Along with $1,500 per scan reimbursement for MRI and lavish, oversized freestanding imaging centers, gone are the days of unknowing and unwitting lenders who only needed to buy into an entrepreneurial vision. Obtaining financing for a diagnostic imaging center today requires a lot more. Times change, circumstances change, and therefore the models of delivery need to change along with them. The goal of this article is to discuss financing of these enterprises and the related nuances of financing, some of which are new because of the changing realities, and some that are not new at all.
While financing the newer models (joint ventures, timeshare arrangements, and cooperatives) have some unique aspects, they share many of the same features with the models of the past. The answers to the following questions will help determine whether a planned outpatient diagnostic imaging service can succeed, and whether you can convince others, such as partners and lenders, that you have a winner.
What is your business strategy and why will the business work? This “hook” explains why patients will come to the new business enterprise. Just having the perceived best or differentiated equipment and the best service does not matter as much as it used to, although they are still very important aspects of a strategy. What does matter is the hook. Is the population growing in your market in such a way that a new service provider in the area just makes good business sense? Or have you partnered with a group of orthopedic physicians who have been referring out between six and eight MRI patients a day to a local imaging center and now want the convenience and financial benefit of having the service in or adjacent to their office? This latter approach is an example of the next new model, and there are plenty of variations on the theme.
Building the Business Plan
A good business strategy is critical, but success hinges on more than that. It is necessary to develop a business plan that is appropriate to the strategy. It is also necessary to demonstrate the ability to get the business up and running, as well as manage it for the long term. Partners will be required for some or all of those objectives. The approach must also be demonstrated to be within the bounds of the Stark legislation, and Fraud and Abuse and Anti-Kickback statutes, as well as any state-specific laws that impact the business plan (see Part I of this series in the July 2003 issue).
Integral to this part of the process is knowing what critical elements a lender will be looking for in the business plan. These include:
1. A cogent two- to three-page executive summary of the project outlining the ownership and ownership structure (including its legality), the key success factors (the “hook”) of the project, a top-level profit and loss statement, and a summary of the sources and uses of funds
2. If raising equity is part of the plan, some items that must be included are:
- number of shares or units for sale
- price per share or per unit
- the minimum and maximum investment size
- projected return on investment
- Other specifications must be made for which it is necessary to
- consult with a securities attorney.
3. The sources and uses of funds should clearly state how much equity is being put into the project by the owners, how much is being asked of the lender, and the use for those funds (equipment, leasehold improvements, working capital, and/or real estate)
4. The balance of the plan is expected to flesh out the details contained in the executive summary. Consistency between the executive summary and the full business plan is critical.
5. A description of the owners, along with their backgrounds and a summary of related experiences, absolutely is required. People lend money to people and experienced people can get it more easily and on better terms than inexperienced people: typically, the first deal will be the toughest, as long as your resources and ability to generate (or raise) cash remain strong and consistent.
A description of the ownership structure of the business is also important. Include a table of ownership. It will add clarity, especially if the structure features overlapping and intersecting partnerships or corporations (eg, equipment partnerships, real estate partnerships, operating entities). If a confusing and intricate structure takes too long to explain or figure out, a lender may suspect that someone is trying to hide something. A health care attorney is very important to this section of the plan, especially if it promotes a new delivery model. His or her description and rationale for the model’s legality are of paramount importance for selling the plan to potential lenders and potential investors.
Finance Sources and Uses
As noted, it is wise to include a clear and concise sources and uses of funds schedule. It should include:
- cost of the entire project
- how much of the source dollars for the project will be in the form of equity from the owners (lenders like more equity rather than less)
- how much money will need to be borrowed (lenders like to see a strong balance between equity and debt: the more equity, the less debt and that will result in the most favorable terms from a lender)
- what will be the uses of all the dollars (borrowed and invested) and how much will be used for each purpose:
- Pro forma financial projections in the form of profit and loss statements, cash flow projections, and balance sheets for a 3- to 5-year period, with the first and perhaps second year shown on a month-to-month basis (an opening balance sheet is always a good idea), are necessary.
- A discussion of the other features, attributes, and risks associated with the project, including:
- Any other key features or reasons describing why the project will be a success. An example would be a federally designated rural market that allows referring physicians to be investors in a project where they will derive a financial benefit in the form of profit distributions.
1. equipment purchases, both medical and nonmedical
2. leasehold improvements, if there will be leased space
3. real estate (acquisition of an existing building or purchase of land and constructing a new building)
4. working capital (lenders tend to like all or most of working capital to come from the owners as equity). Remember, working capital is the bane of any new business and you should never underestimate the funds required to meet that need.
1. demographics of the community, including growth projections, employment, household income, etc.
2. competition in the form of other like services and other providers in the service area
3. managed care and other third-party contracting sources, including a discussion of why your facility will be contracted with as a new service provider by these reimbursement sources
Once the plan is done (or simultaneous to its preparation), show it to some colleagues or other professionals who have written or had experience with business plans. The practice’s lawyer and accountant can be quite helpful, as can other trusted and respected businesspersons. Before going to a lender, be certain it is ready for critical review, and be aware that the financial sales officer is often less critical than the credit review officer, especially during the due diligence process.
After the business plan has been scrutinized and is ready to go to a lender, a number of routes can be taken to finance the project.
You can approach your local or regional bank, but do they have health care project lending experience?
You can approach the manufacturers and distributors that are supplying the equipment and have them arrange to finance their own equipment (and some will seek to finance your entire project). Multiple financing sources can be a big hassle to manage and control.
You can approach any one of a number of third-party finance companies and national banks that have demonstrated health care expertise and project finance appetites.
You can also work with a finance consultant who has established working relationships with many of the regional and national sources. They generally receive a referral fee from the ultimate lender, although other fee arrangement models exist.
Advice on this choice can be solicited from a lawyer, an accountant, or a management company. They often have very strong relationships with more than one lender and can leverage their overall activities to your advantage, especially given the depth of their involvement with your particular project.
terms and conditions
The world of financing, like that of medicine, has its own lexicon of terms and conditions. What follows is a glossary of the terms likely to be encountered during an attempt to finance a joint venture and some of the associated conditions.
Lessee or borrower. The entity that is requesting the funds is called the Lessee or the Borrower. This entity, by virtue of it being the borrower, is the guarantor, whether established, new, or set up for the purpose of this specific project. Some new entities (or ventures) can stand on their own, but many times, the lender will require other support for the transaction (in the form of personal guaranties and additional equity). Many people are fearful of personal guaranties and understandably so. However, there are ways to work with personal guaranties that can mitigate your fears and concerns.
Guaranties, corporate and personal. Depending on who or what the owners are to the lessee/borrower entity, those owners, including individual investors, may be required to provide a guaranty for the transaction.
Corporate guaranties may be acceptable to an owner of a lessee or borrower, but some of the same principles of limitation and release, as described immediately below, will apply here as well.
Personal guaranties can be limited in certain ways or can be as high as 125% of the amount being financed; they can also be collateralized or not. Here are some thoughts about what to expect and what to consider.
Personal guaranties do not always have to be for the full amount of the transaction and they do not always have to be collateralized. Depending on how much equity the owners are putting into the project (more about that later) and how much of the financing will be of a hard asset nature (equipment), you might well be able to negotiate a limitation to, perhaps, everything but the equipment being financed. Lenders look at items being financed outside of equipment as “soft costs” and that may be only 20% to 40% of the total to be financed. Lenders look more favorably at higher equity investment percentages. An arrangement can be made for each partner to be responsible for only their own pro rata share portion of the ownership of the project, meaning that your percentage of ownership would apply to your limitation. That is called a “several” guaranty as opposed to “joint and several” guaranty. In a joint and several guaranty, if you do become obligated to repay a defaulted loan or lease and one of your partners cannot come up with his or her pro rata share of the repayment, you will be responsible for their share as well.
In a collateralized guaranty, the borrower pledges some or all of their assets in support of the guaranty. Assets may include a home, savings and retirement accounts, stock in other companies, and real estate holdings. I have rarely seen the need to collateralize a personal guaranty, but it is certainly a measure of one’s commitment to a project. There are other ways to show commitment as well (see equity and working capital section below).
Be aware that some states have community property laws and some do not. You should know and understand the implications for you in your state. It is always in your best interest when your spouse does not have to sign a personal guaranty along with you, but you may not have a choice.
Further, some lenders will agree to releasing guaranties either in increments or in total over a period of time and under certain conditions. Typically, these conditions include the passage of time with a good debt repayment history and if certain financial covenants are met. One example of a circumstance under which this could occur is if the leasee/borrower demonstrates a cash collection history over your quarter consecutive period that exceeds cash outflow needs by 125%.
Length of Term. The length of the term of the loan/lease can vary, but the typical term is 60 or 63 months. However, the term can range as high as 72 (or 75) months or even 84 (or 87) months. The additional 3 months noted in each example assumes that a 3-month skip payment period starts the repayment term.
Repayment Terms. As noted, there is often, but not always, a “skip” period of no payments at the outset of a repayment period for a project. A longer skip period and/or ramp-up of payments helps facilitate the cash flow of the project. An example would be the first 3 months at $0.00 per month, followed by 1% of the loan/lease amount per month for another 3 months, and followed by 60 level payments. There are many permutations of this and they are generally designed to facilitate cash flow and to match your cash flow needs as projected in your business plan.
Interest Rates. Interest rates are charged based on a financial index (eg, term treasury rates, LIBOR, Swap Rates). Be careful to understand the index and the increment above the index the lender is charging. The ability to lock in an interest rate is unlikely before all funding has been completed and the lease is about to commence. The rate should float either up or down, along with all rates, until then. This protects you if the rate goes down and the lender’s profit margin if the rate goes upthat’s fair.
Capital lease (loan) vs an operating lease (fair market value or FMV). Although there are many more technical and financial differences, the chief difference is that at the end of a capital lease, you own the equipment, and at the end of an operating lease, the lender owns the equipment. From a cash flow standpoint, you spend more on a monthly basis for a capital lease, but you own an asset (hopefully, still usable) at the end of the term. An operating lease has monthly cash flow advantages and, in effect, protects you from technical obsolescence. But as in a car lease, at the end of the term, it is necessary to either buy (or refinance) your equipment at its then “fair market value” or acquire new equipment to replace what is taken back.
Equity and working capital. In many instances, a lender will require the owners of the project to provide the initial working capital as equity. If they do not believe that the amount of equity or working capital is sufficient, then they will work with you to increase one or both (including finding or requiring additional equity partners for your transaction, if you do not have the resources). There are two important points to be made here:
1. The more the equity, the better: guaranties can be for a lesser amount and the interest rates charged could be less as well.
2. Working capital lines of credit can be obtained from a local or regional bank or even from the primary lender involved in the transaction, but they will want either more personal guaranties (especially local or regional banks) or a pledge of the project’s accounts receivable.
Fees. The fees generally associated with transactions of this sort include the application fees, documentation fees, legal fees, and closing fees. Application fees should be refundable if your transaction is not approved or not approved on the terms and conditions as outlined in your original proposal. They should be kept by the lender if the transaction is approved but the borrower declines to move forward with them. Assuming there are other fees listed, they can often be negotiated and/or limited. Some lenders, depending on your track record with them or for competitive reasons, might eliminate or limit some of the fees.
Interim funding arrangements. This is a great feature, particularly for diagnostic imaging centers, as it really helps to conserve the borrower’s cash position for the start-up phase of the project. Assuming that the lender has agreed to finance the equipment and the leasehold improvements for the space, it will provide down payments to equipment providers (it will even reimburse you if you have already made down payments) and make progress payments to contractors. Some will even disburse the money for the borrower to arrange the payments. They usually charge interest-only on the amount you have used during the interim (interim being defined as before the full lease or loan commences).
The approval process
Once the borrower is satisfied with the terms and conditions, interest rate, and qualifications of a particular lender, the borrower/leasee signs the proposal letter and issues the lender a check to start the due diligence process. Virtually all lenders that operate in this market know how to do due diligence and will work with the borrower expeditiously to get the transaction approved, even if it does not always feel that way. A cooperative and thorough due diligence process is crucial: the more cooperative the borrower, the easier the process will be. It is incumbent on the borrower to know the project well and to express it succinctly and accurately in the business plan. In fact, it does not hurt to be conservative so that the lender’s due diligence results are better than your own projections.
Once approval has been granted and accepted, the documentation process begins. Be sure to have a lawyer well-versed in financial transactions. Once the documents have been finalized and signed, the interim funding can begin and the project can get under way. The scanning of the imaging center’s first patient usually triggers acceptance of the equipment and the lease or loan commences. The interest rate is locked in and the interest accrued from the interim funding period is often rolled into the transaction and the final monthly payment schedule is calculated. All you have to do after this is make sure your project works, you see the minimum number of patients you said you would see, collect more cash than you stated in your plan, and repay your debt without any missteps.
Financing the next new models is not much different than financing the old models, except that the new modelsthe new joint venturesrequire more careful and more creative planning. The “we will build it, they will come” diagnostic imaging centers of the past are just that: history.
Today’s business strategies need to demonstrate control of patient flow, business relationships that are consistent with federal and state regulations and statutes, assurances that insurance will provide reimbursement, provision of excellent services, and satisfied customers.
Robert S. Goodman, is managing partner, Goodman & Associates, LLC, a consulting firm based in Westampton, NJ, [email protected].