As health system consolidation picks up steam, more non-profit providers are exploring affiliation options and even looking into the for-profit realm to find suitable business partners. Attorneys and industry experts discussed trends in non-profit transactions and weighed in with their best advice for interested non-profit providers in a Feb. 20 webinar titled "Non-Profit M&A: Benefits and Pitfalls" hosted by Chicago-based healthcare investment banking firm Juniper Advisory.

Trends

The number of hospitals across the country has declined by 10 percent over 20 years, and a much larger portion of them are affiliated with larger systems as opposed to standalone independent hospitals, said Juniper Managing Director Barry Sagraves.

The trend is similar to a 1990s uptick in affiliations that was driven by strategic motives during the era of managed care. Numbers ebbed and grew again in the early 2000s when financially distressed hospitals sought buyouts, but today's activity better resembles the strategic decision of 20 years ago.

Much of that is driven by conditions and incentives embedded within the healthcare reform movement, Mr. Sagraves said, with systems seeking to better integrate their care offerings, access capital and consolidate services. Non-profit systems are no different, but historically have been more leery of large-scale transactions for fear of compromising their charitable or religious mission, as well as the often trickier red tape involved in non-profit transactions.

Lately, however, several agreements involving big-name non-profit systems have made headlines, including several Catholic systems: Trinity Health based in Linovi, Mich., and Catholic Heath East based in Newtown Squara, Pa., are working on a "mega-merger" of their systems, and St. Louis-based Ascension Health, the largest Catholic health system, made formal moves to acquire Tulsa, Okla.-based Marian Health System and to operate Los Altos, Calif.-based Daughters of Charity Health System's hospitals under its umbrella. Dignity Health, a Catholic system based in San Francisco, recently completed a major restructuring and rebranding of its hospitals as well.

Academic hospitals have also made some innovative moves to partner with investor-owned tertiary institutions, much like Durham, N.C.-based Duke University Health System agreed to enter into a joint venture with Brentwood, Tenn.-based for-profit LifePoint Hospitals to form Duke LifePoint Healthcare.

There are a few reasons why systems are looking to grow through partnerships. For one, it's getting more difficult for systems to request small- to mid-sized bonds, Mr. Sagraves said, requiring any seeking capital through that route to request larger bonds often through a partnership or by merging into a larger system.

Perhaps more compelling is the perception throughout the industry that the time is now to find a partner, or else all the best ones will be taken, he added. "Everybody in every market is rapidly seeking a collaboration partner," he said. There's a feeling recently that the music may stop soon and you don't want to be left without a chair." That's compounded by a constricted timetable while providers look to be well-positioned for the largest elements of the healthcare overhaul that will take place next year. He said more hospitals he works with today are actively pursuing partners than just one year ago.

Benefits

Transactions or cashless affiliations can benefit systems by increasing access to capital, improved credit, market share, scope of services and economies of scale or relieve a system from financial distress. "There's pretty compelling evidence that larger [healthcare] organizations have a financial advantage," Mr. Sagraves said, though he cautioned that this is not always the case.

"It's all about your mission and how to advance your impact on what you are trying achieve; that's the real reason to do this, along with the financial stability you want to achieve," said Dan McCormick, CEO of the McCormick Group in Fripps Island, S.C, which advises large non-profits in transactions.

To illustrate a successful non-profit transaction, Mr. Sagraves highlighted Marquette (Mich.) General Hospital, a financially stressed non-profit in a remote area of Michigan's upper peninsula that was looking to be bought out. The hospital had specific goals  — shoring up debt and pension liabilities, updating aging plants, improving quality and stemming patient outmigration to nearby Wisconsin markets — and found 26 potential partners, receiving 10 proposals. Ultimately, Duke LifePoint acquired the hospital and has met the needs Marquette General initially sought, Mr. Sagraves said.

Pitfalls and tips

For all the good well-managed partnerships can produce, poorly navigated ones can be disastrous.

Michael Peregrine, JD, a partner at McDermott Will & Emery in Chicago, said it's important for systems to remember a formal transaction will take eight to 12 months or more to close, and that non-profits tend to face added legal challenges in the process. That makes the negotiation and due diligence process all the more critical to ensure information and intentions are clear and the process moves smoothly.

Communicating with the public can also be of heightened importance when non-profits announce potential partnerships in order to assure them the agreements would align with the organization's stated mission and maintain a mix of services. "We're always happy when there's a PR firm involved in communicating clearly the transactions, especially for non-profit transactions."

In the past, state attorneys general have given little consideration to non-profit affiliations, but with the influx in the number and sophistication of such arrangements, Mr. Peregrine said he believes regulators will take a greater, more energized interest in those reviews.

Governance is a major issue in these discussions and is frequently a source of confusion as talks progress should teams fail to facilitate a "meeting of the minds" among board members who may hold differing views of how the new setup might look, he said. Keeping communication flowing between all parties and addressing such issues in a crystal clear letter of intent regarding core issues is important to prevent discrepancies in the plans and to prevent delays in the process.

Whatever the agreed post-governance may look like, the presenters urged that the new board be kept small, rather than simply combining all members of both boards. "Once you scramble the eggs, you need to mix the governance structure," Mr. Peregrine said.

Charitable entities, more than others, must pay particular consideration to post-closing considerations and draft specific covenants to maintain key issues like faith-based tenets and intellectual property, particularly so in cashless transactions. "The board's job isn't done once closing has occurred," Mr. Peregrine said.

Generally speaking, the presenters warned against excessive deference to advisors. Boards of directors must be involved early and heavily in the discussions at all stages, because there likely won't be adequate time to catch them up later on in the process, and that could prove fatal to the deal. "When the time comes, you can't make it up. If the board wasn't involved in the beginning, it can't speed learn later on," Mr. Peregrine said.

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