Our thoughts . . . 04-10-08

I'VE GOT A SECRET - PART TWO!

The discussion in the last article was focused on the basics of a lender's cash flow analysis of a proposed practice sale. The bottom line was that if there was not adequate revenue remaining after the overhead had been paid and the producer received a living wage, the bank was probably not going to put their money at risk by making the loan. Whether it was from too little gross revenue, too much overhead or too much demand for salary, a lack of adequate excess earnings (somewhere between 12 and 15% of gross revenues) can easily kill a deal.

There are a couple of exceptions. The dental loan industry has been blessed with an extremely low default rate. Whether it be from careful lending practices, skillful business management, willingness of the buyers and their families to make sacrifices or just pure luck, the percentage of loans that have to be written off is apparently very low - I have heard as low as one half of 1%. I don't know if that includes occasional refinance to help lower payments but in any event that percentage is phenomenal! Lenders that understand the industry know that with reasonable caution, their money is safe. Experienced doctors with good track records and credit scores can borrow incredible amounts of money just on the strength of their signatures. Want to expand, remodel, upgrade or construct a building? No problem but what about the young doctor just getting started? Most of the time the request for acquisition funds will depend on our previously discussed cash flow models. I say "most of the time," because I am aware of loan programs for recent grads that will make available a sizeable amount of cash (more than $300,000) without that long track record of practice success. These loans can be used for both acquisitions and start ups.

Another area of exception involves doctors interested in practicing in smaller, rural communities. It is not unusual for a local economic development committee to put together financing packages for a practice, a building, or sometimes even the doctor's own primary residence in an effort to attract someone to come and practice in their town or county. These incentive packages can be in addition to other programs which can assist in paying off the doctor's student loan debts. These communities recognize that between the need for services and the track record of the dental loan industry that their money is well invested.

There is one last area of practice finance that I would like to make you aware of. I recently attended a reception for a retiring doctor put on by an experienced middle age doctor who bought and merged the seller's practice into his. After a little beer and barbeque to loosen everyone up, the local home-town banker that funded the deal approached me to let me know that if I had any more of these "practice buy-out deals" in his area to give him a call. A few months later I contacted him about a pending sale. I explained that the prospective buyer was two years out of school, had no cash and a negative net worth with more than $200,000 in student loan debts. In addition, the loan to asset ratio was about 4:1 and "oh, by the way" the buyer would need about $80,000 in operating capital and living expenses. The phone got very quiet before he finally told me that they would not be able to make that kind of a loan. He had confused his well established dentist/friend with out prototypical buyer.

The point is this: I never like to say "never" or "always," but this is almost always a never. Local lenders cannot usually make practice acquisition loans to young buyers. The banking system will just not allow it. They like to loan money on cars, boats, buildings and houses that they can go and repossess if the buyer defaults. It's really hard to repossess goodwill. These types of loans are sometimes referred to as character loans and have only a very small percentage of asset base. Even if the banker really likes you and personally wants to do the deal, don't be surprised if the "loan committee" decides otherwise. If they do begrudgingly make a loan offer, it will generally be at above market rates and a guarantor will be required. My advice is to stick with qualified lenders whose business it is to fund dental practices: the terms are fair and they won't waste your time.

Please don't think for a moment that I am down on bankers and lenders, because it is quite the contrary! Some of my closest and best friends in the dental practice brokerage industry are bankers. One of my sons has his own mortgage company. (www.wolffmortgagegroup.com) They are hard working, honest and truly strive to make an acquisition a good experience for everyone. Just be sure you are dealing with the right people and respect the work they do towards ensuring a successful transition.

Steve Wolff, DDS
UMKC Class of 1977