Seed money: Getting the funds to grow a new medical practice

This complex process must start with plotting your needs then finding the best place to go for financing.

By Katherine Vogt, amednews staff. Dec. 15, 2003.

When Stephanie Mackey, MD, entered a bank and asked whether she would qualify for a loan to launch a new dermatology practice, the reply came almost immediately in the form of another question.

Before loan discussions could go any further, the banker wanted to know how much debt Dr. Mackey had from medical school.

Startup financing
See related content

Fortunately for Dr. Mackey, then three years out of residency, she had paid off her school costs and developed a solid business plan to prove to the bank that she could make enough money to repay what she wanted to borrow. She secured a loan of $70,000 and line of credit of $30,000 and was able to start her solo practice in Lancaster, Pa., a few years later.

Dr. Mackey is among the scores of physicians who have taken a financial risk to open a new medical practice. Whether starting a solo practice or collaborating with a few others, initial costs can tally hundreds of thousands of dollars in equipment, office space, employee costs and overhead. To pay those startup costs, most physicians need to take out a loan or use other financing strategies until the business starts earning money.

But the days of doctors getting money from a bank with a simple handshake are over. Now, with declining medical reimbursements, banks want more assurances that the money they lend physicians will be paid back. And with a variety of financing strategies available, like lines of credit and leasehold improvements, physicians have to do significant prep work to ensure that they can get the best deal.

"It used to be that doctors could go to the bank more or less informally and without much documentation and they could get a loan. But that's no longer the case," said Sherry Migliore, director of consulting for PMSCO Healthcare Consulting, a for-profit subsidiary of the Pennsylvania Medical Society. "They really need to do a financial feasibility study to get a feel for what they're getting into and because that's what the bank wants."

Developing a business plan

Physicians can develop business plans on their own, though many turn to consultants for help. Migliore said for an average fee of about $3,000, her firm helps physicians put together a feasibility study that includes financial projections for the practice for the first two years. It details anticipated revenue, productivity, payer mix, staffing needs and more.

"Then we look at all the other expenses involved with starting up the practice, rent, utilities, equipment, etc.," she said.

Once the overall analysis is complete, the physician should be able to determine how much he or she will need to start a practice. That figure varies widely depending on the medical specialty and location of the practice. Migliore said a family practice might require $150,000 in startup costs, while a radiologist's practice could cost twice that amount. The cost of liability insurance should be considered as well, she added.

Typically the next step is shopping for the right bank and comparing prices. Migliore recommends that her clients try three banks, including the bank where they have their personal accounts, before making a decision.

For Dr. Mackey, shopping for the right bank was at first a disheartening experience. Though largely free of school debt, she didn't have any money of her own to put into the practice. Some banks, figuratively, shut the door in her face. Ultimately, a small local bank agreed to give her a term loan using a life insurance policy as collateral. Having survived the experience, she now has some advice for physicians embarking on the same quest.

"When I found the right bank to work with, I thought [the process] was very simple. Don't get discouraged if a few shut the door on you," Dr. Mackey said. "And don't underestimate what you need. If anything, borrow a little more. You can always pay it back sooner. But if you're caught short, that can be disastrous."

Some larger banks have divisions devoted specifically to financial services for health care companies, including medical practices. They tout a kind of one-stop-shopping approach by offering everything from loans to equipment leasing. Consultants say these banks can offer good deals, but physicians should shop around before committing to use them.

Developing a financing strategy

Physicians also must choose the right financing strategies to best serve their needs. Among the most popular is the term loan, which can be used to pay for everything from equipment to payroll.

Term loans are simply loans that are paid out over a fixed period. Philadelphia health care attorney Walter B. Ferst said banks often will put a lien on the practice's assets or equipment to secure these loans.

"In my experience, they all also want personal guarantees, and they'll want them from the doctors and the doctors' spouses as well," said Ferst. "They may even want those guarantees secured by mortgages on the residences of the doctors. They want to make sure they get paid."

Ferst said an attorney should review any personal guarantee request.

Experts say a bank might be more willing to grant a larger loan if it is accompanied by a personal guarantee, which obligates the physician to the loan if the practice defaults on it. Jim Ambrose, the Milwaukee-based global general manager for GE Healthcare Financial Services, Equipment Finance, said the guarantees help banks feel more comfortable lending money.

"In many cases, lenders prefer personal guarantees because it's a moral obligation of the person," Ambrose said. "If they're not willing to put their personal backing with the loan, why is it that the lender should feel comfortable putting their money in?"

Along with the term loan, the bank may approve a line of credit for the practice. Ferst said term loans and lines of credit often come from the same lender. "It allows for cross-collateralization. You don't have to do it that way, but it's easier, cheaper [in terms of fees] and less complicated."

A line of credit -- which allows a person to borrow up to a certain amount, repay it and then re-borrow it as needed -- is often used to boost cash flow for a practice that is just starting. Because payments likely won't start coming into the practice for months, a line of credit can create liquidity that might not otherwise exist.

"There are always costs or unforeseen expenses that need to be countered when starting up a practice," Ambrose said. "You need to have working capital. You need to be able to pay vendors, and you need to have cash on hand."

Another way to pay for equipment, furniture and similar items is by using a financing lease, which Ferst likened to a car lease. The leasing company buys the equipment and leases it back to the physician. At end of the lease term, the physician usually has the option to buy. Equipment manufacturers may offer leases as well.

"You need to make sure you have the equipment and technology to be able to perform your trade," said Ambrose. "And very typically the way you acquire that equipment in the primary care ... space is through a dealer."

Leasing rates vary from vendor to vendor. Ferst recommended doing some price comparisons before signing up for a deal.

Physicians may also use leasehold improvement financing to pay for costs that will improve the value or usefulness of the facility where the practice is located. The strategy is well-suited for projects such as installing new carpet or structural renovations. Leasehold improvement loans may have a fixed term for repayment and a fixed interest rate, depending on the project. Ferst said these arrangements often are worked out with the owner of the facility.

The amount it costs to pay for each strategy depends on the lender and the loan itself. Ambrose said the cost of the financial service is mostly borne through the repayment of the loans, though there might be separate legal fees.

Each approach has different tax implications, so Ferst recommends discussing the possibilities with an accountant or financial adviser.

Developing a backup plan

But even with good planning and advice, financing a new practice is still based on projections and assumptions. When those are off, a new practice can be sent scrambling for money.

That is precisely what happened to Steven Brezny, MD, and his partner after they opened a family practice in Powell, Ohio, in August 2002.

After completing their residencies at Mount Carmel Medical Center, the pair put together a business plan, presented it to a bank and took out a loan. They also went to several leasing companies and got equipment and furniture. And they persuaded their landlord to finance a project to build out their office space. The total startup costs were about $300,000.

Everything seemed to be in place, and their practice opened. And then they started waiting for payments. And then they waited some more.

After three or four months, the money ran out. Dr. Brezny said they were forced to borrow money from relatives and start moonlighting doing urgent care. It took six months before money was coming in regularly.

Dr. Brezny, an AMA delegate, said he learned a lesson from the experience and now has advice for other physicians starting a practice. "Really secure or try to secure a credit line and also have a backup line for additional funds if that gets depleted." He added, "If they say you'll get paid in three months, double that. And if they say you'll get paid this much, cut it in half."

ADDITIONAL INFORMATION:

Startup financing

Term loan: A loan that's repaid over a fixed period.

Line of credit: An arrangement with a bank or vendor that allows a person to borrow, repay and re-borrow up to a certain amount.

Financing lease: An agreement with a bank, vendor or manufacturer that allows use of property over a specific period for a set price. The borrower may be given the option to buy at lease end.

Leasehold improvement: An improvement to a leased property that increases its value or usefulness. Financing arrangements for these improvements are often made through the property's owner.

Sources: Various financial experts and investorwords.com.