Jan 26, 2017
How to Get a Bank Loan to Purchase a Dental Practice
Written By: Brian Hanks
Buying a practice is, hopefully, something you’ll do just once in your lifetime and you’ll probably need to know how to get a dental practice loan to make it happen. Some dentists fear that, with how much they owe in student loans, they’ll never qualify for a practice loan.
The truth of the matter is, that if you’re a dentist with at least a year of experience, a decent credit score, and demonstrated ability to produce some dentistry – chances are good you won’t have a problem getting a loan.
But how do you make sure you’re getting the right loan? And how do you know you’re getting the best deal?
Your Lending Options and How Banks See You
Here’s the first thing to know about borrowing money to buy a dental practice: Banks think of dentists are a low risk loan. In fact, according to several bankers I’ve talked with dentists are very low risk. Dentistry is profitable and dentists nearly always pay back their loans.
For this reason, if you look at buying a healthy dental practice and you have a decent credit history, you shouldn’t have a problem getting a good loan. Whether or not you get the loan will all come down to cash flow. Does the revenue that the practice collects after paying expenses cover not just your personal debts but leave enough to live on?
There are no guarantees, of course, but generally the hardest part about the lending process is choosing which loan proposal to accept.
There are several banks that have dental-specific lending arms. These groups understand the unique economics of dental practices and lend accordingly. If you use one of these banks, you won’t have trouble finding someone to work with.
Because lenders change from time to time, and each region’s has different lenders who are better, Reach out to firstname.lastname@example.org for specific lending referrals
Using a dental-specific lender has several key advantages.
- Specialty- There are lenders who ONLY specialize in dental lending. Period. Those lenders know how a practice should run, and are your advocate if the deal works or doesn’t work. Lenders who don’t specialize in dental lending position the loan as a commercial loan. This can lead to hiccups as the cash flow and operations of a dental practice can look very different from other types of businesses.
- Speed – You’ll likely get a loan faster than working with a non-dental-specific lender.
- Amount – Dental-specific lenders typically loan a larger amount of the purchase price than traditional small business lenders. Currently, most dental lenders will lend 100% of the purchase price and will often lend more for working capital or purchasing the accounts receivable. this is typically based on the revenues compared to the purchase price. Lenders tend to go up to 85% of last years collections. Anything over that, the price of the practice is considered it is selling at a premium. More on this number below.
- Advice – Good dental lenders will know good practices from bad. They will be able to help you think through the pros and cons of your practice. They can provide perspective and connect you to other service providers who specialize in your type of transaction.
How Banks Typically Make You an Offer
When you’re choosing a lender it’s important to understand a few of the basics of how dental lenders are structured and how their process works. Typically, there is a separation between the sales and underwriting teams. The sales folks are usually the ones you’re talking with and the underwriters are often the ones who make a final decision on whether to lend you money.
That’s not to say that the sales folks don’t know anything and aren’t helpful. The opposite has been the case in my experience. The lenders who work on the sales side tend to be very helpful, quick to respond, and excellent at picking out what elements of a deal will be troublesome or problematic. Put your best foot forward when dealing with everyone at a bank.
Usually the process to get a practice loan will include three main steps:
- Application and document submission. Each bank will have a different application that will ask basic questions about the amount you are applying to borrow, your background, the practice, and your plans as the owner. A key step in this process will be getting tax returns and financial documents to the bank. Your broker, dental accountant, or even the seller can help with this step if needed.
- Underwriting. This is where the bank’s team of analysts will look at the key financial – and other data – of both the practice and you as the borrower. They put it all in their gigantic computer and see what pops out. In a very real sense, the bank’s underwriting team is performing your financial due diligence. Each lender has a different risk tolerance when it comes to underwriting. Some will do just a basic revenue/expense calculation. Others are more detailed in their analysis, and can give you feedback on the depth of the analysis. If one bank declines the loan and one approves the loan, more than likely the bank who declined the loan did a deeper analysis due to their specialty. Be very cautious about accepting a loan from one bank when another declines to lend.
- Phone interview. Usually the bank will have a member of the underwriting team get on the phone with you to talk about your background, history in dentistry, and goals as the practice owner. They’ll be looking for information on how you handle money, how much experience you are bringing to the table, and your ideas for business ownership. Again, put your best foot forward and be honest.
Be aware that there are the two types of loan proposals that banks give you. Even if you have a loan proposal from a bank in hand, you must know what type it is.
Approach 1: Quick & Unapproved
Some banks will get a written proposal on the table as quickly as possible. In this scenario, your deal has not gone through underwriting yet and the terms are close to what underwriting will approve, but not finalized. The key advantage to this approach is speed and your ability to show a seller than you can get financing. Obviously, the downside to this approach is that the terms on the page could change after underwriting looks at the deal.
Some lenders will provide you a verbal confirmation of a loan amount over the phone. This is not an approval. It is a sales pitch to get you in the door. A lender giving you a verbal pre-approval for $500k is not providing a blank check to then use to shop for a practice. (This is yet another area where buying a dental practice is very different from buying a home.) It’s entirely possible to receive approval for one practice at $750k, but get declined for a practice that is only $350k. Each approval is specific to the cash flow and economics of that one practice.
Approach 2: Slower & Approved
Other banks will get your info through underwriting, and make the first written offer the approved one. The main disadvantage to this approach is how long it takes to get you a written proposal to show the seller and make a plan for timing and expectations. But, you have final terms written down on paper, approved, and locked in. If you choose the lender that takes this approach, typically the deal can move very quickly after you commit.
It’s important to remember that slower is not always a synonym for “worse.” Remember that different banks have different underwriting standards. One bank can provide a quick approval, and another bank can ask for more information. A request for more information typically means that the underwriter found some items that could be potential issues. They are red-flagging items that could burn you as the future owner. As infuriating as repeated questions can feel, usually it’s in your best interest to remember the reason for the extra time is to protect your investment.
What Banks Look at When Deciding Whether to Lend
The bank has one real concern – are they going to get paid back? And how do they decide that?
I’ve asked a dozen different bankers what specifically their underwriting teams look at on dental lending deals, and they all answer with similar numbers: 60% of the decision to give you a loan has to do with the practice, and 40% of the decision has to do with you personally as the borrower.
60% of the decision – the Practice Numbers
On the practice side of the deal, the bank will look at the numbers below and feed them into the cash flow model. They’ll use this model to project how much money you’ll make as an owner of the practice you’re considering, and if you can afford to make the required loan payments.
- Collections – How big is the practice? Are collections growing or shrinking?
- Profitability – How much of each dollar of collections does the doctor keep after paying all the expenses of the business?
- Hygiene Production – What percentage of total production comes from hygiene? What percentage comes from new patients? Returning patients?
- Procedure Mix – Can the purchasing doctor perform the same procedures that the selling doctor performs? How much is being referred out?
How much can you borrow?
Generally speaking, dental lenders will lend 100% of the purchase price of the practice plus an additional amount for either working capital or money to purchase the accounts receivable. This is true at nearly every bank I’ve worked with with one crucial detail to take note of: the 85% rule.
Banks will rarely lend a total of 85% of the prior year collections to buy a practice.
Put another way, if a practice collected exactly $1,000,000 last year, and you’re buying the practice, the maximum amount that banks will lend you is $850,000 for the purchase price AND anything additional, like working capital, money to purchase the accounts receivable or to purchase new equipment.
The 85% number is definitely a rule of thumb, and generally the top limit. Practices should (always a dangerous word) sell for much less than that, on average. If you’re borrowing 85% of the previous year’s collections, you’re probably buying a premium, top-of-the-line practice.
40% of the decision – Your Creditworthiness
Now, over to the personal side. What specifically about YOU will the banks look at?
While the majority of the decision to lend you money will depend on the economics of the practice, you still have to have solid credit to get a loan for hundreds of thousands of dollars for no other reason than you have a dental degree.
First, the bank will run your credit. Make sure your credit score is 700 or above.
Second, the bank will look to see if you’re responsible with money. Their best proxy for that metric is to ask how much cash you currently have. A good rule of thumb of cash to have on hand is 8-10% of the purchase price of the practice you’re considering. If you don’t know the size of the practice you’ll eventually buy, shoot for somewhere between $25,000 and $50,000 of cash on hand. The bank probably won’t make you put that money into the deal (if you’re under that 85% threshold). They’re looking for a sense of whether you spend every cent that hits your account or not. This money is also a safety net in case that the during your first week of ownership your payroll, supplies, the electricity, and rent bills come due at the same time a pipe bursts. No business owner should buy a business without having a safety net.
Third, the bank will look at your production history. They will want to know if you have the hand speed and clinical skills to perform the dentistry you will be doing in the practice you’re going to buy. You do to show that you have already produced close to the amount of production of the practice you’re considering buying. But, the numbers will need to be close enough to tell a story as to why you’ll be able to get close to what the seller is doing. Get and keep track of your production reports for the last 6-12 months. If you don’t have them, ask your employer to provide them for your records. If you don’t know your specific production how are you going to know what size of practice you are going to buy?
What if you have a blemish on your credit history somewhere in the past – like a short sale on a home or something similar? What if you’ve been aggressively paying down student loans and don’t have much cash on hand? Never fear. Those rules of thumbs aren’t deal breakers. They will be black marks that you’ll need to have a good explanation for. If you know the question is coming, you can prepare accordingly and explain your unique situation.
How To Negotiate The Best Deal For Yourself with the Bank
In any negotiation, the person with the most options usually comes away with the better deal. The same is true when getting a bank loan to buy a practice.
If you can get approved from one bank, chances are that at least one more will give you a loan proposal. To get the best deal possible from a bank on your loan, get at least two offers from two different banks. Get written loan proposals from both. Then, ask your dental accountant to run the numbers and compare the two options. No two proposals will be the same. Each lender has a different reputation , parameters, fees, and terms. You need to consider all factors, including if that lender will work with your advisors to provide a smooth ride to the finish line.
I’ve never seen a bank lead with their very best offer with the first loan proposal. But, I’ve also never seen a bank offer a better rate without another bank’s offer on the table. Personally, I’d talk with at least two banks but no more than four. Any incremental benefit you’d see from talking with five or more banks gets negated by the fact that whichever bank you’re talking with knows that the likelihood of you choosing them gets lower and lower the more banks you entertain.
Don’t make the mistake of assuming that they’ll never know that you’re talking to multiple banks. Those credit inquiries are visible on your credit report. Plus, most of the bankers know each other and they run into each other enough to compare notes about who the buyers to avoid are. You’ll need bankers throughout your career. Don’t burn bridges.
When you do get the loan, be on the lookout for more than just the interest rate. Make sure you look at the term (how many years you have to pay back the loan), the prepayment penalty requirements, and any fees. Also, don’t forget to watch for any ancillary requirements like a mandatory requirement to use their bank’s checking account, for example.
I highly recommend using an experienced dental accountant through the negotiation process. If you work with someone with a track record, they’ll know what the bankers want to see, where they could perhaps give a little, and what differences between loan terms really matter.
Know someone about to buy a practice? Share this article with them! Or, have them reach out directly to me via email, email@example.com to help them through the process.
Read more below about dental transitions because good advice is important!
Four Things Your Attorney Should Do for You When Buying a Dental Practice
A Letter of Intent Should Include This When Buying a Dental Practice
Why You Should Buy a Dental Practice BEFORE Your Student Loans are Paid Off