Raising Capital: The Proper Process
The process of raising capital to fund healthcare business is one that requires a sense of organization and finesse in a business plan. The Ambulatory M&A Advisor has already discussed the errors that could be made by a business owner attempting to raise capital. Find out now, the proper process for raising capital. Experts advise how to plan, some routes to take when raising funds, and legal advice.
Dave Finklang, tax manager with Anders CPAs + Advisors, who leads the firm’s start up and emerging company practice says that the first thing to consider when starting the capital raising process involves one of the biggest questions that people don’t ask but need to. Finklang says this is the question of why the physician owner needs to raise the money.
“Some people start a business and just think that because other people are raising money that they need to do the same,” Finklang says.
“They don’t really think about why they need it, what it is going to be used for, and if they really need to go out into the capital market to raise money. Very often they do need to, but there are times where operational changes could free up the cash flow that they need, or maybe the business doesn’t need to raise additional capital if it can hold out temporarily for a projected change in market conditions.”
Don Wienbren, attorney with Trenam Law says there are lots of issues that an owner has to think about in order to attempt to raise capital the right way.
“The first place that I would start in any of this is that health care is, if not the most regulated, one of the most highly regulated industries in this country. Both from a federal law and state law standpoint, because there are very few healthcare providers in this country that don’t take some kind of federal monies for the services they render; whether that be Medicare, Medicaid, Tricare, or the myriad of other federally sponsored healthcare programs,” Weinbren says that all of those federal laws carry with them a significant amount of regulation that limit the types of investor that a healthcare business can take in.
Typically, the law frowns upon a health provider selling interest in his practice to someone who refers business to the practice or to whom he refers business, Weinbren says. According to Weinbren, navigating these issues can be done, but there are significant planning concerns to ensure compliance with the law in that regard.
Weinbren says there are also tax issues that have to be considered in the capital raising process. This involves how the practice that the person is going to invest in is set up.
“Is it set up as a corporation? Is it an S-Corporation, is it an LLC? All of those questions are important, because many of the people out there investing in the healthcare businesses today are venture capitalists and others like that who invest through entities and not individually,” he says.
“The third thing that I think most owners of healthcare businesses have to consider is that governance of the entity is important. If you are giving up a significant portion of the equity in your business because you need that capital to grow your business, most investors are going to expect a significant amount of control over how
Russell C. Weigel, III, shareholder of the firm Hoffman and Weigel, PLLC, says that there are many ways to raise funds, but in the current market business owners often seek capital from private investors.
There are many considerations to be aware of if owners are seeking outside investors to participate through cash investment. Weigel says this is investment form of passive investment.
“Medical businesses may seek private investors who are not necessarily MDs, but these investors won’t be active participants in this business. These investors may be people in the community, friends or family, or other MDs in the profession who like what the business owner is doing,” Weigel says.
“If you are building a medical business in which the participants in the business such as other doctors are going to be active employees in the business and they are also putting in a capital contribution, then what they are doing essentially is creating a partnership style of business. The more physicians who are brought in, the more funds are going to be contributed to a common enterprise. They are all expected to participate at a significant level so they are in fact, acting like partners.”
Weigel explains that this is a scenario that is a very real one but does not have the same legal implications as seeking passive people to contribute capital has.
Finklang says that while raising capital, there are many different rounds one can go through.
Aside from institutional funding from big investors, Finklang says one of the most accessible is the friends and family round of funding.
“If you are looking to raise a smaller amount of money, or you don’t want to go out to the various Angel Investment Groups or Venture Capital Groups, a friends and family round, depending on your network, can raise a substantial amount of money,” Finklang says.
“This is typically the first place to start because you have to generally put less time into the investor due diligence process, since they are usually lending in part on your character, your background, and their relationship with you. They are going to put a lot of trust in you and what you tell them about the business. There is not as much leg work involved when you start with your friends and family.”
Finklang says that while there is less leg work involved, there is still risk when going the friends and family route for capital raising.
According to Finklang the biggest risk with raising money from friends and family is that they may not be sophisticated investors, accredited investors, or not as business savvy.
“I think most people go into an investment assuming it is going to pay off and make them a lot of money either by way of ongoing dividends or by way of capital appreciation. An unsophisticated investor needs to be made well aware of the risk of investing in a private enterprise or a growing enterprise. Investing in an upstart medical business could bea lot more risky than investing in Apple stock,” Finklang says.
Weinbren says that as an owner preparing to raise capital, it is absolutely critical to gain legal advice from an attorney prior to taking those first steps.
“Because of the regulations, you have to have someone who understands the laws, both in the state you are in, and the federal healthcare laws.
Also, if you are borrowing money and not selling an interest in your practice, there are rules that apply to what you are giving as collateral and how that works,” Weinbren says.
“The physician business owners would want to protect themselves even if they are just borrowing money and not just selling an interest in the practice. I look at law like going to the dentist. You don’t really want to do it, and it is painful.”
According to Weinbren, the time a business owner has the greatest leverage over someone who wants to buy their business or someone who wants to lend them money is really at the front end when they are negotiating the transaction.
“That is when it is most critical to have an attorney involved. Like Ben Franklin said, an ounce of prevention is worth a pound of cure,” he says.
Weigel agrees that soliciting for investment is a highly regulated activity and is one that requires significant legal planning in order to comply with legal requirements.
“We want to create a sound strategy so that capital can be raised with the least amount of bureaucratic red tape, but at the same time we want to protect the business and the entrepreneur individually from the investors by delivering a documented level of disclosure to the prospective investors so that they have fair access to the information material to their investment decision i and can go into the investment with eyes wide open,” Weigel says.
If you have an interest in learning more about the subject matter covered in this article, the M&A process or desire to discuss your current situation, please contact Blayne Rush, Investment Banker at 469-385-7792 or Blayne@AmbulatoryAlliances.com.