Practice Finance 101:
As a dentist, obtaining a loan is not something new to you. Most of your academic career has been dependent on the ability to finance your education and living expenses. However, along the journey of acquiring a practice, first time owners quickly find out that financing a practice is quite different and more involved than obtaining a credit based consumer loan.
Although the current and historical performance of the target practice is at the core of the underwriting process, a prospective Buyer should be taking the appropriate steps to prepare for the process of applying for a loan. There are many topics to discuss, but here are some initial tips to keep in mind when applying for a practice acquisition loan:
When to Apply:
The process of acquiring a practice starts with securing financing from a lender. Most Sellers understand that their prospective successors will need financing in order to purchase their practice. Per your LOI (letter of intent/offer), you will have a certain amount of time to acquire financing. Typically, a lender should not take longer than 7-10 business days upon receiving a complete package. The key word here is “complete”. Incomplete application packages will extend the time frame of getting an approval from any lender.
It's usually a good idea to obtain an approval prior to investing in your team of advisors. If you are unable to obtain a loan from a bank and have no other options to finance the practice, the investment made towards your due diligence may become a sunk cost.
The Application Process:
Nobody enjoys the process of completing a loan application, hence this step is often neglected and rushed with applicants providing minimal information. Most forms are broken into two parts, the credit application and the personal financial statement (PFS). The PFS is a snapshot of your finances (assets/liabilities) on that particular day. Your assets (e.g. cash on hand, real estate, etc.) demonstrate financial strength and your liabilities (e.g. student debt, mortgage(s), credit cards, auto, etc.) are crucial in our preliminary analysis when cash flowing the target practice. It’s extremely important that you are accurate when completing this area of the application.
If the initial information is inaccurate, lenders may misqualify the request with incorrect ratios when performing their preliminary review. The annualized payment on your liabilities is used in a bank’s cash flow analysis in order to validate that the practice has sufficient net income to support your practice and personal debt responsibilities (Global Debt Service Ratio). Lenders typically look for a Global Debt Service Ratio of 1.25x, which basically means we expect the practice to generate $1.25 of income for every $1.00 of debt both personally and against the practice. This calculation usually incorporates living expenses and projected taxes as well.
Liquidity (Cash on Hand/Marketable Securities):
Save, save and save!!! Paying off debt is always a good practice, but having inadequate cash reserves can be concerning to a lender. Your level of cash on hand may be an indication of your behaviors in managing your personal finances, but these reserves also mitigate risks of unplanned life events that may cause disruption in the production of your practice. It is important that you have reserves to fall back on for the “what-if” scenarios in life.
It isn’t expected that we see a significant amount here, but trying to work towards saving 5-10% in liquid assets is a good rule of thumb and would be viewed as a strength.
It’s key that you not only know your production ability as an associate, but that you’re able to properly communicate that to your banker. This assists lenders in their assessment on your ability to replicate the clinical responsibilities of the current practice owner. If your production report is not accessible, use a spreadsheet to keep a daily and monthly record of your net production. Make sure you clarify to your banker what your schedule was for the data you’re presenting. Producing $50,000/month on 5 days is quite different than an associate producing the same amount on 3 days.
Business Plans are never a requirement for a practice loan application, but over the years I’ve realized that it’s a good practice for prospective buyers. Forcing yourself to address on paper what the current state of the target practice is and how the practice will be managed post-acquisition help you visualize and plan for the future.
It also helps you communicate to a bank the value you will bring as the new owner. Although this information does not impact an underwriter’s financial analysis of the business, it gives confidence in the ability to lend capital to a doctor who has never owned a practice before. Don’t just focus on the positives of the practice as it stands today, but also the weaknesses, as that is your opportunity to provide insight on how you plan to improve the current operations. For example, perhaps the current doctor refers all endodontic procedures out and this is an immediate opportunity for you to capture unrealized income as the new practitioner.
There are many things to consider and manage when you’ve identified a practice to acquire and it can be a daunting process. Many factors for a successful outcome with the loan process are outside of your control, but hopefully this gives you some insight on the areas you do have control over that can contribute to a positive outcome through the underwriting process.
Vice President, Healthcare BDO
Citibank Healthcare Practice Finance