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Julianne Andrews, MBA, CFP, shares her expertise in a conversation with Medical Economics.
How can practices finance growth?And what are pitfalls to avoid when seeking outside sources of funds? Julianne Andrews, MBA, CFP, has more than 30 years’ experience helping doctors answer questions such as these as a principal and co-founder of Atlanta Financial Associates, which was acquired earlier this year by Mercer Advisors. Andrews shared some of her insights during a recent interview with Medical Economics. The conversation has been edited for length and clarity.
Medical Economics: Where can practices go to obtain a loan, or other types of financing? And what are the advantages and disadvantages of each source?
Julianne Andrews: Historically, banks have been a good source of funding. Doctors do need to be aware that if they obtain bank financing the bank will want a personal guarantee from the partners in the practice, which simply means the bank is loaning the money to the practice, but each of the partners will be personally responsible if the practice is unable to repay it.
If you qualify for an SBA (Small Business Administration) loan, the interest rate might be a little lower, because the bank has a guarantee from the SBA on that loan. So that’s certainly something to investigate.
Some practices now are turning to venture capital and private equity as funding sources. You do need to understand that in the case of venture capital or private equity you’re giving up something in exchange. For instance, with venture capital you’re probably giving up seats on the board, and some decision-making power. With private equity you’re giving up some equity in your practice in exchange for that funding.
But those are options, and in fact those types of entities are very interested in medical practices at this point.
ME: Wouldn’t a practice be reluctant to give up the kind of power or equity that would come with venture capital or private equity? What are the advantages over a conventional bank loan?
JA: It’s usually an entirely different kind of transaction. Many times a PE and VC firms are interested in practices that have good, solid cash flow, are growing, and that’s actually what they’re interested in purchasing. It can work very well for a practice with older physicians that are looking to retire and for some sort of a succession strategy. It can also work for younger physicians looking to become part of a larger group and aren’t interested in the administrative part of running a practice. But it’s a very different transaction than just getting a loan to refurbish your office or purchase a new piece of equipment.
ME: Under what circumstances should a practice consider going outside for a loan rather than trying to finance growth through its own revenues?
JA: You want to look at what kind of cashflow you have and how large is the purchase compared to the cashflow you have on hand, and also compared to the cash the practice might have in the bank. Right now interest rates are extremely low, so getting a loan for large purchases makes a lot of sense. But you need to make sure that you have enough free cashflow to service that loan, because again you’ll probably have to personally guarantee it if you get it from a bank.
That’s going to mean the partners are going to have to provide tax returns, personal balance sheets, that kind of thing, to demonstrate that should the practice default on the loan the partners would have the capital to take care of it.
Having said that, it’s not the bank’s objective to foreclose on a loan, so they’ll be very accommodating typically with practices on working out terms of the loan. You saw that happening last year when we had the downturn in revenue from COVID.
ME: Are they required to put up collateral of some kind? And what kind of documentation do banks usually require when a practice applies for a loan?
JA: Typically they’re not going to require collateral, but most loans are made on a cashflow basis so they’re going to look at the practice’s cashflow, their historical revenues, their receipts and expenses to make sure there’s free cashflow to repay the loan. The bank will want to see tax returns, profit and loss statements and balance sheets going back a few years just to make sure there’s a consistent history of good cashflow. On the personal guarantee side, usually they’ll require a personal balance sheet and sometimes a tax return.
ME: What about lines of credit? When should a practice consider opening one of those, and what should it be used for?
JA: This is something I think practices should do preemptively. By that I mean just having a line of credit sitting out there. They don’t need to use it, but it’s always good to get one when you don’t need it. When you need it you’re going to have more difficulty procuring it.
Determine what amount you need—maybe three to six months of practice expenses. So if you run into a downturn, like with COVID, you have that to fall back on. What you have to be careful of is not using the line of credit as a way to spend more than the practice can afford. It should be used only for temporary shortfalls then paid back immediately.
ME: Were you seeing practices relying on lines of credit at the start of the pandemic just to stay afloat financially?
JA: Yes, and for those that had lines of credit it was very beneficial. Many of the practices I work with took out PPE loans, but those loans weren’t available immediately. Typically it took practices 3-4 weeks to get those loans in place after Congress had authorized them. In the meantime, for many practices their revenues just dropped precipitously. If you were an internist or pediatrician no one’s coming in for well checkups in the middle of all that.
So revenues dried up, but practices wanted to retain their staffs, and of course most had leases on their office space and that kind of thing. Many of the ones I work with did get PPE loans and most of those will be forgivable. But initially they needed that line of credit just to tide them over until they got those government funds.
ME: Is there a difference between a line of credit and a revolving line of credit?
JA: A revolving line of credit is what I was talking about before. You have it in place, use it if you need it, then pay it back. Usually there’s a term involved and typically banks are going to want to renew periodically because they’ll want to look at your income statements and balance sheets and make sure you’re still able to pay off the line of credit if they draw on it.
Sometimes a practice will have a line of credit that’s more for a special purpose. For example, a practice decides it wants to reconfigure and refurbish one of its offices and needs $100,000 for that. They’d go to the bank, get a $100,000 line of credit and draw on it as they’re doing the project. Once the project is over, it would turn into a regular loan with a certain payment period and the line of credit would go away.
ME: Is there an advantage to using that approach compared to just getting a loan?
JA: The advantage is two-fold. First, sometimes with a project you don’t know what the ultimate cost will be so that gives you a little more flexibility. You’re also only paying interest on what you’ve already used. A lot of times that can be preferable.
Now, it depends on the upfront negotiation, because banks may or may not be willing to set the terms of the ultimate loan 6 or 12 months out. So if you can’t get them to agree to a specific “five years at this interest rate” kind of term you might be better off just saying, “OK, this is the project, just go ahead and less us the $100,000 and let’s set the terms now.” Ultimately it just depends on what you’re able to work out with the bank.
ME: Are there common mistakes you see when practices seek financing?
JA: The biggest thing that gets practices into trouble is taking on too much debt. If a practice is growing rapidly and opening new offices and buying equipment and expanding their staff, that’s all great, but a lot of times they take on a lot of debt to do all those things because they don’t yet have the revenue to pay for it all.
So typically what you’ll see is a practice growing rapidly and using a lot of debt to pay for the growth, and then you have a downturn, or maybe one of the physicians becomes disabled. Any of those things could really put a dent in the expected revenue stream and that’s where you end up having a problem.
The other option is to pay for growth out of cashflow. For physicians the problem with that is it’s really coming out of their income. That’s the tradeoff.
ME: Has there been any impact from the pandemic in terms of practice financing?
JA: The situation was very dire for many practices initially, because their revenue streams were almost zero, and most of their expenses are fixed—staff, equipment and offices. Most practices do not keep a lot of cash on hand. That is why banks often ask for personal guarantees.
For many practices PPP (Paycheck Protection Program) loans were really critical. I had physician clients who said, “I never thought this could happen to me but I may have to close my practice.” It was gut-wrenching to watch them go through it. And the process of getting the loans was difficult and stressful. It highlights why you should have safety nets like a line of credit in place, because you just never know what’s going to happen.
ME: So far we’ve been talking about existing practices. What about new practices? Where can they go for financing to start a practice?
JA: Typically what’s going to happen in those cases is the bank will look at the individual applicant because there won’t be a profit and loss statement or balance sheet. Many banks have specific areas that deal with medical practices and physicians and will give them favorable terms because you’re going to feel pretty good as a bank that this is a viable entity.
I have seen instances of physicians starting practices using things like a home equity line of credit, which is very risky because this is really putting your own personal finances on the line. But typically it will be more a combination of your own capital and bank lines of credit.
ME: What about when it comes to deciding whether to buy or lease new equipment? What are the advantages and drawbacks of each?
JA: It’s a key decision that many practices face. If it’s a piece of equipment you’re going to be changing out every few years because the technology changes then you’re probably going to want to lease it. On the other hand if it’s a piece of equipment you think you’ll be able to use for five, eight, 10 years then you’ll probably want to buy it. Buying it can either be done outright with cash or you can get a loan from a bank.
The advantages of using a loan are that typically the terms will be a little better [than with a lease] and when the practice pays off the loan they own the piece of equipment and can depreciate it, which has tax advantages.
ME: If you lease, is that done directly from the manufacturer?
JA: Either the manufacturer will do the lease themselves or will have some sort of a financing arm that will handle the lease. And the lease is going to have an interest rate and term associated with it and a terminal value. So a practice may want to ask their financial to help weigh the tradeoffs of buying versus leasing, especially because there are tax considerations for each.
ME: Can any of the terms be negotiated?
JA: They can be. Particularly on the purchase side, depending on your credit history, and your relationship with the bank. Leases tend to be a little less so, but there may be some room to negotiate better terms depending on the size of the practice and the dollar amount of the equipment being leased.
ME: Going back to venture capital and private equity, why are they showing more interest in medical practices now, and what should a practice think about when considering whether to get funding or sell itself to one of these firms?
JA: The business model of private equity and venture capital companies is to invest in a business such as a medical practice, grow it, make it more profitable, then divest themselves of that investment, typically to another private equity or venture capital firm. The reason for increased interest in medical practices is that traditionally they have had very predictable cashflow, and that is very attractive to a private equity firm that is basing their decision-making on cashflow.
So they’re looking for practices with lots of free cashflow, that are growing, and where they feel they can help the practice grow faster by injecting additional capital and profit from their investment.