By Joshua A. NemzoffThe scenario is all too common:  Your hospital – not the dominant provider – is one of several operating in a competitive market.  Market share and financial performance are eroding.  The competition is calling to see if you want to sell or merge.  You tried joining a network but ended up with more volume and less money because the managed care rates were so low.  Management and the medical staff are pointing fingers at each other.  You are losing managed care contracts, and your fellow board members are discussing the idea of hiring a turnaround expert.  Management has tried everything and still believes the hospital will turn around.  The situation doesn’t look good.

At some point, no matter what you’re hearing from management and outside advisers, it is your fiduciary responsibility to make a fundamental decision:  Can you survive as a stand-alone facility?  If the answer is no, you need to begin a process you have probably never undertaken, and one about which you may know very little.  At this point, a discussion of some key merger and acquisition concepts may be helpful.

Control.  The primary reason hospitals do not merge or sell is that they are not willing to give up control. The board sees a sale or even a merger as a loss of control and an admission of failure; they are letting down the community, the medical staff and the employees. The thought of selling out to the hospital with which they have been competing for years is a difficult one to face.

The fact of the matter is, if you don’t think you’re going to survive on your own, you can give up control now or you can give up control later. Either way, eventually you will lose control.

Merger versus sale.  As the “weaker” hospital, if you think you can maintain control or even maintain 50 percent of the new board slots, think again. If you have a 15 percent market share along with the problems just discussed and are thinking of merging with a competitor who has 35 percent of the market and none of these problems, it is highly unlikely they will agree to a 50/50 merger.

You will undoubtedly end up with a minority position on the board – i.e., loss of control. You can call it a merger to make it more palatable to all parties involved, but when you get five out of 20 seats on the new board, you have “sold” your hospital, and the other party should be considered a buyer.

.  Networks/affiliations are primarily a defensive strategy to deal with managed care. They are very effective in markets in the early stages of competition. They do not, however, resolve many of the problems a hospital faces in a highly competitive market. In fact, there are many examples of networks/affiliations falling apart rapidly as soon as consolidations occurred in competitive markets.

Conflicts of interest.  Loss of control affects all levels of the organization, not just the board. Your administrative team may see a merger or sale as a potential loss of their jobs. Your accountant may lose the audit. Your legal counsel may lose its retainer. Your chief of staff may not be the chief of staff in a combined entity. In short, most of the people advising you don’t have much of an incentive to tell you that you should consider selling the hospital or merging with the competition.

Conversely, if they are telling you to do so, you should listen very carefully to what they say; they’re probably right.

Consolidation.  The fixed costs of operating a hospital are extremely high. As in any business, when you combine two hospitals you are going to save a significant amount of money. Merging your hospital with the competition doesn’t mean they can run it better than you can. It means they can realize the substantial benefits of consolidation.

In addition, since the majority of costs in a hospital are labor-related, you are going to have to deal with the “L” word – layoffs. If you sell your hospital, people will lose their jobs. However, if you don’t survive, all will lose their jobs.

.  If you’re thinking of consolidation, make sure the people selling your hospital are working for the board and have a significant amount of experience in hospital merger and acquisitions. If you do not proceed with an experienced team, you will exacerbate the problems – and potentially ruin your organization.

.  Announcing that your hospital is for sale is tantamount to signing its death warrant. The exodus of management, employees and medical staff will occur immediately. Employee morale will drop within 24 hours. Your CEO will have his or her resume on the street within a week, and the press and community leaders will be involved immediately. The need to keep a sale confidential is extremely important.

Decisional paralysis.   When a hospital is in trouble, everybody has an opinion about how to resolve the problem. Trustees get advice from lawyers, management, the medical staff, accounting firms, etc. With all of these opinions, combined with a general sense of panic due to the rapid deterioration of the situation, it is typical for trustees to get into a situation where they don’t know what to do. As a result, they do nothing. Psychologists call this an avoidance-avoidance decision. When faced with two unpleasant choices, most people will choose neither.

Public hospitals
.  Tax-supported hospitals have unique problems relative to selling their hospitals. First of all, they typically operate “in the sunshine,” which makes confidentiality a problem. Although there are ways to deal with this issue, keeping a transaction secret is virtually impossible for most public hospitals.

In addition, public hospitals must confront legal and moral issues involved with the ongoing care of the indigent population. Most, if not all public hospitals, have an obligation to care for the uninsured. They are not absolved of this responsibility based on a sale of the hospital.  Therefore, they must provide for their care through some type of insurance product or force the buyer to assume this responsibility.

Finally, the sale of a public hospital literally takes place in the press. All of the key meetings of the board are heavily attended by the public and the press. The transaction receives heavy media attention, and board members who live and work in the community have to deal with substantial personal pressures.

The sale of a public hospital is one of the most difficult transactions to complete and requires an experienced transaction team. However, when they are done properly, these sales can provide enormous benefits for taxpayers and the indigent populations alike.

What to do.
  Given the issues described above, the following is a checklist of steps that must be taken in order to successfully complete a sale or merger:

Make a decision. 
The most difficult step is the first – the actual decision to sell or merge your hospital.  The best way to make such a decision is to have a meeting of the executive committee of the board, or if the board is a small one, the entire board.  the meeting should be extremely confidential: no pre-announced agenda, no minutes, no physicians, no lawyers, just board members and the CEO.  An experienced merger and acquisition (M&A) expert – one who can serve as project director, lead you through the decision process and review the options available – should also attend.  Remember:  The decision to sell is yours.  The purpose of the project director is to tell you how to do it.

Select a project team.
  The team should consist of the project director, an experienced transaction lawyer, a health care antitrust expert and two board members.  In exchange for the CEO’s assistance and confidentiality, some sort of golden parachute should be arranged at this point.  Under no circumstance can the CEO be left unprotected (unless he or she is part of the problem), nor can the lead negotiator report to the CEO.  The relationship must be directly with the board.

Prepare a confidential memorandum
.  The confidential memorandum (CM) is a document that contains a general description of the hospital’s services, market share and financial position.  It is very similar to the type of data that you see in a financial feasibility study, but without the forecasted utilization/financial data.  The purpose of the CM is to provide sufficient information to prospective buyers for them to decide if they want to proceed with the submission of a bid.

Prepare a bidder’s list
.  Bidders are selected from a group of potential local market buyers as well as from a national search conducted by the project director.  Bidders are screened based on financial qualifications, management ability and antitrust criteria.  If the bidder can’t afford to buy the facility, or if there is a substantial risk that the transaction will be challenged by the Department of Justice or the Federal Trade Commission, these bidders will be eliminated.

The competitive bid process is used to obtain the best terms as well as to satisfy the fiduciary responsibilities of the board to sell the assets of a not-for-profit corporation for fair market value.  Although a fairness opinion can satisfy this responsibility, it is not necessary if a competitive bid is used.