BANKS

Banks are the most common source of funds for new practice loans. Bankers are in the business of lending money to people who they think will repay it. So, a dentist must convince the banker that they will repay the loan (Box 6.2).

There are two types of banks, national and local. (Actually, it is a continuum between these two ends.) National banks are larger and often have an entire division dedicated to working with professionals, called “private banking.” The private banking section manages small businesses and other particular banking concerns. Large banks may have people within their private banking group who manage only professional (or even dental) practice loans. These people are knowledgeable about practice financing issues. The dentist may need to establish all professional (and often personal) bank accounts within the private banking section. However, it works well because the banker will know the dentist personally. On the other hand, local banks are variable in their understanding of dental office finance. Some small banks do not have private banking sections. Instead, the dentist may need to educate the banker about the specific problems faced by dental practices. (Bankers do not like to take risks they do not understand.) Many of these people are also knowledgeable and helpful to young professionals setting up their practice.

OWNER FINANCING

Many professional practices finance some portion of the cost through the previous owner. If a bank is unwilling to lend the entire amount, the owner may finance the remainder of the purchase price. The seller does this by allowing the buyer to pay part of the price over time to the owner rather than the lending institution. The seller will generally charge a comparable interest rate and require a promissory note detailing the loan terms. Owner financing carries additional risk for the owner over simply getting the total purchase price as cash up front. If the buyer runs the practice into the ground, becomes disabled, dies, or is unable, for any reason, to pay off the loan, the owner may not receive the entire purchase price. Generally, the bank will require a first lien position on all tangible (hard) assets of the practice, which means it gets to sell the assets to satisfy its loan first. So, the previous owner may be left holding an empty bag. This may be the only way the owner can sell the practice for the price they want. If so, the buyer can expect to pay the owner a reasonable interest (comparable to a bank rate) for the portion they finance. The buyer may need to finance the down payment through a bank and arrange the rest of the purchase price as owner financing to make the buy‐out work.

DENTAL SUPPLY COMPANY FINANCING

Most major national supply companies (e.g. Patterson, Sullivan‐Schein) have arrangements with banks or finance companies that allow a dentist to borrow money to establish a professional practice. There is an obvious advantage for the supplier (the dentist buys equipment and supplies through them). The advantage for the dentist is that they may qualify for financing through these organizations when they may not qualify at the local bank. The downside is that the dentist often pays a higher interest rate than they would at the local bank. The finance company may also have significant prepayment penalties and other disadvantageous loan clauses. The dentist generally must buy their equipment through the supply company as well. Some only finance new practices, not buy‐outs of existing practices. Others only offer to finance equipment purchases or upgrades. However, these companies know the dental marketplace, and if someone cannot gain financing through a bank, they may offer a method of financing the establishment of their practice.

FAMILY MEMBER FINANCING

Someone may be fortunate enough to have family members with sufficient assets to lend them for practice or personal needs. If this is the case, the dentist should structure the loan as an “arm’s‐length” transaction. This means that it is a bona fide business transaction, like someone else would negotiate at arm’s length or without the benefit of family ties. The Internal Revenue Service (IRS) considers family loans partly as a gift if they are not negotiated at arm’s length. This infers an actual interest rate and payback schedule.

A more common occurrence than an outright loan is when a family member guarantees the security of a loan by pledging assets or cosigning a loan for the young professional. Here, the family member has not provided the direct funds but has agreed to pay the loan cost if the borrower defaults and cannot pay.

MORTGAGE COMPANIES

Previously, the professional might have used a mortgage company primarily when purchasing a home, and they generally have not entered the commercial loan market. In the past several years, mortgage companies that cater to young professionals have emerged. They have found a niche in lending to professionals establishing their practices. Many of these clients have high student and other personal debts and do not qualify for traditional bank loans. They are still reasonable long‐term lending risks because of their high expected incomes. Traditional banks may be unable to lend money to these people because of banking regulations. However, finance companies are not under the same guidelines. They may charge a higher interest rate and include prepayment penalties that make these loans less attractive compared to a traditional bank. Despite these shortcomings, many young professionals use them as a source of start‐up financing.

SMALL BUSINESS ADMINISTRATION

The Small Business Administration (SBA) is an agency of the federal government whose charge is to help developing businesses secure start‐up financing. It does not provide the loan proceeds but instead guarantees the loan through a local bank or lending agency. Usually, two or more banks must have turned a person down for a traditional business loan. That person may then contact an SBA officer who may help arrange for financing. The SBA often will only guarantee a loan for a start‐up rather than a buy‐out (because the latter is not a new business). It typically requires substantial down payments that young professionals cannot make. There is a considerable amount of paperwork involved in securing these loans. Some banks will not work with the SBA. Because the federal government backs the agency, the borrower is subject to the whims and attitudes of Congress and other governmental bodies. Availability and rules change constantly. Some young professionals have found success in this source of loans; others have not. While worth investigating, SBA loans are not a common source for new practitioners.

SWEAT EQUITY

Sweat equity occurs when someone works for another dentist, taking less pay but building up an equity or ownership position in the practice. The employee dentist shifts the decreased salary to the seller, who takes the amount given up as additional compensation. They value the practice and develop an imputed loan (with interest, term, principal, and possible down payment). These arrangements occur more frequently in buy‐in situations. There are substantial risks for the owner–dentist in this arrangement. The purchasing dentist may decide during the buy‐in that they do not like or want the practice. They may not be able to handle the load. Alternatively, the purchaser might decide they do not need to pay extra for this practice because they can quickly start their own. Because of these risks, these arrangements are tightly structured (from the seller’s perspective), which leaves the buyer little room to change their mind. Box 6.3 gives an example of a sweat equity buy‐in.