In every business, growth requires money. A small group practice is no exception.
Physicians need capital for a variety of reasons, such as acquiring an office building, purchasing an information system, financing new diagnostic equipment or making room for new physicians.
Regardless of the specific need, raising capital isn't a cakewalk. In fact, "the people who need the money the least are the most likely to get a loan. That's common sense, but it has to be said," says Joel Shalowitz, M.D., director of the Health Services Management Program at Northwestern University's Kellogg Graduate School of Management in Evanston, Ill.
Physician groups have three basic choices when it comes to obtaining capital: tapping retained earnings, debt financing (borrowing money) and equity arrangements (selling an ownership interest in the practice).
Greg Koonsman, a principal of Value Management Group, a healthcare consulting firm in Dallas, says retained earnings are the preferred way to finance growth-related investments. "One of the most powerful tools that a physician group has is the retained earnings that it can reinvest in the practice, which avoids their having to leverage their practice," he says.
When self-financing isn't practical -- as is usually the case with small physician groups -- a group can try to borrow money or enter into an equity arrangement. The biggest obstacle to borrowing money is convincing a traditional lender, usually a commercial loan agent at a bank, that a physician group is deserving of credit. Only a handful of lenders understand the business dynamics of a medical practice. Even fewer understand such day-to-day operating realities as waiting for reimbursements from insurers for lab work or how managed-care capitated contracts affect cash flow. Lenders also tend to be skeptical about the value of a medical group's collateral and the group's ability to repay borrowed funds.
Equity financing typically involves selling the assets of a practice -- laws prevent selling the practice itself -- to a hospital or physician practice management company. The only way to realize the equity value of the practice is to sell it on the open market. This way of raising capital has its own set of difficulties for small groups because traditional investors, like their lending counterparts, tend to be wary of businesses they don't clearly understand.
Also on the downside, equity arrangements often raise governance issues about who's in charge -- the doctors from the original practice or their new partners? The answer depends on the structure of the arrangement. "The more the investment looks like a loan, the less likely it is that there will be a governance issue. The more it looks like an equity investment, the higher the control and participation of the investor," says Dan Cain, principal of Cain Brothers, a New York City-based investment banking company specializing in healthcare financing.
Despite these many challenges, small groups can obtain financing from a variety of sources, provided they take steps to provide an attractive opportunity for a lender or investor. One step is for the physicians to educate themselves about the world of financing by reading and talking with other physicians who have been through the process.
Retaining a consultant might be helpful as well. "(Acquiring capital) is a business, and it often makes sense to use a professional who can short-circuit potential problems. (Principals) spend a lot of time trying to do it themselves, whereas an experienced intermediary knows exactly where to go," Cain says.
Groups that are serious about growth and independence need to think big when it comes to planning their long-term capital expenditure budget because many consultants are reluctant to work with clients who are seeking relatively small amounts of money.
"The rule of thumb is the more money you are looking for, the higher likelihood that you will get it," Cain says.
It sounds illogical, but financial intermediaries are much more excited about working on a percentage of a large transaction, he says, because they make more money.
It's also important to prepare a careful strategic plan that outlines the purpose of the needed funds and how the investment will generate additional revenue for the practice. "If you don't have a plan, you can't get from point A to point B because you don't know what point B is," Koonsman says. "The group has to come to a consensus as to what its long-term strategic objectives are. A lot of physicians have thought about it, but they haven't sat down and gone through the planning meetings."
Some types of capital investment are more attractive to lenders and investors than others. Cain says the top of the "hierarchy of needs from an investor's perspective" is a use of funds that results in collateral (e.g., an information management system or a medical building). Next comes a use of funds that generates additional revenue for the group (e.g., diagnostic equipment or a new service provider contract). The bottom of the hierarchy is a use of funds that results in neither collateral nor increased revenues (e.g., buying out a senior partner). "Anything that becomes a sunk cost is difficult to finance," he says.
Developing an ongoing professional relationship with a banker can help the group's chances of obtaining a loan, Shalowitz says. But even then, it's likely the physicians in the group will be asked to sign personal loan guarantees.
"Typically, the banks are going to require collateral either through accounts receivables or the (personal) balance sheets of the physicians," Koonsman says.
Another option is for a local hospital or a PPM to co-sign (or even directly fund) a loan to the group. "A lot of hospitals will help their medical staffs as long as they can get around the fraud and abuse issues, and (the financing) is at commercially reasonable rates. They're happy to do it because their return comes in loyalty to the hospital (and) admissions to the hospital. (That) is exactly what the government is concerned about, but it doesn't mean (a hospital) can't make a commercially based loan to a group of doctors and, if they admit patients to the hospital, that's terrific, but it can't be a condition of that investment," Cain says. "What often happens is the doctors go to the local bank and the hospital gets involved in the guarantee of that loan."
If an equity arrangement is sought, the group needs to identify investors who understand the business side of medical practices and, most likely, have a vested interest in the success of the group. Again, the possibilities include a local hospital or a PPM.
Remember that equity financing is always more expensive than borrowing.
"You pay your debtholders first, then you pay your equity shareholders," explains Shalowitz. "If you are paid last, it means your risk is higher, so you must demand a larger return (on your investment)."
A larger group or one that performs expensive procedures and has a well-established cash flow is better positioned than a smaller group to attract investors.
"A 10-doctor multispecialty practice probably (is) a bit small (for equity financing). A 10-doctor primary care group (that is) a real busy group with a large referral base may be interesting for a PPM," Shalowitz says.
Cain also believes the group's size and services matter. He says a group of five or six cardiovascular surgeons is more appealing to investors than, say, eight or nine internists or a multispecialty group. "It's not the number (of physicians), it's the creation of revenues that is important, he says.p>
Marcie Geffner is a Los Angeles-based freelance writer.