Respecting the Process of Funding a Healthcare Business Project
When planning to develop a de novo center or fund a new expansion project for a healthcare business, owners need to understand that the financing process of the deal is extremely important, and that there are several options on the field, and areas to consider before pulling the trigger on a decision.
The Ambulatory M&A Advisor discusses some of the options to look at when deciding to fund a project privately, finance the project with debt, the advantages and disadvantages of these options, as well as common areas where physician owners tend to make mistakes.
Fund on Your Own or Finance?
Robert Greising, partner with Krieg DeVault says this question takes into account many variables that the business person is going to need to balance from return on investment type questions to control questions.
“Doing it yourself, you will be able to control the project yourself, getting financing from a bank allows you to control most of it but still sees some control to your lending source through covenants,” Greising says.
“Bringing in an equity partner brings into play a number of governance, transfer issues and other negotiable topics. Making that decision, you need to see if you have sufficient funds of your own, and whether the person wants to deploy their personal funds or whether it is a better financial decision to diversify the risk a bit and bring in partners through debt financing or equity partner of some kind.”
Peter Greenbaum, Shareholder with Wilentz says that when making this decision two thing come to mind, the first is, is there actually access to outside financing? Some projects are so speculative, in their infancy, or just not structured properly, that perhaps there is no market for outside financing, and thus, owners are left with the only alternative of funding it themselves.
“The other consideration is, if you have the ability to get outside financing, then it frees up internal cash reserves so that you can then use that cash on future projects that you would not have been able to think about had you financed the original project yourself,” Greenbaum says.
John Fanburg, Partner with Brach Eichler LLC says that on this topic, with regard to bringing on a partner for cash, depending on the composition, of the physician owner, it is not necessary because most centers are very successful.
Fanburg says there is some out of pocket cash, but once the deal is operational and moving along, because the equity participant is going to get returns on the investment, that money is not going to the doctors who are supporting it by bringing patients to the center.
“To me, I think physicians ought to own 100 percent when developing a center because they are the ones who are really going to make it successful. As result, depending upon what the cash needs are, I have no problem with recommending a funding source in the traditional financing process via the bank. The banks are paid back over a period of time, but they do not own any stake in the center,” Fanburg says.
Positives and Drawbacks in the Current Financial Market
“The healthcare sector tends to be very robust right now, though there is some degree of uncertainty with what is happening with Washington and whether there will or will not be reform. The environment certainly indicates that long-term needs for healthcare services will continue, so I would say that the financing options will continue to be available and they range from personal and banking resources based on the scope of the project,” Greising says.
“There are a number of healthcare lenders and national lenders who will oftentimes have a healthcare group that focuses on financing healthcare projects. Whether it is an ASC itself, a medical office building, or even hospitals, they are getting funded and the size and scope of the project will indicate the degree and complexity that you need to go to. A 50 to 100 million dollar project will be different than a 4 to 5 million dollar project.”
Greising says there is money available through public debt, there is private debt through the financial institution sector, then if owners are driven down to other equity facilities, they have private equity groups. There are quite a few PEGs that focus on the healthcare arena. Based on the nature of the project, owners will be able to find someone that has experience and interest in those areas.
As far as pros and cons, in any financing, there is the cost of funds. Debt funding tends to be at a lower long-term annual cost. Private Equity or venture funds tend to be on the higher end of things because they will want a significant multiple of their investment as an ROI.
“Cost is a big variable to consider, as well as governance control. Private Equity is going to want to have a say in what is going on, and sharing that vision is going to be a challenge for someone who has the vision; they may not want to share it completely,” Greising says.
“There are some timing issues; we are working on a project right now that a credit facility that is known as a mid-market tax credit, and that has an approval cycle of multiple months. It could even be a year if you have missed the deadline, because many places do it on an annual cycle. The biggest issues are cost, shared upside, and shared governance.”
Greenbaum says the first available option is always the self-financing option.
“I think the positive aspect of that is that you don’t need to answer to a theoretical partner. However, it then ties up your resources and you don’t have that cash to use for other projects. The other option is to go to the outside. I would say that in this healthcare climate, banks and Private Equity are becoming more willing to loan for healthcare projects. Many years ago, banks were just recognizing the upward potential of financing healthcare projects. Private Equity is now becoming more in line to that potential upside,” Greenbaum says.
“Now you have got both banks and Private Equity who are really interested in doing healthcare projects.”
When discussing the benefits of taking on debt to fund a project, Greenbaum says that when bringing on debt, there is a partner that the owner now has to answer to, but there is typically negative covenants and financial ratios in the debt document the physician needs to live by.
“You do have somebody that you need to answer to, but at the same time, you free up your cash-flow, and then you now have that freed up cash-flow to use on other projects,” Greenbaum says.
Fanburg says the pros of financing through a bank or other investor is it is less cash from the physician participants, but the con is, they are sharing the profits with an entity or individuals who are not supporting the business through volume and bringing patients.
“To me, I think the lesser of the evils is to get traditional financing through a bank or a lender,” Fanburg says.
Common Areas Where Mistakes are Made in Finance Planning
Fanburg says that the most common mistake that he sees in the process is trying to finance too much.
“I know the physician participants want to contribute as little as possible from a capital standpoint, but I think that there is a balance where physicians need to understand that they have made an investment, it is a serious investment, and in order to get a return on investment, they have to be supportive. It is the notion of having appropriate skin in the game,” Fanburg says.
“There is no dividing line of what that number is; it depends on all of the factors. You want physicians to be engaged and treat the process seriously, so they will be supportive.”
Greising says he finds that when people are starting a project, they underestimate several variables like the length of time needed, the cost, and implementation issues. A common mistake is assuming that it will happen quicker than it will, assuming that it will happen on budget, also, in the healthcare arena, the regulatory environment is something that is not fully understood by people that don’t have the experience.
Greenbaum says the first mistake is to not recognize that there is a natural billing cycle in the healthcare industry. If a physician sees a patient or perform a procedure today, they are not necessarily going to get paid within 30 days. Every payor has their timeline; some are quicker, some are longer. It is all about recognizing the billing cycle from actually seeing the patient, to billing, and actually receiving funds from the payor.
“Tied to that is failing to recognize the percent of the actual invoice that you will collect. If a physician does a procedure, they will not collect 100 percent of their invoice. It is making sure that you recognize and budget the amount that you can reasonably expect to receive from that invoice,” Greenbaum says.
If you would like to learn more about the concepts covered in this article, want to sell your business or discuss how Ambulatory Alliances, LLC might be able to help you out, contact Blayne Rush, (469)-385-7792, or Blayne@ambulatoryalliances.com.
If you have suggestions for future topics, email Blayne@ambulatoryalliances.com.