A not-for-profit hospital conversion is a transaction that results in the shift of all or a substantial portion of the assets of a not-for-profit hospital to for-profit use. Most hospital conversions have been structured as asset sales; however, recently some hospitals have, for example, entered into joint venture arrangements. In an asset sale, a not-for-profit hospital sells its physical assets, name, and accounts to a for-profit purchaser in exchange for cash, stock, notes, or other property. In a joint venture, a not-for-profit hospital contributes its assets to a for-profit partnership in exchange for cash and an ownership interest in the new venture. For example, in an 80/20 joint venture, the not-for-profit entity receives cash equal to 80 percent of the value of the hospital’s assets and a 20-percent ownership interest in the for-profit venture. Other methods of conversion include lease arrangements and corporate restructurings. Federal and most state laws require that proceeds from the sale of charitable assets continue to be used for charitable purposes. These proceeds are generally directed to a not-for-profit foundation or other charitable entity. Market and institutional factors, such as the growth of managed care and the need for capital, are often cited as primary reasons for conversions. To be successful in a managed care environment, not-for-profit hospitals must be in a competitive position. This position can be achieved by building networks that guarantee patient flow and increase bargaining power with managed care plans and physician groups. Access to capital is particularly important in a managed care environment, in which substantial investments may be necessary for information systems, network development, and expanding market share. Columbia/HCA Healthcare Corporation, Tenet Healthcare Corporation, and Quorum Health Group are major players in the hospital acquisition market. Columbia/HCA is one of the largest health care services companies in the United States. As of February 1996, Columbia operated 343 hospitals, 135 outpatient surgery centers, 200 home health agencies, and extensive outpatient and ancillary services in 38 states, the United Kingdom, and Switzerland. Columbia reported 50 not-for-profit hospital acquisitions, joint ventures, and lease arrangements between 1994 and 1996. Until recently, Tenet, a nationwide provider of health care services, owned and operated 76 general hospitals and related businesses in 13 states. On January 30, 1997, Tenet acquired OrNda HealthCorp, one of the nation’s largest investor-owned hospital management companies, with 49 hospitals in 15 states. Through this transaction, Tenet now owns, leases, or operates 130 hospitals in 22 states. Tenet reported nine not-for-profit hospital acquisitions and one joint venture since 1990. Quorum owns and operates acute-care hospitals and local and regional health care systems in 43 states and the District of Columbia. As of June 1996, Quorum owned 14 acute-care hospitals and had management contracts with 253 hospitals and consulting contracts with another 161 hospitals. Quorum reported 12 not-for-profit hospital acquisitions and leases since 1990. The hospitals we reviewed followed the same basic process in converting from not-for-profit to for-profit status: They valued the hospital’s assets; sought out a buyer or partner, generally through a competitive process; and negotiated the terms of the final agreement. The methods used to determine the hospitals’ value were commonly used approaches, according to industry experts. A key component considered in estimating the value of the hospitals we reviewed was their most recent earnings. The valuation estimate is a benchmark that hospital officials can use in considering bids from potential buyers or partners. The IRS and others suggest that hospitals solicit competing bids through a request for proposals (RFP) in order to increase the likelihood that fair market value is realized. While few hospitals followed such a formal competitive bidding process, officials at most hospitals said that they received multiple bids and accepted the highest bid offered. Once a bid is accepted, the terms of the purchase or partnership agreement are negotiated and formally agreed to by both parties. Participants in the conversion transactions we reviewed told us that items negotiated included the final purchase price and continued charity care and hospital services. During the conversion process, the communities that the not-for-profit hospitals served generally were not informed about or involved in the various phases of the transaction. However, the not-for-profit hospitals’ boards of directors, who viewed themselves as representatives of the community, reported having responsibility for managing the conversion process and having a fiduciary duty to ensure that the conversion was in the best interests of the organization. The for-profit hospital boards of directors, which usually included former not-for-profit board members, generally monitor and oversee compliance with the purchase agreement. The IRS and valuation consultants cite the income, market, and cost approaches as generally accepted methods for valuing hospital assets (see table 2). One or more of these approaches were used to arrive at a minimum dollar value. This estimated value of a hospital is not intended to represent its fair market value. Instead, in many cases, it represents a benchmark for the not-for-profit hospital to use in negotiating a purchase price. The income and market approaches, which were the approaches most commonly used in the transactions we reviewed, multiply a hospital’s adjusted earnings by a variable—or multiple—to calculate the hospital’s value. The multiple depends on the weight given to certain tangible and intangible factors, which can include a hospital’s debt and competitive position. For example, lower multiples reflect hospitals that are considered a greater financial risk. Multiples that ranged from 5 to 10 were applied by investment bankers to value six of the not-for-profit hospitals we reviewed. In recent years, investment bankers have commonly applied a multiple of six to value independent not-for-profit hospitals. Experts and representatives from organizations who are knowledgeable about hospital finance, such as the Prospective Payment Assessment Commission (PROPAC), suggest that not-for-profit multiples be carefully monitored to ensure that the not-for-profit hospitals are valued appropriately. Each of the 14 hospitals we reviewed had obtained either an independent valuation (or conducted its own valuation of the hospital) or a fairness opinion, which is a documented analysis and confirmation by a reviewer that the valuation process resulted in a fair estimate from a financial point of view. In obtaining their valuation, 13 hospitals hired outside consultants, whereas 1 relied on in-house expertise. The one hospital that relied on in-house expertise for valuation, Lloyd Noland, hired experts to render a fairness opinion. Five hospitals—Arlington, Goodlark Regional Medical Center, Good Samaritan Health System, Tulane, and St. Francis—obtained both a valuation analysis and a fairness opinion from an outside consultant. For the conversions we reviewed, officials with Columbia/HCA, Quorum, and Tenet told us that they did not retain the same consultants that the not-for-profit hospitals did for valuation purposes. However, a Quorum official reported using Valuation Counselors Group, the consultant retained by the Carolinas Hospital System, for asset allocation purposes related to that hospital following completion of the deal. In addition, all three for-profit companies reported using some of the same consultants for business transactions and services unrelated to the conversions in our review. (Table 3 lists the hospitals that hired consultants by the type of service rendered.) Eight hospitals disclosed the valuation estimates they received; however, only four provided documentation to support the information. Mary Black and Retreat reported in their IRS revenue rulings that they received valuation estimates of $56 million and $14 million, respectively. Carolinas’ valuation report provided an estimated range of $55 million to $60 million, and Good Samaritan’s valuation report estimated the hospital’s value at $140 million to $160 million. (See table 4.) The remaining six hospitals would not disclose their valuation estimates. The valuation estimates generally represent a benchmark for the not-for-profit hospital to use in negotiating a purchase price. According to officials involved in the conversion transactions, most of the not-for-profit hospitals in our review received more than one bid from potential buyers or partners (see table 5). The process used to solicit offers varied among the hospitals. According to the IRS, sellers can more accurately determine the fair market value of their hospitals by soliciting competitive bids through an RFP, which opens bidding to the public. Of the 14 hospitals in our review, 4 used an RFP process; 9 said that they considered several not-for-profit and for-profit entities as potential buyers/partners before focusing on one or more from which to solicit a bid(s); and 1, Jacksonville, only considered one buyer, Quorum, which was selected because of its previous experience—an 8-year management contract with Jacksonville Hospital. Of the 14 hospitals, 7 received more than one bid. Although most of the hospitals we reviewed received multiple bids, not all reported accepting the highest offer. Some officials told us that the bid amount is only one of several factors considered by the not-for-profit hospitals in selecting a buyer or partner. The Retreat Hospital, for example, accepted a bid from Columbia/HCA that was $3 million lower than the highest bid it received because the higher bidder did not appear to bring any complementary strengths, such as access to third-party payer contracts and economies of scale in operations, to counter Retreat’s weaknesses. Hilton Head accepted a lower bid from Tenet because of the for-profit’s financial stability, access to tertiary care, philosophy regarding patient care and employees, and other health care relationships. Hospital officials told us that, in addition to bids, they also considered such factors as the bidding entity’s managed care network, presence in the community, corporate culture, reputation for providing quality care, and access to capital, which was reported to be a major factor in the not-for-profit hospitals’ decision to accept an offer from a for-profit company.