Business financing is commonplace in today’s economy in order to provide steady cash flow. Most standard business financing is asset based; meaning that it is based upon advancing money up to a percentage of the accounts receivable that are deemed by the lender to be “eligible” (usually meaning not over 90 days aged, with not concentration in a single customer over 25%), together with financing of a percentage of current inventory at cost, and possibly durable equipment with residual value.
Unfortunately, medical practice financing is a lot more complicated due to the intricacies of both the types of accounts receivable and their collectability, and the lack of inventory as a base source for financing. In fact, Article 9 of the Uniform Commercial Code (UCC)[1] that governs secured lending by creditors and others who provide financing and others, separately classifies the “health-care-insurance receivable” from other accounts receivable. By the definition under the New York UCC, “health-care-insurance receivable” is an “interest in or claim under a policy of insurance . . . for health care goods or services provided or to be provided” (UCC §9-102(47)).”
The difficulty in financing health-care-insurance receivables is twofold. First, as most medical practices are aware, payment rates by insurance payors may be discounted by as much as 70% or more from the standard billing rate of the medical practice. Second, neither Medicare nor Medicaid receivables are deemed health-care-insurance receivables, nor may they be assigned to or made subject to lien in favor of a lender. Thus, significant value in securing asset-based lending is lost to medical practices. Therefore, securing financing is somewhat more complicated, but it can be accomplished both in the context of borrowing money to fund practice improvements or operations, or in offering a seller protection for the payment in the sale of a medical practice.
In the context of an ordinary small business loan for asset based formula financing, the institutional lender will require a note, security agreement providing a security interest in the assets of the business perfected by the filing of a financing statement under the UCC, and likely the personal guaranty of the principals, along with the regular delivery of financial statements, sometimes quarterly, but always annually. Assuming the loan is an asset-based revolving loan using accounts receivable and inventory (as opposed to a line of credit with a single cap) the lender will allow the borrower to maintain a borrowing base (for this example only) of 70% – 80% of eligible accounts receivable, and 50% at cost of current (i.e. not over 90 day) inventory. The borrower will be required to fill out and certify a monthly borrowing base certificate and will have an eligible amount to draw upon, up to a pre-set limit. Interest will be paid monthly, either drawn by the lender from the account of the borrower (usually lending banks require borrowers to maintain their accounts with the bank), or otherwise paid monthly. Equipment financing is usually done on a lease finance or amortizing loan basis, designed so that the residual value of the equipment always exceeds the balance of the indebtedness, with security also granted to the lender.
Medical practice loans are somewhat different. Although they usually include similar types of notes and security interest documents, guarantees and financial statements, they are much more often line of credit agreements, with no borrowing base certificates required. The amount of credit provided by the lender is based, most often, upon the medical practice’s historical and projected cash flow. The amount of the base and the method of collateralization is very different. First, medical practices (and lenders) should be very careful to make sure that accounts receivable are valued, for financing purposes, based upon their collectible value. In other words, if the standard billing rate is at $100.00 for a particular procedure, but the payable rate based upon the agreements with the insurance payor is $30.00 for that procedure, the lendable rate should be based upon the payable rate, not the standard billing amount, which may be reflected in the financial statements. In that way, the medical practitioner will not be over-borrowing, thereby causing a shortfall in available collateral and potentially creating an insolvency situation for the medical practice.
What about Medicare and Medicaid receivables? Many medical practices rely heavily on Medicare and Medicaid receivables as a significant part of the income of their practice. While a lender cannot lien or take an assignment of a Medicare or Medicaid receivable, there is a methodology which allows a medical practice to borrow monies on anticipated revenues from Medicare and Medicaid. In the agreement with the lender, the practice will be required set up a single bank account into which all Medicare and Medicaid receivables will be deposited as they are received from the government. The practice will also agree to allow the lender to sweep the bank account to pay interest and principal due, which will keep the line of credit open for further borrowings. The bank account, if not at the lending bank, will be secured to the lender through what is called a “Deposit Account Control Agreement” or “DACA” for short. The DACA was created by Uniform Commercial Code §9-104 to allow lenders to have a security interest in bank accounts which they did not otherwise control. Not only is the DACA process usable by a lender to a medical practice to collect Medicare and Medicaid receivables, but it is eminently usable to protect the interest of non-banking small business lenders as well.
As I stated above, small businesses and medical practices should be aware that in almost every instance, lenders who are financing the business, will require personal guarantees in conjunction with a loan. Interestingly, it is in the best interest of any guarantor to assure that the business assets including accounts receivable, inventory, equipment and/or health-care-insurance receivables are properly collateralized in favor of the lender, so that in the event of a default, or an adverse claim by unsecured creditors against the business or medical practice (even malpractice claims), the assets of the business or medical practice will be used to make payment on the secured debt, rather than have the guarantee called upon.
In many medical practices and small businesses, the equity holders decide to provide financing themselves. While you should always consult with your accountant to make sure you have adequate capitalization in the business or medical practice, often such self-financing takes the form of loans to the company. Many times, business or medical practice owners take out home equity loans to provide such loans. While this may seem to be a good idea in concept, because it provides an easy source of financing at a relatively reasonable interest rate, the mistake that most medical practitioners and other business people make is in their failure to protect themselves to assure the repayment on those loans. The best way to approach self-financing is to remember that you are the lender making a loan to the medical practice or business. If you are thinking of yourself as a lender, you will not only have a note, which calls for the payment interest in an amount equal to if not greater than the interest you are paying on the home equity loan, but you will also seek collateral protection in the same way any lender would. That would include obtaining a security interest in accounts receivable or health-care-insurance receivables and potentially executing a DACA with the borrower and the borrowers bank to control Medicare and Medicaid payments as well as any other receivables.
All the financing techniques and protections above are also applicable to the sale of a small business or a medical practice. Remember, as a seller of the assets of a medical practice or a small business, if you are agreeing to take payments out over time, you are effectively also a lender, loaning the buyer the money to purchase the medical practice or business assets. Therefore, you should make sure that you act like a lender; have a note, a security agreement, a guaranty from the buyer’s principal and any other reasonable protection needed to help protect your investment in the sale.
In every instance of financing, whether self-financing or financing through a lender, or on a sale of a business or medical practice, it is very important to consult with both your attorney and your accountant to make sure the financing is done correctly and your rights and money are properly protected.
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[1] Each state may have some variations in the provisions of the UCC, but most provisions are universal across the states.