What to Do When Converting a Hospital From Nonprofit to Investor-Owned

While perhaps not as controversial as it once was, the 'conversion' of a nonprofit hospital to a for-profit venture can raise questions and spark unhelpful rumors.

Editor's note: This article is an excerpt of the HealthLeaders book Healthcare Mergers, Acquisitions, and Partnerships: An Insider's Guide to Communications.

In most communities, the conversion of a hospital from a not-for-profit to an investor-owned enterprise no longer stirs the heated debate that it did decades ago. Instead, you're much more likely today to see not-for-profit and investor-owned hospital organizations working in partnership.

Renowned not-for-profit health systems such as Duke Health and the Cleveland Clinic have formed strong affiliations with investor-owned hospital companies. In these and other partnerships, not-for-profits and investor-owned organizations are working together to strengthen hospitals, invest in communities, and serve patients.

In fact, the issues facing investor-owned hospital systems during a partnership are the same as those faced by not-for-profit health systems during a partnership discussion: Local control and governance, cultural compatibility, charity care support, and commitment to local investment are leading hot buttons for both.

Still, the "conversion" of a not-for-profit to an investor-owned organization can represent a change that can raise questions and ignite unhelpful rumors.

To help you be prepared, start by answering these basic questions: What's the difference? How are not-for-profit and for-profit (investor-owned) hospitals different from one another?

• Taxes: First, a (very) broad definition: "Not-for-profit" and "for profit" are tax-related designations. A not-for-profit hospital does not pay certain taxes, including those on property used for care, income, and sales. How- ever, it usually does pay payroll and other federal employee taxes. A for- profit hospital pays property, sales, and income taxes as well as payroll taxes. Not-for-profits sometimes make payments in lieu of taxes to help offset the costs of providing important community services, such as police and fire coverage.
   
• Capital: Not-for-profit and investor-owned hospitals are also differentiated by where they get capital to invest in their facilities for infrastructure improvements, new equipment, staff, and the like. Not-for-profit hospitals usually go to the bond market for capital. Investor-owned hospitals go to the public stock market, the bond market, or investment groups for capital.
   
• Analysts: Now for a word about financial ratings. Both types of organizations have outsiders judging the hospital's financial performance. To help investors monitor their portfolios and make buying and selling decisions, not-for-profits are graded by credit rating agencies, such as Moody's Investors Services and Standard & Poor's. Publicly traded, investor-owned hospital stocks are watched by analysts and valued daily in stock exchanges.
   
• Ownership: Who "owns" the hospital after such a sale is an important question and can reflect a community's concerns about having a future voice in the care provided at its hospital. The answer can be complicated and inconsistent from hospital to hospital and community to community.

Here's an overview: Independent, not-for-profit hospitals are, in a sense, owned by the communities they serve. The boards are usually comprised of local leaders and physicians. Excess revenues—profits—are fully reinvested into the community's care after debt payments, payroll, and other expenses. Hospitals that join a regional or national not-for-profit health system, however, may or may not have a local board with a say in the direction of the facility and may or may not share their profits with the system. (In fact, if your local hospital is in financial trouble, the money flows into your hospital, not out of it!)

Investor-owned hospitals are, as you might guess by the name, owned by investors, who can be private individuals or stockholders. Investors traditionally benefit as the value of the company's hospitals increases over time, through effective operations and local investments, and as the company overall grows by adding more hospitals.

Adding to this complexity is the trend for hospitals to pursue joint venture partnerships where ownership is shared by two or more organizations, including the "seller." These partnerships call for strong and trusting relationships by every party. Communications is key to success.

Familiarize yourselves with these terms and issues as you move through a partnership. Be prepared for some myth busting.

That's where the fundamental structural differences end. The driving forces of both organizations, however, are precisely the same:

• No matter your tax status, every hospital must take in more dollars than it spends to be financially healthy and to reinvest in the care it provides.
   
• Every hospital must offer quality care, provide current medical equipment and facilities, and support a trained staff to attract (and keep) patients  and serve the needs of physicians, payers, and others.

Now, consider some specific questions you may hear related to the structure of a not-for-profit to investor-owned conversion.

What Happens to the Proceeds of the Sale?
 

When there are funds left over from a sale, they are often referred to as the proceeds. These proceeds exist once the hospital's debt and any other obligations (e.g., a pension fund) have been paid.

The answer as to what happens to those dollars depends on the ownership structure of the selling organization and the terms of the transaction. Here are a few scenarios:

• The sale of a stand-alone, not-for-profit community hospital to an investor-owned company may lead to the creation of a community foundation. The creation of the foundation—including its board and mission—may be directed by your state attorney general's office, and the proceeds from the sale will fund it.
   
• When two not-for-profits merge, it is rare that there are proceeds. Instead, the common practice is for all assets from both organizations to combine for the good of the new system.
   
• From the sale of a hospital owned by a religious organization, the remaining proceeds will likely return to that order or denomination.
   
• When a government-owned hospital is sold, money left over may return to the city's or county's coffers, which may deposit it into the government's general operating fund or create a new organization for meeting the charitable healthcare needs of the community.

Will Charity Care Continue at Its Current Level?
 

This is really a question of community commitment and may be an indicator of how much the community-based culture is or is not going to change under the new ownership. In most cases, a commitment to either a specific level of charity care or a guarantee to continue the hospital's existing charitable mission and policy is written into the deal documents. Expect the question and know the answer.

How Much Money in Local Taxes Will the New Hospital Owner Pay?
 

An investor-owned hospital pays taxes that benefit local government. This question is an opportunity to highlight the added contribution as a distinct benefit of investor-owned partnerships.

In many cases, the fire department, police force, schools, parks, and other com- munity assets will benefit on an annual basis from an investor-owned partner paying state and local property and sales taxes.

One cautionary note: In some cases, new hospital owners may seek appropriate tax incentives when entering a new community and investing in a hospital. Be sure you understand the local government strategic thinking before you answer the tax question.

The full book, Healthcare Mergers, Acquisitions, and Partnerships: An Insider's Guide to Communications, is available in the HealthLeaders store.