October 20, 2023
How to recognize conflicts and protect your practice by using the 3 Cs
Every partner in a joint venture (JV) wants the project to succeed. How they define success and the paths they take to get there, however, can be very different. Let’s look at three real examples to demonstrate this point and discuss what physician groups can do to ensure a clear path to their own success.
The Alabama Orthopedic Group
This group built its facility as a 50/50 partnership with its developer. After some years, debt paydown and property appreciation caused a substantial growth in equity. As the buy-ins for new partners grew more expensive, many of the practice partners could not afford to become real estate partners. Therefore, the practice asked the developer to agree to a loan refinance so the property could be leveraged up to reduce equity and allow new practice partners to buy in.
Unfortunately, the developer refused, telling them that his priority was to pay down debt and leave a free and clear property for his estate. The problem worsened over the years, but the developer never relented. As a result, more and more practice partners were left out of the real estate and its enticing ancillary revenue stream. They lost control over major building decisions. And because the doctors owning the real estate no longer controlled the practice, they lost the ability to arrange a sale/leaseback of the property.
The Utah Multi-Specialty Group
This 50/50 JV was created to build a new medical office building (MOB). In the minds of the physician group, this building would become a long-term part of its expanding real estate portfolio. Within months of occupancy, however, the developer partner sought and received an LOI for the purchase of the building. Although the medical group had desired to hold it, and maintained the right of first refusal, the group had no choice but to sell. It was not able to afford to pay the developer what had been offered by a third-party buyer.
As a result, the developer took 50% of the gain without any ongoing responsibilities while the practice group will be paying its rent to an outside party for the next decade.
The Washington Orthopedic Group
This group sought a piece of desirable land to construct a new MOB/ASC that was owned by a local developer. They subsequently entered a 50/50 JV partnership that relinquished control and the financing procurement to their development partner.
The terms of the contract, however, stipulated that the developer required a set return on investment. The financing terms had basically no impact on the developer. Even if the interest rate paid was higher, the leases would be increased proportionately by the practice to ensure the return on investment was met. In some ways, the developer was even incentivized to procure worse financing terms, because doing so would result in higher starting rents, and a subsequent sale or refinance would only improve the outcomes for the development partner!
In the end, the projected rents became unfeasible for the practice, and the project didn’t move forward.
Using the Three Cs to Ensure Success on YOUR Terms
The Three Cs are very simple. They are Control, Control, and Control! When entering into a JV partnership:
- Do not give de facto Control to a JV partner by agreeing to conditions that you may not be able to meet (e.g. first right provisions).
- Do not cede Control of project financing to a JV partner if that partner’s return is not tied to the interest expense (and thus rent) that the practice pays.
- Wherever possible, maintain unilateral Control over major issues. (Remember, this project won’t happen without your group. Your partner should not object so long as their economic interests are protected.)
OK, so really there’s only one C, but it’s so important we should repeat it three times. (Think Dorothy chanting “There’s no place like home” in Oz). Keep shouting “control” or you may quickly find yourself going in the wrong direction.