this stage are typically high and consistent over time with equitable returns to both exiting and buying surgeons. It is at the end of this stage that many ASCs encounter the challenges discussed previously. If an ASC is unable to attract new physician investors due to market factors, a shortage of physicians, or pricing constraints associated with success, it may face declining profitability and overall value.
Phase 4: Exit or Decline Phase
The exit phase, or decline phase, is characterized by shareholder physician attrition outpacing new physician investment. The value of an ASC declines as the departing shareholders no longer contribute case volume, and finding physicians to buy in remains a challenge. At this point, it is common to see a few physicians or the corporate partner increasing ownership due to shareholder redemptions with no new physicians to invest.
Phase 5: Repeat
ASCs remain one of the more attractive investments in the healthcare space because of their proven resiliency when managed appropriately. Long-standing, successful ASCs may have been through this life cycle several times. At the decline phase, the value of the ASC will likely be at one of its lower points, creating an attractive purchase price for interest by new surgeon investors. If ownership is re-syndicated to align with growth and key physicians, the ASC then starts at the growth phase and moves to maturity with its new base of physician owners.
The VMG Health Advantage
The increasing demand for outpatient procedures and the opportunity for substantial returns make ASCs a desirable option for potential physician investors. Physician alignment through investment is critical to the success of any ASC and is the key factor in the life cycle of the business. When determining values for physician investment and redemption, it is essential to consider the current and expected future operations.
The valuation of the ASC should be as accurate and thoughtful as possible—not only for the relationship between physician buy-ins and redemptions to maintain the operations of the ASC, but for regulatory requirements as well. Often, ASCs engage an independent and unbiased third party to conduct a fair market value analysis pursuant to any ownership transactions. VMG Health, with its experienced team, provides expert knowledge and data-driven analyses to support parties in ASC transactions. Our expertise in the ASC marketplace enables stakeholders to navigate the challenges and opportunities associated with ASC investments as they move through their life cycle effectively.
