By Adam Cmejla, CFP®
August 8, 2018
Whether you are looking to finance a start-up, or purchase a practice, there are important points to remember. Here are tips for creating a business plan for your new practice, and a few keys to think about when attempting to secure loans.
Create a Business Plan
Lenders expect a business plan, and you will also want one for your self-interest, to make profitability more likely.
Editor’s note: Click HERE for a helpful tool from the Small Business Association to help you build your Business Plan.
Your business plan should be tied to your personal plan. I see too many ODs that succumb to the “more, more, more” mentality of thinking that they always need to be growing bigger, seeing more patients and adding more staff. While every practice needs to constantly work to bring in new patients, I would shift that line of thinking to first identifying the dollar amount that you need to make, so that you can enjoy the personal quality of life you aspire to. Then, you can focus on building a practice that supports that lifestyle.
For example, let’s say that you want to build a practice that nets you $200,000 in income (before taxes). And let’s say that our goal is to have a 28 percent profit margin. That means to net $200,000, we need to have top-line revenues (gross receipts collected) of about $714,000 ($200,000 divided by 28 percent).
From that number we can then “work the plan” to determine what we will need to generate that revenue based on the number of days you want to work throughout the year. Let’s assume you want to take three weeks off, and have a total of eight holidays throughout the year. That brings the total time out of office to 23 days.
There are a total of approximately 260 “normal” working days in the year (M – F), which means that you will be in the office for 237 days. Take your total days in office and divide that into your target gross revenue of $714,000, and you get an average daily production number of $3,012. Now you need to determine your average revenue per patient. Then you will know how many patients you will need to see per day to hit that target daily production number, and whether you will need to increase your revenue per patient.
Knowing this information and where you need to invest your capital (new equipment to increase revenue per patient, advertising to bring in more new patients, additional staff to help increase daily volume, etc.) can help bring clarity when determining how much you’ll need to borrow.
Strive for Fixed Interest Rate
As the business owner, all of your financial goals in starting a new practice are going to come down to monthly cash flow, and debt repayment is no exception. Your monthly payment on loans from banks or credit unions is going to be driven by three variables: the interest rate, the term (duration) of the loan and the amount borrowed.
While your term, and the amount borrowed, are typically a fixed variable from loan origination, the structure of your interest rate can vary. In an ideal situation, you’ll want to have a fixed interest rate, which means that the rate cannot change for the duration of the loan.
Your rate can also be variable, which means that the rate can reset on a pre-determined basis according to the current interest rate market. Given that the current interest rate market in the lending space are at historic lows, getting into a variable rate will typically mean your rate will be lower than a fixed rate right now, but has a much higher chance of going up when the rates reset.
Understand What 10-Year Rate Lock on a 25-Year Amortization Means
Another common note structure, especially on the purchase of commercial property and/or land, is a “10/25 structure”—this means that your rate is locked for 10 years, but the loan is amortized over a 25-year payment term.
After 10 years, your rate will reset and lock again for another pre-determined time period and the rate will be based off the current interest rate market. There is usually no cap on how high the interest rate can be—it will be competitive with the current interest rate market. However, the long amortization schedule gives you a lower monthly payment than if it was a fixed rate over a shorter, 10- or 15-year note.
How to Choose Between a 10-Year & 15-Year Rate Lock
First, let’s look at a side-by-side, hypothetical comparison of borrowing $600,000 for the purchase of the building where an existing practice is located. The table below illustrates only the cost of capital over the term of the loan; it does not include any additional lending fees that may or may not apply.
The advantage of the 15-year note is that you take interest rate risk out of the equation (because it’s fixed), you’ll be out of debt sooner, and your cost of capital (total interest paid) is much lower. On the other hand, your monthly payment is $1,265 higher. The inverse is true with the 10/25: monthly payments are lower, but the benefits of the 15-year option become risks and negatives.
You may be asking “What happens after 10 years if I have a 25-year note?” You basically have two options: the loan will “balloon” and you’ll be expected to pay it off in full or you can refinance the note based off the current interest rate environment.
If we were to assume that the interest rate environment caused your interest rate to increase 1.5 percent during your refinance in 10 years and also assume that you lock in the remaining 15 years on a fixed note, your new monthly payment will be $3,612. On the surface, this doesn’t look too bad: your monthly payment only increased by $160. However, just know that the total amount of interest that you paid over the duration of the $600,000 loan was higher:
• Total interest paid of $249,002.
• Total cost of loan (P&I): $849,002
• Interest Paid on first 10-year rate lock: $255,358
• Interest Paid on second 15-year rate lock: $245,504
• Total cost of loan (P&I): $1,100,862
Difference in cost of capital between two notes: $251,860
As you can see, this is where it’s important to have clarity in understanding the trade-offs between both strategies and weighing the consequences accordingly. Having a clear plan in other areas of your practice can help you decide which strategy is going to be best suited for your practice needs.
Adam Cmejla, CFP® is a CERTIFIED FINANCIAL PLANNERTM Practitioner and Founder of Integrated Planning & Wealth Management, LLC, an independent financial planning & investment management firm focused on working with optometrists to help them reach their full potential and achieve clarity and confidence in all aspects of life—personally, professionally, and financially. For a free copy of his “Top Five Tips to Financial Freedom” visit https://bit.ly/2Mo3NV8.