Pick the wrong loan and you could be in a ton of trouble
Whether you’re buying a veterinary practice, refinancing commercial real estate or plotting a start-up, finding the right loan can be a long and arduous process. Plus, the borrowing landscape is constantly shifting, and choosing the wrong loan can have a lasting impact on your practice and cash flow.
The following are nine areas I believe all veterinary practitioners should consider when looking for the right loan for their practice. Some of this is basic business knowledge, but even the savviest practice owners may find tidbits as well.
1. Commercial, SBA and private loans
Banks typically fund commercial loans. Small Business Administration (SBA) loans are funded by the bank in partnership with the government. Private party loans are funded by an individual or group, like family or interested investors.
SBA loans typically require more paperwork and come with additional fees, or points on the loan, to keep the SBA up and running. However, they also offer a variety of packages for the riskier, unsecured business loans that veterinarians often require.
Private party loans are easier and quicker to pull off, but there’s a drawback to borrowing from family or friends. For example, looking across the dinner table at Dad, whom you owe $100,000, can be awkward.
2. Interest rate
This is often the most crucial component of a potential loan. Typically, there are two types: fixed and variable. The fixed rate remains stable throughout the length of the loan. The variable rate fluctuates based on outside factors (U.S. Treasury Notes or Prime Rate).
At the outset of the loan, the variable rate will be lower than the fixed rate, making it more attractive—but there’s the risk that the variable rate will climb higher over the course of the loan. A 4 percent variable rate could rise to 7 percent in a few years, depending on uncontrollable factors. The fixed rate, while higher initially, won’t fluctuate and provides what many borrowers prefer: peace of mind.
The term, or length, of the loan varies depending on what you’re financing and the risk involved. A smaller piece of equipment generally has a shorter loan term, typically five to seven years. Real estate usually has a longer term, about 20 to 25 years.
A longer loan term can be a two-edged sword. It means a lower monthly payment, which helps cash flow. But it also means more interest is being paid over the course of the loan.
4. Down payment
This is one of the biggest potential stumbling blocks to financing. Whatever the transaction, the loan is impacted by how much you’re willing to put down at the outset.
Depending on what you’re financing or whom you’re financing with, down payment can vary significantly. A real estate purchase may require a down payment of 20 to 30 percent, while a veterinary practice purchase may require no money up front.
Determining the right down payment often depends on personal cash flow and the need to keep a significant cash reserve. Some practitioners feel more emotionally secure with more money in the bank as a safety net; some need less. If an owner has a business credit line or home equity line of credit in place, he or she may be more willing to make a larger down payment.
5. Prepayment penalty
Lenders sometimes restrict how quickly the borrower can repay a loan. Too fast, and you may be subject to a penalty, which typically decreases the longer the loan stays active and disappears in two to four years.
Why? Lenders often package and sell your loans to outside investors. To make these packages more attractive, lenders want to guarantee cash flow generated by the loans for up to three years—thus, the penalty to you for refinancing or repaying these loans ahead of schedule.
A prepayment penalty limits the borrower’s flexibility, but in most cases, it’s a lesser issue and shouldn’t disqualify the loan for the borrower.
6. Balloon payment
Another technique banks use to help borrowers’ cash flow is the balloon payment. Instead of fully amortizing the loan—requiring equal payments over the length of the loan to ensure the balance is paid in full—a bank allows lower payments in exchange for a large payoff at the end of the term.
This loan requires a steady nerve by borrowers. Will they have enough money at the end of the term to pay off this big chunk of cash? Will they be able to refinance the balloon payment amount at similar terms when the time comes? It boils down to better cash flow now versus the chance of worse cash flow down the road.
7. Veterinary lenders
A lender who knows how to interpret veterinary practice finances will help your chances. Veterinary lenders have studied every type of practice, have seen every veterinary transaction and should be able to structure something best suited to you. Equally important, if they recognize that the loan can’t be done for whatever reason, they’ll tell you up front.
8. Collateral and personal guarantees
To complete the loan, what assets will the bank require to be held as collateral? If you’re buying real estate, then the land and building will be secured by a “first trust” deed. Similarly, if you’re buying a veterinary practice, all practice assets—equipment, goodwill, clients—will also be secured. But will the lender require anything else? Will the borrower have to personally guarantee the loan? Sometimes there’s no choice.
9. Hassle factor
Anyone who has borrowed before knows what they’re in for: mountains of paperwork and hoops to jump through. Don’t be afraid to ask your potential lenders about the process. How much documentation is involved? What is the approval process? Typically, the larger the loan, the further up the chain of command it needs to travel. Is there a loan committee that approves these loans? How often does this committee meet? What’s the turnaround time?
Assuming a smooth approval process, what’s the expected timeframe to get a loan completed? Though it can be difficult to define, a real estate loan typically takes longer because of the size and the need for an appraisal. An equipment loan can go much faster.
Borrowing can be a positive experience. It allows you to pursue a lifelong dream (buying a practice) or short-term financial goal (buying a new piece of equipment). Paying attention to these nine items will help ensure that the next loan is the right one for you.