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Thought Leadership

Joining Forces: Consolidation Through Member Substitutions



Hospices are increasingly looking to buy, consolidate, or merge to achieve administrative efficiencies and expand operations for growth. A common approach among nonprofit hospices is to combine through a member substitution. In today’s episode, Husch Blackwell’s Meg Pekarske and Adam Royal discuss key considerations and strategies for hospice member substitutions.

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00;00;05;01 - 00;02;48;10
Meg Pekarske
Hello and welcome to Hospice Insights, The Law and Beyond, where we connect you to what matters in the ever changing world of hospice and palliative care. Joining Forces: Consolidation Through Member Substitutions. One of my favorite topics. I'm so glad you're here to join me for break. Yeah, exactly. But it's an inside joke. Adam knows that I don't love corporate law, and so this is where we merge our brains together because Adam had heads up, all members substitutions and all kinds of corporate things that we work on in our group. So it was really fun. Adam, when you joined our team because we're doing a lot of this work in one of the categories we've been doing a lot of work in is member substitutions, and we thought we'd do a podcast just to talk about what that is. And we have some helpful handouts. And I think as sort of a historical note for our listeners that now it's two summers ago my colleague Noreen and I did a podcast on different ways hospices can come together to collaborate and we're going to link to this what has been a really well listen to podcast and hand out of everywhere from like a messenger bottle network model to what's on the far end of that spectrum is member substitutions or sometimes a call parent subsidiary model. So we're going to relay back to that handout we released a couple of years ago because I think it's still I still get asked for this tour. So we're going to link to that as well as a handout that Adam and I created. And about what are the the key steps in a member substitution. So just wanted to get that out there for all of you to know that there's going to be some helpful links in in the podcast now. So anyway, with all of that being said, what is a member substitution? Because I think folks even that doesn't really always make total sense to to what that is. And so for some people who have never been through this process, which I think for a lot of our nonprofit clients that we help through this, you know, as the CEO, this might be the first time they've ever done this. And so why don't you talk a little bit about what a member substitute should is?

00;02;48;25 - 00;04;27;08
Adam Royal
I think it is common for people to have less familiarity with member substitutions for people who are sort of like transaction or corporate adjacent, they probably hear a lot about equity deals or asset purchases, even share purchases or membership interest purchases, depending on the corporate entities. In the nonprofit space, the member substitution is the analogous version of an equity purchase in the for profit space. So essentially a corporation has shares to sell. LLC is have membership interests to sell. Many nonprofits are organized as non-stock corporations and technically don't have owners in the same way you would think of owners in the for profit space. And so what a membership substitution is, is essentially a nonprofit version of an equity purchase, giving some kind of ownership or control in that nonprofit to another entity. Usually by providing some other entity, you could think of this other entity as the purchaser or the buyer, a sole membership interest in the target, nonprofit or seller. And usually that that comes with seats on the board or board control, that kind of thing.

00;04;27;22 - 00;07;17;29
Meg Pekarske
And so I think that sometimes, you know, we've worked on members substitutions where the the purchaser is really that say, you know, I run a hospice and this territory and now I'm going to be acquiring this hospice through member substitution and my hospice now as the sole member, we do that. But oftentimes when people are coming to the table to do these things, it actually sometimes what happens is you create a new company who becomes the sole member of both of the hospices that are coming together. Now, some of our large nonprofit clients, they already have a parent model, right, where they have a non, you know, provider entity at the top that is providing administrative services down. And so they might already have that model. But I think oftentimes when we're helping people, it is two hospices coming together and they want to create a new on BARELA because sometimes they might be having other people join down the road and so there's different models of that. Ohio's Hospice Care Synergy. Lots of people have different models. Mike Millward talked about the California Hospice network model. So there's lots of models out where, you know, you create sort of the parent to be the type and then the individual hospices go underneath. And I think that in all my years of doing this and I know we're going to talk about cultural impact, but I think identity is really important to organizations. And so I think a lot of the successful models, whether it is a member substitution, oftentimes they may keep their name. Like you're not creating a single brand, you might be keeping your name. And we all talk about governance in a second, but, you know, just because there is a parent to now, you know, each hospice is underneath that, it doesn't mean your name necessarily needs to change or some of those other things or that everyone needs to be employed at the parent or I mean, you can potentially, but so so anyway, that's a really sort of helpful introduction to, you know, what we're dealing with here. I guess in the things that we've been working on together at Why are people coming together? I mean, I think there are some pretty common themes.

00;07;18;17 - 00;07;54;17
Adam Royal
Yeah, the buzz words for the industry right now are administrative efficiency, kind of consolidation. And and in moving to a more efficient model of care. Also, the consolidations can help if a hospice is looking to move upstream. So looking to provide the non hospice palliative care consolidations can can sort of facilitate a broader organ or organizational structure that works well for different service lines.

00;07;55;00 - 00;09;23;04
Meg Pekarske
Well, and I think to that point on the palliative care point, I think people are realizing they need to up their game, they need to get into value based care, and they don't on their own have the resources to do that or they're not going to get the attention of the payer because they just don't cover enough geography or they don't they're not, you know, have enough service diversification or whatever that is. So absolutely. I mean, I think that those are the big drivers for, you know, coming in the had I think feel like we have four or five of these right now that we're working on that are, I think in different stages. And so, you know, I think three years ago I thought this was going to start. And I mean, it's been going on for some time. But I would say, at least in our practice, there seems to be a lot of momentum in this area. But so I talked about that. We have a handout to sort of talk about. We want to have a runway right when we're talking to clients about what are the steps in this process, Because as we said, a lot of people haven't been through this before. So we created this handout about what does a the different steps, big picture steps in the process and sort of what is the overall timeline. So maybe flush that out a little bit at like what's the first thing you need and then what happens next?

00;09;23;16 - 00;09;54;15
Adam Royal
Sure. Yeah, it is. It was always helpful to see kind of big picture the steps you're looking at and the various phases of a transaction. And so generally the initial stage or any transaction, including membership substitutions, is an ally and or a non-disclosure agreement and usually these are coupled into one document. The ally was just is.

00;09;54;16 - 00;09;55;13
Meg Pekarske
An ally.

00;09;56;01 - 00;11;24;21
Adam Royal
A letter of intent. Okay, letter of intent. So the letter of intent sort of spells out the the party's intent to undergo a transaction and it can identify big picture issues like, for example, whether the transaction will be a membership substitution or an equity or asset deal or that kind of thing. Allies are also a good place to talk about purchase price, financing, fundamental reps and warranties, indemnification, all of the issues that are are really the primary issues and what will eventually be that the transaction document, the definitive agreement that actually accomplishes the deal the other way is a is a process early in the stage to kind of identify issues that may be sticking points for the parties or maybe big concerns for each party without putting pen to paper on a 60 page definitive agreement. So from an efficiency standpoint, it's a it's a good way to give the parties one single document to look at and negotiate around and work through some issues that may be determinative for the transaction.

00;11;25;09 - 00;12;50;10
Meg Pekarske
And I would say when we work in the nonprofit space and things like this, the process moves slowly typically. And so I think while you could combine, as you said, like the non-disclosure agreement with an ally, I would say more often than not, people start conversations early and you get a nondisclosure agreement because there might be some exclusivity to those talks. But people are feeling out and I think this is sort of the difference between the for profit, not for profit space. It's like they're feeling out culture a lot more and feeling out like, does this make sense? And I don't know. It just seems that a lot of people are getting that nondisclosure agreement out, but they haven't really talked much about deal terms and stuff. So, you know, we're working on one right now where they have the confidentiality agreement. Now they want to move to, you know, the ally. Now that's and you use the word definitive agreement, which the definitive agreement in these cases is usually like an affiliation agreement or a member substitution agreement. That's when when you said definitive agreement, that's that's what you're getting at, right?

00;12;50;22 - 00;12;58;01
Adam Royal
Correct. That's the the primary agreement that memorializes the transaction, the member's substitution.

00;12;58;23 - 00;14;30;04
Meg Pekarske
And so but before you're going to as you said, put pen to paper on that, you're going to want to do due diligence. Right. And so I think that sometimes in not for profit deals, you know, sometimes I feel like the due diligence maybe isn't as significant as it is in some other deals that we work on. But we have very lengthy due diligence document and I think it's helpful to give that to people so they can see the kinds of things you want to ask for. And I think, frankly, a lot of people have been audited, which can be actually helpful. So it's like you can see the feedback they've gotten on their election form, their certification forms. You know, some of the I always say in diligence, at least from a regulatory perspective, understanding do they have any forms issues that could have significant liability, like a potential 60 day repayment liability and stuff like that? So, so many people are on TPI or HEP CPI audits or something. So you might simply have those kinds of results, but that our due diligence list has a whole bunch of different staff other than hospice regulatory things like and maybe just give people a flavor of the kinds of things that would be exchanged and due diligence.

00;14;30;22 - 00;16;47;04
Adam Royal
Sure. So at a at a really high level in due diligence, we look for governing documents, articles and bylaws, any amendments to the articles and bylaws. And that's really just getting a sense of corporate history, but also the authority to conduct the transaction is one thing you'd want to look at and what what sort of consents are required to achieve the transaction. So that there's corporate governance issues or one financial due diligence, the extent to which parties want to get into financial due diligence varies a lot by the transaction, but that's looking at financial documents. Also kind of debt instruments that are encumbering the hospice or its assets, employment, due diligence. So we're looking at employees, any employee benefits, those are going to be really pertinent for the parent subsidiary model that Meg mentioned earlier. To the extent the hospices want to consolidate administrative processes in the parent and possibly employ all employees at the parent level and then kind of in addition to the regulatory issues Meg was looking at. So documents and documents of pending audits, we'd also look at litigation history, any pending or threatened litigation that could also affect risk in a transaction. And finally, there are things like intellectual property, and that includes things you may not ordinarily think of as intellectual property in the in the sense of a patent trademark. But domain names, even social media accounts, if hospices are merging, depending on how they want to do their branding, these websites, social media accounts are all things you need to look at and think about. Kind of consolidate the hospices.

00;16;47;04 - 00;19;30;27
Meg Pekarske
And I think there is no one size fits all. Like as you're going down your list of diligence and thinking about, you know, when we have conversations like this with people, I mean, it sort of cuts down the middle, like some people use the word merge, right? So we have some, you know, folks we work with who I want a single legal entity. I want to consolidate provider numbers. I want to streamline, streamline, streamline. And, you know, we talk through that option because sometimes that means we're talking about member substitutions here, but sometimes ultimately that ends up sort of all folding in to one legal entity. So even the the you know, because when you do a sole member. Right, you still are the member of something, right? It's like we're working on right, right now that we're going to merge all together into one legal entity and, you know, one Medicare provider number. But oftentimes, you know, when you're doing a parent subsidiary, people, they don't they want to keep separate ness. Right. And you want to keep separate provider numbers and separate. And because then if one hospice is here, then they can't touch the other hospices assets. You know, they have different tax IDs and stuff. So, you know, I think people make different choices. And so back to that whole what does the structure look like? And so so anyway, and I think we did another podcast, which maybe we can link to that because we have a whole transaction series where we talked about some of the regulatory consideration and about how you do these things, because today we're really focused on the corporate kinds of things, but actually regulatory things oftentimes need to, you know, be sort of front and center and not sort of, you know, after the fact consideration. Because when you have inpatient units and all this other stuff, getting all of that stuff lined up, depending on when you want to consolidate your Medicare provider numbers, keep them separate. I mean, the regulatory component can actually be fairly, fairly complicated or may actually, you know, need to be addressed earlier on. And you got to back in to your timeline of when things should happen.

00;19;31;12 - 00;20;10;06
Adam Royal
Exactly. Yeah. The structure oftentimes can depend on on regulatory considerations. So in the for profit space, doing an equity or asset deal can result in either a chow, a change of ownership, or actually a change of information from a CMS perspective. And so issues like that can can determine how parties structure a deal. So those are regulatory considerations. Like you said, are, are and should be at the forefront of the analysis and often kind of informed the corporate aspect of the deal.

00;20;10;15 - 00;21;22;11
Meg Pekarske
Yeah. So I think when we work on these things, we have our little spreadsheet where we want to say we want we want to understand how many provider numbers we have, what licenses do you have, what geography are you able to cover? You know, what IPOs do you have residential units? Because all of that stuff, I think, goes into understanding how to effectuate. I mean, there can be five different ways to get to one spot, but sometimes most people want to take the the shortest route possible if you can. But so so anyway, we talked about, you know, the definitive agreement. When you do do a parent and you have subsidiary model, there's also a management services agreement that we usually draft as well that goes into how the parent relationship is going to be worked. Are its subsidiaries in hospices?

00;21;23;12 - 00;22;06;21
Adam Royal
Right? The Management services agreement is sort of what memorializes and governs the services that the parent will provide to the subsidiary and can also determine how cash can be consolidated from the subsidiaries up to the parent. And so if the if the parent company is providing administrative services on behalf of the subsidiaries, you ought to spell those out in a management services agreement that can include things like like billing for claims, paying employee benefits, and also use that management services agreement to document the authority of the parent to do those things.

00;22;06;21 - 00;27;21;14
Meg Pekarske
And I think we've been working on a lot of issues around where employees should be held and what makes sense because, you know, the back office functions of h.r. Are, you know, your emr, your c-suite people that are going to be helping across the continuum. Should those people be at the parent and then more of that, the core services, direct care staff are at the hospice level. Those are discussions that we've been having and talking through are pro and con on those types of things. But it is, I guess when you add up all these steps, it means some deals I think in the for profit realm come close like in three months or something. I mean, I would say all of these can take from the very beginning, like a year or more to go through because you have to board your, you know, getting on board. And I think governance issues are really important to people. And those sometimes take a while to work through right? Like through are there going to be advisory boards or something at the hospice level? And then there's like a combined board at the parent and my experience, a lot of nonprofit boards have giant boards, which sometimes isn't always the, you know, the best. And so then if it's like, well, now we're going to the parents going to have a 40% board, I mean, it just so sometimes there needs to be hard conversations about, especially if, you know, one provider has a AWA, a huge board and someone else, you know, has become more streamlined. So I think that sticking point is, is something that takes sometimes a while to work through. And then I think just some of these identity issues like are we keeping our own name? How is this going to feel now? I feel independence comes up a lot because I think people know they need to change, but I still think there can be some sticking points. But I really feel like when we've helped people through this, I mean, I do think this is a really good path going forward if it's with, you know, a like minded partner. I mean, not everyone is going to be, you know, the right kind of partner. But I think if you do have synergies, it does really make sense to consider this. And and I guess one last thing. Two years ago, we talked about this with Noreen on that chart about, well, why do people, you know, entertain a substitution? And sometimes it's also retirement of key staff. And I think that in a number of things that we're working on, there is sort of there's going to be a next generation coming together. And our you know, our CEO is is going to be retiring at some point. And now's a good time to do this because why hire someone to then, you know, take it through? I mean, I think that sometimes CEO might say this is I'm going to get us through this because then we're going to like the future will take off from there. So it's a really interesting time. And I do think that there I mean, administrative efficiency isn't a foregone conclusion just because you're bigger, you that does not mean you will necessarily be efficient. But I think if you do the hard work of really changing how you do certain things because this is going to involve some change, it's not just like on a paper kind of thing, right? Like, I think people have to realize that if you're doing this, the hurdle is in just signing this piece of paper, but changing the way we do certain things, like, right, how we staff things, maybe how we do our telephone triage is going to change and other things in ways that can actually be better, right? Improve quality and improve response time, you know, enhance your compliance function. I mean, I think people feel really buried in a lot of, you know, payment audits and other things like just having more resources to deal with with a lot of, I think, what's to come. So I'd rather be in a boat with someone and have another brain. I mean, that's why I like working on a team, right? I mean, I think it's sort of better together. So anyway, well, this is a great, I think, overview. Adam and there's obviously a ton. We could do a whole like five part series. Probably no one wants to the website. Yeah. What fun and but I think this is really helpful to get the lay of the land here. But any closing thoughts?

00;27;22;29 - 00;28;18;27
Adam Royal
Yeah, I mean we joke about about corporate work being being boring and not interesting, but there are a lot of moving pieces to these projects and you've already talked about the importance of culture. I think the interesting thing from from the legal perspective and advising clients is identifying what matters and also where there's flexibility and where there is it and where there is working with the client to help determine how we can best approach our cultural issues and integration of to hospices, because that is a very real difficulty at the provider level and one that I think shouldn't be disregarded at the corporate and regulatory stages from an attorney's perspective. So yeah, kind of provides opportunities for creative thinking and problem solving.

00;28;19;14 - 00;29;20;15
Meg Pekarske
Yeah, well, I like it in corporate. It's always like, Can we do this? And it's like you can do whatever you want. And then it's only like, are there regulatory issues? So there's a lot of different ways you can put things together. And usually the regulatory constraints are going to be the constraint. So one member substitution doesn't need to look like another member substitution, like governance can look different and then other things. So I think our job as lawyers is to help guide you through what's important and how to achieve that, because you don't need to do what your next door neighbor did. There's other ways to to get that done. So anyway, I don't think this work is boring. I actually really love it. Like, I think this is exciting, but talking about LLC versus AGs versus that, that does not excite me, but that's why we're a great partnership. Adam Because.

00;29;20;22 - 00;29;21;08
Adam Royal

00;29;21;26 - 00;29;59;13
Meg Pekarske
And I love thinking about these things conceptually and working through the strategy and then like, you know, So anyway, it's been fun working with you on these projects. I think by bringing our clients to sort of a next stage and in, you know, the life of their organization. So I think they're, they're fun things to work on. So yeah, anyway, till next time I feel like for, for lots of things cooking here. So I guess this will not be the last time we're talking about different ways people are coming together.

00;29;59;13 - 00;30;01;16
Adam Royal
So now more material coming.

00;30;02;04 - 00;30;04;08
Meg Pekarske
Exactly. Thank you.

00;30;04;08 - 00;30;09;29
Adam Royal
Thank you.

00;30;09;29 - 00;30;25;25
Meg Pekarske
Well, that’s it for today's episode of Hospice Insights, The Law and Beyond. Thank you for joining the conversation. To subscribe to our podcast, visit our website at or sign up wherever you get your podcasts. Till next time, may the wind be at your back.


Adam L. Royal