In the financial sense, there's may never have been a better time to start a new ASC. Thanks to Alan Greenspan, interest rates are at their lowest level in years. And thanks to vigorous competition for ambulatory surgery center deals, you have a number of borrowing options open for the build-out and equipment of your center. But the bad news is that you will have to do a little work to make your project attractive to a lender, and once you do, you will encounter a perplexing array of options. "There are all different types of products with all different types of rates," says David Pflueger, MBA, a consultant with Colorado-based Pluris. He adds that the stakes are high, as "interest can take up as much as 30 percent of total expenses on your P & L." Here are a few things to think about when you are ready to go borrowing for your ASC.
Before approaching a lender, get your house in order. You want to look like a can't miss proposition.
For any lender, you will need a feasibility/business plan. Since you likely will be borrowing more than $1 million for your new facility, realize that your plan will need to be thorough and highly credible, no matter who your lender is.
Anthony Knapp, a vice president with the Healthcare Enterprise Group of CitiCapital Structured Finance, says your business plan needs to include the following at a minimum:
- A monthly pro-forma profit & loss statement with a cash-flow projection for the first year;
- A beginning balance sheet with sources and uses of funds (see below)
Land and Building
- A one-to-two page executive summary that describes the rationale for and the scope of the project. The rationale should describe the reasons for the center beyond just making money; i.e., better service to patients, more efficient surgery, more control over staff, etc. Include market demographics if possible, and just stick to the facts; avoid the use of "buzzwords" like "conservative" and "synergy."
- A list of involved physicians, including their specialties and projected case volumes per physician. Include CVs, addresses and phone numbers.
- The resume of the developer, if you are using one;
- The structure of the partnership or corporation;
- A list of assumptions behind the P&L. Include expected reimbursements and disposable costs per case for each specialty;
- Estimates of fixed costs, the more detailed the better;
- A competitive analysis, including both hospitals and other ASCs;
- A realistic timeline.
Says Steve Jasiukiewicz, Vice President of Sales at DVI Financial Services. "A 12-page narrative with projections from the physicians' accountant is typically not enough." He says the most impressive business plans are done by developers with experience in the business.
Most lenders will want to see one to two years' tax returns from each physician. Some may want to see a P&L from each of the practices. Lenders will also be examining the credit of you and your partners; don't assume that just because yours is good your partners' is also. "Very often you'll have three guys who are great, one OK, and two who went through a bloody divorce and missed their last two car payments," says Mr. Jasiukiewicz. Ask each partner to investigate his own credit prior to applying for the loan. To the extent that it's possible, take care of any problems prior to applying. Know any other problems that may crop up on the report and inform the lender of them beforehand.
Realize that in almost every case, the lender will expect the principals to front at least part of the cost themselves. Ed Lawrence, of Philadelphia's First Financial Bank, says his organization might expect the principals to front 10 percent of the equipment cost, 25 percent of the leaseholder improvements, 20 percent of the working capital, and probably all of the "soft" costs like attorney and consultant fees. DVI expects the principals to come up with the working capital, which might be $500,000 or so in a typical two-OR center. Marcap's Terry Gill says his company might loan the entire amount "if the project is a home run," but he adds that most projects are "doubles and singles." Actually, it may be to everyone's advantage to have the physicians contributing money to the project, as it helps commit them to the success of the center.
Mr. Gill lists six items that he says make deals exceptionally attractive:
- An experienced developer. Even better if the developer will stay on as the management company;
- Lots of doctors in the deal. He says for a $1 to 2 million project, he likes to see 10 doctors in the deal, and for projects costing more than $2 million, 15 doctors or more.
- A per-physician investment of at least $40,000;
- Six months of operating expenses either covered with cash or borrowed from a bank against personal assets;
- Majority ownership by the physicians. "They are driving the income, and you don't want them saying (to a hospital or corporate partner) 'Hey wait a minute, you're getting all the money and I'm doing all the work.'" He says the physicians should own at least 60 percent of the center and ideally more.
- A break-even cash flow of 1.5 times case volume. "In other words, if the 10 doctors in the deal needed 200 net cases/ month to break even, they would need 300 cases on the books" to achieve the 1.5 ratio, Mr. Gill says.
Choose the right lender
Most physicians use their traditional bank for ASC borrowing. The big reason why is that banks will offer you the lowest interest rate of any other option. Banks will loan at 1.5 to two points above prime, which now stands at about 5 percent. Specialty lenders are typically 1.5 to 2 percentage points higher, and leasing companies perhaps two points higher than that. Banks will also be inclined to want your deal. "We like doctors," says Mr. Lawrence, "they have good cash flow and high personal income levels."
There are also disadvantages to using the bank, unfortunately:
- The bank will nearly always insist that you and your partners and possibly your spouses personally guarantee the loan. This means that if your ASC goes belly-up and you have to sell the assets, you personally will have to pony up the difference or the bank will help itself to your assets. A personal guarantee not only puts your assets at risk if the venture fails; it also may tie up your personal credit. Depending on the project, some other lenders may not insist on a personal guarantee, or may reduce the amount you must guarantee.
- The bank may not offer the flexibility that some other lenders do. For example, some specialty lenders will offer "balloon" payments and "skip" payments to ASC owners to help preserve cash flow toward the beginning of the venture. Manufacturers offer leases, which means that you won't have to make a payment until the equipment is installed. Sometimes they will lease it to you on a "per procedure" basis, more on which later.
Mr. Knapp feels banks may be the best option if you are doing the ASC with your own group and you all trust each other and are confident of success. He says physicians who are joining together from different groups often feel less comfortable with the personal guarantees and end up seeking a financial partner that will assume more risk. He also points out that even though a couple of percentage points may seem like a lot of interest, the difference may boil down to just a handful of procedures per month.
A couple of other notes:
- Banks will ask for a point or two to put the loan in motion, the same as with a mortgage. For example, on a $1 million loan, your up front costs will be $10,000 to $20,000.
- If you do use your bank, and you must agree to a personal guarantee, make sure it's a pro rata agreement rather than a "joint and several" guarantee, advises Mr. Pflueger. The former limits your liability to the amount of ownership you have in the center. In a joint and several agreement, you could be liable for a partner's share if the partner defaults.
Several companies specialize in lending to physicians and other entities who want to start up new health care facilities.
There are three big advantages to using these kinds of companies:
- They may be able to loan you the money without personal guarantees, or with your guaranteeing less than you would with a bank. Mr. Gill says his organization sometimes does deals with no guarantees, but other times requests that the doctors personally guarantee 20 to 30 percent of the loan amount.
- They may be able to structure the deal creatively. For example, says Mr. Gill they may be able to arrange a "skip payment" schedule to lighten the load up front (see table at left). "The second plan costs you $60,462 more," Mr. Gill says, but you preserve more than $200,000 of your cash during the first six months, when your collections will lag the worst.
- They typically will require less paperwork than will a bank. For example, a specialty lender may not need to see the partners' practice P&Ls.
A downside of using a specialty lender is that the cost is higher. Whereas bank rates typically may be only 1.5 to 2 points above prime, specialty lenders typically charge between 10 and 11 percent, says Mr. Jasiukiewicz (he says that with interest rates as low as they are right now, some companies may be willing to do a point to a point and a half better than that).
Also be aware that although these companies may not demand a personal guarantee, they may very well demand some type of guarantees. For example, they may want to subordinate partnership distributions; if you haven't made your loan payment, you can't distribute any profits. They also may demand first position on your accounts receivable, meaning that you will not be able to get a loan on these from someone else.
You may also be able to spread out your financing by leasing at least some of your equipment from a leasing company or from the vendor.
Leasing has several advantages:
- It is an excellent tool if your state requires a Certificate of Need and you need to build your center without spending more than a certain amount. This is because you can treat leasing as an operational cost rather than a capital cost.
- Like a non-recourse loan, leasing may help preserve your borrowing power. Some lenders also treat leasing as operating costs rather than long-term liabilities, making you and your organization seem like a better credit risk;
- Depending on the lessor "and type of lease, your downpayment may be minimal or non-existent;
- Payments don't need to start til you take possession of the equipment;
- You may be able to roll all your equipment into one lease and save a lot of paperwork headaches;
- Leasing can be more flexible than a loan. For instance, some companies, like Olympus, offer "capitated" leasing, where you pay for the equipment based on the number of procedures you do. Others, like Fujinon, offer "skip payment" options like the loans mentioned above. Some companies make part of your interest payments for you. Some fold maintenance into the deal.
- If you lease through a vendor, the vendor may be willing to negotiate on some aspects to get all ends of the deal.
Leasing also has disadvantages.
- It's usually more costly. Depending on the circumstances, you may end up paying a fraction of a percentage point more in interest to as many as six or seven points more. (Be sure to have your accountant analyze any lease carefully. Some leasing companies use foggy terminology that makes it difficult to compare costs).
- At the end of the lease, you must either turn the equipment in or buy it, typically at fair market value. This may be just fine for equipment that quickly becomes obsolete, such as some kinds of lasers, and for equipment that sustains a lot of wear and tear, like flexible endoscopes.
Just a few other notes on leasing:
- Traditional leases come in two versions. Full payout leases (sometimes referred to as long-term, financial or capital leasing) typically have extended terms and you purchase the equipment at the end for $1 or some predetermined percentage of the original invoice price. These are the least favorable types of leases from a tax perspective; you get to deduct the interest portion, but you must depreciate the asset as though you were buying it. Short-term leases (sometimes called operating leases) have terms that are much shorter than the expected useful life of the equipment. At the end of the lease term, the lessor typically re-leases or sells the item. These are better tax wise because they allow you to deduct the full amount of your lease payments from your tax bill in the year you made them.
- A relatively new phenomenon may work for some surgery centers. It's called "per procedure" financing or "capitated" financing. This is actually a lease, but it allows you to "pay as you go" so that your expenditures more closely match your income, an important factor early on in the life of an ASC.
Olympus, an endoscope supplier which also finances entire ASC deals, will provide "per- procedure" financing on the part of the cost represented by the company's equipment. For example if $500,000 of the cost of your center is Olympus equipment, the company will finance this part on a per procedure basis if you wish. This works in the following way: Olympus charges you, say, $50 per endoscopy procedure. Your center performs 250 colonoscopies in March, reimbursed at $323, for a total of $80,750 in reimbursement. You owe Olympus $12,500 for the use of the equipment. After deducting your other costs, the rest is profit.
There are several benefits to this arrangement:
- As long as you meet certain conditions, more on which later, the cost of the capital equipment remains completely predictable. It does not vary depending on the number of procedures you do.
- As with any leasing arrangement, instead of having to capitalize the equipment and write it off over a long period you can take the payments as operating expense.
- If you fold repairs into the capitated cost, you can also even out those costs. "In the beginning, service costs are low, but in mid life the cost goes up," says Olympus's Tom Sawyer. "What physicians may want to do is level out that expense." These kinds of deals have the same downsides as traditional leasing. In addition, you must meet a minimum number of procedures per month under these types of arrangements (in other words, you may owe Olympus $6,000 per month regardless of how many procedures you do). Another thing to consider is that such a deal eliminates any profit you might be able to realize by maximizing the life of the equipment.
If you do opt for a capitated lease, make sure you negotiate for a per case payment rather than a per procedure payment, recommends Caryl Serbin, RN, BSN, LHRM, with Surgery Consultants. She says a true "per procedure" deal might actually lose you money, because second procedures on the same patient are reimbursed at much lower rates.
As you can probably tell from this article, financing decisions can be extremely complex. Most of the experts with whom we spoke recommend making the final decision only with the help of a financial consultant.