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Financing medical equipment: Details matter

February 2014
By Lisa Wood, MBA Senior VP, Medical Industry Specialist, IBERIA BANK

No matter how large the medical practice nor how long it has been in business, there comes a time when expenditures must be made to utilize new technology, improve efficiency or expand capabilities – attention to detail can help assure the practice’s economic vitality and profitability.

The potential reasons for investing in a medical practice are many. Healthcare technology advances rapidly and equipment needs to be replaced. Office equipment and computer systems become outdated. Tests and services being referred to outside facilities can be handled more efficiently and profitably in-house. Or perhaps it’s time to expand the size and scope of the practice.

Whatever the reason, it’s likely financial arrangements will need to be made with a lending institution – preferably one with an understanding of the healthcare industry and experience in arranging loans for medical clients – to achieve a designated goal.

Banks evaluate prospective clients using a qualitative and quantitative analysis knows as the “Five C’s of Credit” to determine credit worthiness. The criteria are capacity, character, collateral, capital and condition, and were described in the December article in the Medical Journal-Houston. While discussing specific types of loans, we will assume that character, condition, and cash flow are adequate and focus on collateral and capital as it relates to equipment loans.

When applying for a loan, it’s a good idea to create a basic business plan and projections to spell out how the funds will be used. A solid plan that demonstrates revenue enhancement , such as practice expansion or the offering of new services, provides lenders more assurance that the loan will be repaid. Projections should be made to demonstrate the expected level and timing of increased revenues. This will help the prospective borrower and lender arrive at terms that are fair and equitable.

Timing is important because the revenue from new equipment may not generate cash flow immediately. Certain equipment may require lengthy installation or a training period before it is viable. The billing cycle can add 30-60 days (or more) before cash flow is received by the practice.

This should be anticipated and the structured into the loan agreement accordingly. The borrower and lender might agree to an interest-only loan for a specified period to accommodate the anticipated availability and impact of the new equipment on actual cash flow.

In many cases, the acquisition of new equipment can be made through purchasing or leasing agreements. It’s important to review your plans with business and tax professionals to determine what approach best suits your particular situation.

Leasing terms are often offered by the manufacturer, leasing companies and larger financial institutions. For big ticket items, it’s possible that the equipment manufacturer or distributor will be able to offer leasing rates that are more attractive than traditional bank financing. It’s also important to take into account supplemental expenses that might accompany the purchase of expensive equipment or technology. High tech imaging equipment might require highly specific building modifications or other installation fees – it is essential to include these in the financing agreement.

Leases typically come in two forms. Capital leases, like loans, cover the overall cost of the equipment. At the end of the lease, the borrower can “buy” the equipment outright for a nominal amount. There are potential tax advantages for depreciation that can benefit the borrower in this scenario as well. In both a sale and a capital lease, the equipment serves as collateral and is owned by the borrower at the end of the loan.

An operating lease provides temporary use of the equipment to the lessee for a period of time – often one to three years. At the end of the lease term, the equipment is returned or can be purchased outright for a price determined by the lessor. It’s much like leasing a car that one turns in every couple of years for a newer model.

The operating lease option can be particularly advantageous for medical technology that changes rapidly and must be updated for a practice to remain current. Old technology loses its value rapidly as new equipment surpasses it in capability.

It is important to understand that equipment has a reasonable period of effective use, known as its “useful life”. Useful life will play a key role in determining the term of the loan or lease. Financing should match up the useful life of the equipment with the loan term. When set up properly, equipment is still holding some of its value as collateral during the loan term. As an example, a reasonable person would not finance a laptop computer or tablet device for 10 years – that’s because such technology is likely changing every few years. A term of 3 years is more appropriate for a loan to purchase laptops and tablets.

Used equipment has already used some of its useful life. Loan terms for used equipment should be shorter and/or require a larger down payment (capital) from the borrower. Banks often require an equipment appraisal when used equipment is being purchased. The appraisal will give insight in to the remaining useful life.

The down payment, or capital, needed for an equipment loan will vary. Depending on the strength of the practice’s cash flow, loans can be made for up to 100% of the purchase price and installation of new equipment, requiring no capital from the borrower. Loans for used equipment can range from 50 to 100%. Pledging additional collateral can be an alternative to making a cash down payment.

When preparing a business plan for expansion, it’s also a good idea to conduct general research by talking to contemporaries and potential suppliers about special opportunities. At present, the U.S. government is offering stimulus money to practices to encourage implementation of new electronic medical records systems. The five-year program, currently in place, can provide an incentive of between $44,000 to $63,000 for every participating physician in the practice. Find out more at http:// www.cms.gov/Regulations-and Guidance/ Legislation/EHRIncentivePrograms/index. html

Incentive programs offered by government, manufacturers or special interest groups can “sweeten the deal” significantly for those who take the time to do the research.

Bankers and lending institutions are well versed in the potential benefits of business expansion. By working with business and tax professionals, members of a practice considering expansion or the addition of new equipment can determine how best to arrange a business transaction that serves the needs of the organization and fits within the parameters of the bank or lending institution of their choice.