In today’s world of dental practice sales, 99% of private, non-DSO, dental practice purchases are financed 100% by a bank. Of course, paying cash for a practice purchase would work very well, but unfortunately, most buyers don’t have the amount of cash necessary to purchase a dental practice outright. Financing is the most common way of purchasing an existing practice. Bank financing is fairly easy to obtain provided certain requirements are met. More about the specific requirements below but the important ones to note are:

• Good credit history for the buyer
• Adequate information from the seller so that bank can evaluate the loan risk
• The practice in question “cash-flows”
• All conditions to close are met

How Does Bank Financing Work And Why Are Banks Considered The “third” Partner In Any Dental Transition

While I cannot say the process of obtaining a bank loan for a dental practice purchase is always easy, it is always predictable. Once you accept the parameters under which banks must operate, you can work through the required steps. The first step is always for the bank to evaluate the buyer’s credit history, liquidity, and years of experience in owning and/or operating a dental practice the size of the proposed practice to be purchased.

Banks usually require that the buyer have been out of dental school and in private practice for at least two years with a history of personal doctor production being in the same range of that as the practice they are considering purchasing. These criteria are not carved in stone, but this is a good place to start. If a buyer is lacking in either of these areas, they should be prepared to make the case to the bank as to why they are still a good risk for the loan.

As the Seller, be prepared to give the bank a considerable amount of business financial information you would prefer not to share.  Business tax returns, practice production reports, Profit and Loss statements, as well as information on any debt that is secured by the practice will all be required by the bank. I usually tell sellers that this stage will be uncomfortable, but it is necessary to get a bank, any bank, to grant the buyer a loan. Simply put, if you want to sell your practice, you will need to provide the bank with whatever they ask for. Keep in mind that a bank is not able to share any of your information so, as far as humanly possible, your business information should be secure.

The actual loan application process is straightforward. The information needed is gathered from the buyer, and information about the practice to be purchased from the seller. Once that is complete, you can expect a preliminary approval, or denial, to happen within 3-4 weeks. I say preliminary because every approval will come with certain “Conditions to Close” that must be met for any practice sale to actually be completed.  Conditions to close mainly are items that the buyer must complete but occasionally require the seller to complete something as well. Examples of Conditions to Close for the buyer may be items like opening an office bank account, providing proof of any liquid funds they have, and obtaining life insurance or disability insurance. On the seller’s side examples of conditions to close may be to provide an updated Proft and Loss statement or proof that a previous practice loan has been paid off.

Most of the time, once preliminary approval is granted and the conditions to close have been met, the practice financing can be considered complete.

Sometimes, a loan may is not be approved. The number one reason for this is usually that the practice does not have “cash flow.”  What this means is that in the eyes of the bank, the practice is priced too high.  In other words, there is not enough profit left over once all the practice expenses are paid for the buyer to pay the cost of the debt service on the loan and still have enough money left over for an adequate salary to cover their living expenses.

It is difficult to quantify how much profit must be remaining once expenses are paid and it may vary from bank to bank and be predicated on the situation of the buyer. Most of the time when a loan request is denied, the problem comes down to the fact that the purchase price being too high to be supported by the practice profit. I know not many sellers or buyers want to hear that the deal they have painstakingly negotiated will not work in the eyes of the banks, but the banks use a very strict set of rules and ratios that must be met in order to grant a practice purchase loan.  From the bank’s perspective, if these rules or ratios are not met, then this makes the loan a much riskier proposition.  Remember that a bank is in the business to lend money and if they do not grant a loan, look inside the deal itself first for answers because I have found that most often when the bank does not grant financing it is not the fault of the credit worthiness of the buyer but has more to do with the structure and terms of the practice purchase and the sales price.  Also, if a loan request is turned down, you can try other banks but the problem that the first bank had with the loan will likely show up for all of the banks.

What Information Do Banks Require From A Buyer And Seller To Grant Financing

Each bank will provide its own list of requirements, but in general, the following information will be requested:

FROM THE BUYER:

• The last 2-3 years of personal tax returns
• A personal financial statement
• A list of all debt, personal and business, and the specifics of that debt
• A production report of the practice they are currently working in

FROM THE SELLER:

• The last three years’ business tax returns
• A Year-to-Date Profit and Loss statement of the practice
• A practice profile or summary sheet filled out that includes the specifics of the practice and the facility it is located in
• A list of all the debt that is secured by the practice with the specifics of that debt

Why Interest Rate Should Not Be The Most Important Criteria When Selecting A Bank If You Are The Buyer

The biggest lament I hear from bankers is that buyers are only concerned with the interest rate of the loan. While the interest rate is important, it seldom is the most important item for a buyer to consider.

Keep in mind that a loan for a practice purchase is rarely for more than 10 years. These loans are not like a home mortgage where over 30 years the interest amount paid can cost as much as the loan principal. You need to evaluate the entire cost and prepayment penalties associated with the loan. Also, look very carefully at any services you will be required to purchase from the bank. Credit card processing fees and other bank fees can often end up costing more than having an interest rate that is ¼% to ¾% higher. It is wise to evaluate the total loan costs before you choose a bank. I recently sold a practice where the buyer used a certain bank because it had an interest rate that was 0.1% lower than another competitor but, the bank fees were significantly higher. I calculated that the buyer would have to pay more than $500 monthly in fees over and above what she saved by the going with the bank with the lower interest rate.

One last point about loan interest rates. Big banks are almost always cheaper than local banks. Quite often I see where a local bank quotes a lower interest rate only to find out near the time of closing that the rate has increased or that the buyer will need to come up with significant cash at closing. I do not believe that local banks are deliberately being deceitful.

Smaller banks usually are not very experienced when it comes to lending money for dental practice purchases and this fact can lead to confusion on the part of the bank. This usually does not become evident until very close to the closing which makes it nearly impossible to work with another lender.  The moral is to use a big bank well versed in dental practice financing and if you still decide to use a smaller local bank verify and reverify the conditions of any loan approvals.

Should I Consider Seller Financing If The Bank Will Not Approve A Purchase Loan If I Am The Seller?

What happens if the bank does not approve a loan, should the seller finance the sale of their practice for the buyer?  I have to say that in my opinion, you should never do this. In today’s market, if the bank says no to a loan request, there is something wrong and you should think long and hard before agreeing to take on that kind of risk by becoming the bank.

There are two primary reasons why the bank will not grant the loan. The first reason is that the buyer is in some way lacking in creditworthiness. This might be due to some sort of benign reason such as lack of experience or not having enough liquid cash in the bank, but no matter the reason, the risk to the lender, you or the bank, remains the same. The bank has determined that they have concerns about the buyer’s ability to repay the loan. If the buyer has flaws in their credit history, why would the seller be the one to assume the risk that the bank would not?

The second reason the bank may not approve a purchase loan is that there is something wrong with the purchase price, usually it is too high in light of the practice profit. This is where a seller may propose to self-finance because they believe that if they agree to self finance they will receive the purchase price that they have negotiated with the Buyer. Again, if the bank says that the buyer may not be able to make the loan payments because there is not enough cash flow or the practice profit does not support the purchase price, why would you be willing to accept that risk? It may sound tempting because you will make more money for the sale of your practice. But think about this, how would you like to have to repossess your practice three or four years after you have retired because your practice buyer could not repay the loan you gave them? Not a pleasant thought but I have seen it happen more than a couple of times.  To be clear, never self-finance.

Dental practice financing can be confusing and frustrating at times, but if you understand the process, you can navigate this hurdle with a minimum of work and angst.  Remember to work closely with your transition specialist and your bank representative to ensure the loan process is progressing and the bank has received all of the necessary information.